How does a home equity loan work for home improvements?

We are all unique human beings who change over time — and the same is true of our homes. Your house may have been perfect as soon as you moved in, but even if it wasn’t, your wants and needs will change as the years tick by and age your home. Updating your home is also a wise investment move, allowing you to grow your home’s value so you can reap the rewards later when you sell or borrow against the equity in your home.  

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Paying for home improvements is another story, however. Unless you have a significant amount of savings you’re willing to part with, you’ll need to obtain financing first — and when it comes to that, a home equity loan for home improvements is one of the best tools for the job. 

Should you use a home equity loan to renovate?

It’s a good idea to match your funding needs with the right financing method whenever you borrow money. Home equity loans are well-suited for major home upgrades and improvements because you’ll get access to a single infusion of funds that you can use to pay for contractors or materials right away. 

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Home equity loans also offer a nifty way to use your home’s value to improve your home’s value, as long as you’re careful to choose high-ROI improvements. That’s because home equity loans use your home’s value as collateral for the loan. When the work is done, your home’s value may actually increase, growing your wealth along with your satisfaction with your house. 

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In fact, the impact of this handy trick — using your home equity to further grow your home equity — is one of the reasons why some financial experts caution against home equity loans for other uses. That’s reflected by the data, too: in 2022, about two out of every three home equity loan borrowers used their funds specifically for home improvements, according to the Mortgage Bankers Association.  

Advantages

• Tax write-offs: You may be able to deduct home equity loan interest as long as the funds were used for “substantial improvements,” defined by the IRS as anything that “adds value to your home,” increases its lifespan, or “adapts” it for “new uses.”
• Lump-sum funding: Not all home equity financing offers a lump sum of cash upfront. A home equity loan does, however, and that makes it the perfect choice to pay contractors or other large one-time expenses as your home upgrade project commences. 
• Home equity growth: Thinking about your home purely as an investment, taking out a home equity loan can help you grow your wealth in the same vein as someone taking out a student loan to increase their wealth over time. 
• Home customization: A home equity loan can help you improve your home so you can stay in it comfortably for a longer period, particularly if you use the funds to remodel your home for aging in place. 
• Interest rate benefits: Home equity loans charge lower interest rates than some other home equity funding options. These rates are also fixed, so you don’t need to worry about your payment changing over time with the broader interest rate environment.
• Term length flexibility: You can choose home equity loans ranging anywhere from five years to 30 years. This allows you to closely dial in how long you want to spread your costs out over, which impacts your payment amount and interest paid.

Disadvantages

• Closing costs: Although some lenders waive closing costs, it’s fairly typical to pay between 2% and 5% of your total loan amount in the form of closing costs for things like home appraisals, filing fees, title insurance, etc. 
• Tighter budget: Making monthly payments on a loan is probably something you’re already used to, but it bears repeating: taking on any debt obligations means that you’ll have less money left over each month for other things or as a buffer for emergencies.
• Foreclosure risk: If you default on your loan, you can lose your home. You can’t always predict when you’ll run into financial problems, even if you’re sailing along smoothly today, making this the biggest danger.
• Negative ROI risk: Not all renovations are created equal. While some work comes with a great ROI and boosts your home’s value, some renovations can make your home too specific and more difficult to sell. 
• Qualification requirements: The requirements to get a home equity loan can be tough for many borrowers to meet, particularly if you have bad credit, an inconsistent income, or don’t yet have much equity built up in your home.  

How does a home equity loan work for home improvements?

There aren’t really any differences in applying for a home equity loan for home improvements as opposed to any other use of the funds, such as consolidating your debt or paying for college. Individual lenders may set different qualification requirements, but in general, here are the main criteria you’ll need to satisfy in order to get approved:

• Credit score: 620 or higher
• Minimum equity: 20% or more
• Loan-to-value ratio: 80% or less
• Debt-to-income ratio: 43% or less

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Once you apply for and receive your home equity loan funds, you can pay off your home improvement project or store those funds in your bank account for later as it suits you. No one will be snooping around and requesting receipts; it’s up to you to use the funds when and how you see fit. 

Tips for using a home equity loan for home improvements

Taking out a home equity loan may work just the same whether you’ll be using it for a new kitchen or a round-the-world cruise. Some special considerations can help you make the most of a home equity loan for home improvements, however. Here are a few tips:

• Check your household budget so you know exactly what you can afford for a monthly payment, and remember to leave in some wiggle room.
• Play around with home equity loan calculators to see how large of a project you can afford based on what you can safely pay each month. 
• Choose a high-ROI home improvement project if you can, such as installing a heat pump or replacing your garage door. 
• Gather quotes from contractors in advance to see how much your project may cost and how they handle payment.
• Calculate the amount you need to borrow for a home equity loan by budgeting an extra 10% for overages and surprise expenses. 
• Get prequalified for home equity loans to shop around for rates and check your approval odds.
• Apply for the home equity loan before you officially hire any contractors in case of any unanticipated application setbacks or funding denials.
• Have a Plan B ready in the future in case you run into financial difficulties and are unable to make your full home equity loan payments. 
• Consider whether another funding option may be more appropriate for your situation — while home equity loans are great in many cases, they’re not right for every homeowner. 

HELOC vs. home equity loan for remodeling

Best for: DIY remodelers and weekend warriors

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Home equity loans and HELOCs are similar in that they’re both made as separate debts against your home equity and have essentially the same qualifications. A HELOC, however, is structured as a line of credit that you can draw against for several years, to be repaid afterward during a repayment period. 

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Thus, a HELOC allows you more flexibility in when and how much you borrow, but it comes with an additional cost in the form of an unstable variable interest rate.  

Home equity investment vs. home equity loan for remodeling

Best for: Homeowners on a fixed income

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Rather than taking on a new debt, you also have the option to cash out a portion of your home’s equity with a home equity investment company. You’ll get access to home improvement funds today in exchange for a portion of your home’s future equity, with no monthly payments in the meantime. Many homeowners repay their HEI when they sell their home, build up enough savings, or take out debt when they’re better equipped to qualify for a good loan. Point’s Home Equity Investment comes with a flexible 30-year term, so you can repay your HEI when it makes sense for you. 

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An HEI can also be a more accessible option if you have bad credit – homeowners may qualify as long as their score is above 500. You’ll typically need to meet the same amount of home equity to qualify (i.e., have at least 20% equity).  As with other home equity products, you will need to pay various closing costs out of your funding proceeds, such as a 3.9% processing fee in addition to appraisal fees and other charges. 

Cash-out refinance vs. home equity loan for remodeling

Best for: Homeowners looking for a streamlined monthly payment

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A home equity loan allows you to take on debt solely for your home improvement project, but a cash-out refinance allows you to wrap all of your home loan debt together into one loan. When a lender approves you for a cash-out refinance, they’ll pay off your old mortgage and become your new lender for a larger loan, offering you the remaining funds as cash that you can use. 

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Compared to home equity loans, cash-out refinance loans often have lower credit score requirements and charge smaller interest rates. However, you’ll be lengthening the clock on your debt payoff timeline, and you may or may not save money in the long run once you factor your current mortgage interest rate and fees into the mix. That makes it especially important to use a refinance loan calculator to see what your monthly payment, debt payoff date, and the total amount of interest paid will be under your various scenarios. 

Reverse mortgage vs. home equity loan for remodeling

Best for: Seniors on a fixed income

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If you’re over age 62, you can also consider whether a reverse mortgage is right for you. Reverse mortgages work differently from any other loan type, so you’ll be required to undergo counseling during the loan application process.  

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Like a home equity investment, a reverse mortgage doesn’t require monthly payments, making it useful if you don’t have a regular income. You’ll be required to pay various fees that can add up to several thousand dollars and pay off your first mortgage, although you can roll these costs into your reverse mortgage. Your loan balance on a reverse mortgage will grow over time and can make it difficult or impossible to leave your home to your heirs, but there are special provisions to help your family after you’re no longer there. 

FAQs

How long does it take to get a home equity loan?

It depends. Most home equity loans take between two weeks and two months from the time you apply until you have the funds in your account. Some lenders are able to move much quicker than others, particularly if they can do remote appraisals and your application file is in order. 

Can you get a home equity loan with bad credit?

It may be difficult or impossible to get a home equity loan if you have bad credit. You may be able to overcome this hurdle if you have an excellent income, a low debt-to-income ratio, and can find the right lender, but you may still have to pay higher loan costs. 

Is it a good idea to use a personal loan or credit card for home improvements?

It depends. Many people prefer to use a personal loan or credit card to fund home improvement projects, particularly if they’re not very costly, they don’t want to risk losing their home if they default, or if they can’t qualify for a home equity loan.

Final thoughts

Taking out a home equity loan for home improvements is one of the best possible uses of this funding method, especially if you opt for a high-ROI upgrade. Not only will improving your home help you enjoy it even more, but you’ll also be growing your wealth at the same time, too — a powerful one-two boost to anyone’s health and wealth. 

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In order to ensure you have the best outcome, however, it’s a good idea to take a measured approach to borrowing money, especially when it comes to your home. Make sure to calculate your loan costs in advance, explore whether other funding options may work better, and have a backup plan in place in case you run into financial snags in the future. 

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If you think a Home Equity Investment might be a better fit for your needs, see how much home equity you can unlock without monthly payments today.