At some point in their lives, most homeowners want to renovate their homes to improve their quality of living and use the home, their biggest investment, to its full potential. Whether it is a kitchen remodeling, or building a deck, home renovations tend to be large expenditures that a monthly wage will usually not cover, but a loan will. To finance these home renovations, homeowners can tap into their home’s equity and use it as collateral to get a loan. Because of the benefits it offers, a Home Equity Line of Credit is an attractive alternative to doing this.
What is a HELOC?
A HELOC, or a Home Equity Line of Credit is a type of loan that lets you access your home’s equity. Your home equity is the portion of the house that you own and have already paid for. HELOC serves as a line of credit where you can borrow every time you need to up to a borrowing limit set by the lender. HELOCs typically have 2 periods: the draw period and the repayment period. You are allowed to draw as much money as you need only during the drawing period. Once it expires, you can not draw anymore. Then you only pay for what you borrowed during the repayment period. This schedule makes HELOCs more appealing to other loans such as home equity loans where you get a one-time lump sum payment, because with HELOCs, you can decide how much you need to borrow during the process of renovating.
Prior to deciding on getting a HELOC to finance your home improvement, you can use a HELOC calculator to check how much you would be able to borrow depending on your home value and your outstanding mortgage balance.
HELOCs for Home Improvement: Pros and Cons
HELOCs are one of the most popular sources of funding when it comes to home improvements. If you are considering using a HELOC, it is important to understand the benefits and drawbacks that it presents.
Pros
- You can borrow as much or as little as you need and you only have to pay back what you borrowed
- HELOCs typically offer lower interest rates compared to other financing options such as personal loans or credit cards
- If you use HELOC for home renovations, you can get tax deductions on your interest payments
- HELOC can offer you the option to make interest-only payments during the draw period
Cons
- HELOCs have variable interest rates, which depend on a benchmark index, such as the prime rate affected by the Fed funds rate set by FOMC. This means that if interest rates go up so will your monthly payment
- Since you can borrow as many times as you need through a HELOC, you might run the risk of taking more than you need and waste money along the way
- It requires you to have at least 20% home equity
- By using your home as a collateral, you are facing the risk of foreclosure if you fail to make the monthly payments
Mortgage Refinancing
An alternative way to fund home renovations, is to use cash-out refinancing. Through cash-out refinancing, you can use the equity you have built in your home (in other words, the portion that you own and have already paid for) and use it to refinance the existing mortgage into a larger one. The difference which is taken in cash can be used to pay for your home renovations.
However, there is a limit to how much you can borrow using cash-out refinancing. You cannot take out all your equity in cash, as the lender usually requires leaving typically 20% of the equity in the home. After this and all the other closing costs, what is left is given to you in cash.
Why renovate?
There are two main reasons why homeowners choose to renovate their homes.
First, home renovations increase the quality of living of the house’s residents. You can always either remodel your home to increase its functionality and provide you with the optimal comfort and convenience. For example, for individuals who value space more than anything else, tearing down the right wall can have a major impact on their comfort while living in the house. Others might value outdoor areas more, such as the front porch. Redoing the porch in a way where you can use it and enjoy it can drastically improve you and your family’s quality of living.
Next, home renovations can significantly bump up your home’s value. Even if you are not thinking about selling your home, increasing its value can have several benefits, such as how much you can borrow in the future using it as a collateral. For example, a house with a finished basement is worth much more than a house with an unfinished basement, because of the extra living space that it offers.
In conclusion, whether you choose to use a HELOC, cash-out refinancing or other funding alternatives, home renovations present many benefits for you, your family and the home’s value. Depending on your home equity, outstanding mortgage and your spending habits, make sure to compare your financing options, the repayment plans they offer and choose the one that will cost you the least in the long-run.
Article Submitted By Community Writer
