Building equity in your home is one of the great advantages of being a homeowner and accessing that equity when you need it is even better. So when it comes to home improvement and house repairs, what’s the best way to tap into your home equity? For homeowners who have seen a big jump in the value of their home in 2020, you have a lot of options. This short article breaks down the benefits and drawbacks of using a Home Equity Loan vs. HELOC (Home Equity Line of Credit) for home repairs and renovations.
Home Equity Basics
Home equity is the financial difference between what you owe on your home (your mortgage balance) and the value of your home (based on a formal appraisal). For example, if your current mortgage balance is $478k and the current market value of your home is $680k, then you’ve got a little over $200,000 in home equity.
When you want to access the equity in your home, most lenders will only approve up to 80% of your home’s value. This allows for market fluctuations in property value and lowers the risk of foreclosure in the eyes of the lender. In the example above, the 80% Loan-to-Value maximum would be $544k, giving you potential access to $65k.
How to Use Home Equity Funds: Home Renovations, Repairs, and Remodels
To decide if a home equity loan or home equity line of credit might be a good fit, it’s a good idea to figure out how you want to use the funds. A few popular updates are:
- kitchen remodels
- bathroom remodels
- new roofing, siding, windows
- major landscaping & backyard improvements
- home office additions
Since both a home equity loan and a home equity line of credit are big financial commitments, take time to consider the value of the improvements you want to make. Renovations don’t necessarily have to improve the value of your home but they will work to your benefit if they do. Both loans are designed to help maintain and improve the value of your home. Ideally, you want to increase your property value in the process. If you need to sell your house for an unexpected reason, you won’t be upside down when it comes to your mortgage.
Home Equity Loan Advantages
Home equity loans are almost always fixed-rate loans with set terms, fixed monthly payments, and a fixed payment schedule. When you’re approved for a home equity loan, you get the full amount in one lump sum. Then you pay off the loan in fixed payments over the life of the loan.
Highlights and Advantages:
- A low interest rate that is locked in for the life of the loan
- Fixed monthly payments which make it easy to budget and plan
- Lump-sum disbursement so you can start a big project right away
- No limitation on the use of funds
- The interest on your home equity loan may be tax-deductible
Worth noting: higher credit scores mean lower rates. Check for prepayment penalties in case you decide to pay it off sooner than scheduled, or if you might want to refinance later.
Home Equity Line of Credit (HELOC) Advantages
Home equity line of credit operates like a revolving credit account. Instead of having a set payment schedule and a fixed rate, HELOCs give you access to a line of credit with a maximum limit. You can use the funds at any time and you won’t accrue any interest until you draw from the account. HELOC’s have a set draw period (typically 10 years) and a variable APR which is based on the prime rate and market trends.
- Access as much or as little money as you want to meet the needs of your projects
- Interest only accrues when you access the funds
- Repayment terms are flexible, pay it off or make minimum monthly payments
- Use the funds for whatever you want
- The interest on your HELOC may be tax-deductible
Additional Resources for Home Renovations
Home equity loans and HELOC’s are both set up as a second loan using your home as collateral. If you don’t want a second loan, or you want to refinance your mortgage and take advantage of other financing options, you’re not alone. A few other options to consider:
- Fannie Mae HomeStyle Renovation Loan
A conventional home loan that wraps everything into one mortgage: purchase price (or mortgage balance), repairs, updates, labor, and materials.
- FHA 203(k) Home Loan
A government-backed home loan to purchase a fixer-upper or refinance a home loan to cover major repairs or renovations. One mortgage will cover the purchase price (or refinance) plus the costs of all upgrades and repairs.
- VA Renovation Home Loan
The VA renovation home loan is a government-backed mortgage with exclusive benefits for active-duty service members, veterans, and eligible spouses. It rolls the cost of the mortgage plus the cost of repairs and upgrades all into one home loan
Each of these renovation home loans has various requirements and limitations for loan approval. Talking with a mortgage expert can help decide which options will save you the most money and help you reach your financial goals.
If you’re thinking about tapping into the equity in your home, talk with an experienced mortgage advisor. A great loan advisor can save you money and keep the process moving easy and stress-free. Just knowing what to expect can help you decide the best action to reach your goals. When it comes to saving money on your mortgage, we can help.