Using a Home Equity Loan for a Remodel: What to Know Before You Borrow

Look around your home. Are there a few things you'd like to repair or upgrade? Maybe a kitchen refresh, a room addition, even a new roof? If so, a home equity loan could help you make it happen. 

A home equity loan for a remodel offers a way to access your equity in cash, using your home as collateral. You can borrow a lump sum and pay it back over time with interest; rates are typically fixed, so you get the benefit of predictable monthly payments. 

How does it all work? Let's look at how a home equity loan for renovation works, and what you need to know before you apply.

Can You Use Home Equity for Remodeling?

Yes, you can use a home equity loan for home improvement projects and plenty of homeowners do just that. Using home equity for remodeling means you don't have to drain your cash reserves to pay for repairs or upgrades. You could also gain more equity in the long run if the renovations you make boost your home's value. 

You might be a good candidate to get a home equity remodel loan if you:

• Have a decent amount of equity

• Know what you need to borrow to complete renovations

• Have a steady income and good credit

• Prefer a fixed-rate loan with predictable monthly payments

Using home equity for remodeling could be less attractive if you're worried about long-term job or income stability. A home equity loan, whether it's for renovations or something else, is a second mortgage. So you'll have to be reasonably confident you can handle two mortgage payments for the long term. 

You may also decide to hold off on a home equity loan for renovations if rates are more than you want to pay right now. Home equity loan rates can go up or down; it all depends on how the Federal Reserve handles interest rates. If your reno project isn't something you need to do right now, you might hold off on applying until rates drop. 

Other ways to use home equity

You might be focused on using a home equity loan for remodeling. There are even more ways to put equity to work. For example, you could get a home equity loan to:

• Consolidate credit cards or other debt

• Pay medical bills

• Cover emergency expenses

• Pay for a large planned expense, like a wedding

• Fund education costs for yourself or someone else

Each option has a different return on investment. The only one that can positively impact your home's value is using a home equity loan for remodeling. 

How a Home Equity Loan Works

Home equity loans enable you to access your equity, or the difference between what your home is worth and what you owe on it, in a lump sum. You repay a home equity loan alongside your original mortgage, typically at a low, fixed interest rate.

Here's an example of how a home equity loan for remodeling might work.

• You want to overhaul your kitchen and replace the flooring throughout your home, so you apply for a $50,000 home equity loan.

• You're approved for the loan at 8%, and choose a 15-year repayment term.

• You receive the funds from the lender and use it to pay for materials and supplies to complete your reno projects.

• Each month, you pay the lender $477.83 for your home equity loan, until it's paid off. 

A home equity loan calculator can help you estimate what you might pay before you borrow. You can experiment with different loan terms, amounts and rates to see what works best for your budget. 

Loan terms may last anywhere from 5 to 30 years. A longer term lowers your payment and increases the total amount of interest you pay; a shorter term increases the payment and reduces interest. 

Is a Home Equity Loan a Good Idea for Remodeling?

A home equity loan could be a good choice for remodeling if you know how much you need to borrow to complete your projects, and you want to borrow at a low, fixed rate. Home equity loans take the guesswork out of planning your monthly budget since the payments don't change. 

Using a home equity loan for remodeling is a good idea if you:

• Can qualify for the lowest interest rates

• Have 20% to 25% equity in your home

• Know how much you'll need to complete your renovation projects

You could use a credit card for renovations instead, but that has its drawbacks. Credit limits may be lower, and rates are often higher. Instead of a fixed monthly payment, you're only required to pay a minimum amount, which means there's no set end point to pay off the debt. 

Pros and Cons of Using Home Equity for Remodeling

Before you get a home equity loan for renovations, look at the big picture. How does it benefit you? How could it work against you? Here's a quick look at the pros and cons of using home equity for home improvement to help you decide if it's the right move. 

Pros

• Fixed payments can make it easier to budget for longer-term or more expensive remodeling projects. 

• Home equity loan rates are often lower than credit card rates or personal loan rates. 

• You have flexibility in deciding when and how to spend home equity loan proceeds. 

• If you use a home equity loan for remodeling only, you could write off the interest you pay on your taxes. (Talk to a tax pro to learn more)

Cons

• If project costs change, your original loan amount may not be enough to cover it. 

• Home equity loans reduce your equity and increase your monthly debt payments.

• You could lose the home if you default on your loan. 

Home Equity Loan vs. HELOC vs. Other Renovation Loans

You could get a home equity loan for home improvements, a home equity line of credit, a cash-out refinance loan or a personal loan. 

• A home equity line of credit (HELOC) is a line of credit that typically has a variable interest rate. You borrow during an initial draw period, and make interest-only payments. Once the draw period ends, you repay the amount you borrowed, plus interest. 

• A cash-out refinance replaces your current mortgage with a new, larger one. You withdraw your equity in cash at closing. 

• Personal loans let you borrow a lump sum of money you can use for virtually anything. Rates are fixed and you don't need any collateral to qualify. 

Each one could help you cover renovation costs. Here's a quick comparison of the options.

How Much Can You Borrow With a Home Equity Loan?

Typically, you can borrow up to around 80% of your home's value, minus what you owe on your primary mortgage. Lenders use your combined loan-to-value ratio, or CLTV, to decide how much to lend. CLTV is the total amount of home debt you have divided by the market value of your home.

Here's how to gauge the amount you could borrow with a home equity loan:

• Estimate your home's value (online real estate valuation sites can help with this step)

• Check your most recent mortgage statement to find your current balance (or call your lender to confirm)

• Multiply your home's estimated value by 0.80 and subtract your mortgage balance

The end number is how much you might be able to borrow with a home equity loan. Here's an example of how the math works out. 

Say your home is worth $500,000 and you still owe $350,000 on it, here’s the simple math:

$500,000 x 0.80 = $400,000

Next, subtract your mortgage balance:

$400,000 - $350,000 = $50,000

You might be able to get up to a $50,000 home equity loan for home improvement. Your actual home equity loan amount is determined by your equity, credit, income and debt. Your choice of lender also factors in, since eligibility and qualification requirements can vary from one lender to the next.