Should You Use a Home Equity Loan or Line of Credit for Remodeling Improvements?
- July 28, 2018
- Posted by: Kimberly Goodwin, PhD
- Category: Home Equity
Styles may not change as quickly for home design as they do in fashion design, but over time, your home can start to look like it needs a makeover. Not only do styles change, but preferences related to your home’s functionality also change.
For example, homes today integrate technology in so many ways, from automating your shopping list to generating solar power to warm your house. In addition, flooring, appliances, roofing, and all the other components of your house can wear out over time and need to be repaired or replaced. So, remodeling can be a good way to bring some life back into your home.
Remodeling can be a good lifestyle investment as well as a good financial investment. Before you start to remodel, however, do some research to evaluate the cost against the potential value the changes can add to your home.
Some remodeling projects, such as bathrooms and decks or patios, traditionally add much more value than the cost of the remodel. Other projects may not add any value to the home at all. Then, determine if a home equity loan or line of credit will be a good way to finance your remodeling improvements.
Home Equity Loan for Home Improvements & Renovations
A home equity loan lets you borrow some of the money you have built up as equity in your home. The lender provides a lump sum at closing and you can pay the loan back over a period of around 10 to 15 years. Since the home serves as the collateral for the loan, you can borrow at a relatively low interest rate. Lenders typically charge borrowers slightly more than the current mortgage interest rate on a home equity loan.
Changes to federal tax laws in 2018 altered the rules for deducting home equity loan interest from your taxes. Homeowners can still deduct the interest paid on their home equity loan, but only if they use the proceeds for remodeling projects. So, you have the added benefit of a federal tax deduction.
The only drawback to using a home equity loan to finance a remodeling project is the additional risk it adds to your home. The home serves as the collateral for the home equity loan, so you could lose your home if financial hardship prevents you from making your home equity loan payments.
Home Equity Line of Credit for Home Improvements & Renovations
A home equity line of credit offers homeowners many of the same benefits as the home equity loan. Homeowners can borrow against the equity in their home at a low interest rate because the home serves as collateral for the loan. Lenders usually charge a variable interest rate that is just slightly higher than current mortgage interest rates.
Rather than providing a lump sum at closing, however, lenders give you an open line of credit that you can use as you want. You can take the maximum line of credit at one time, pay down the balance, and use the credit line again. Alternatively, you can use smaller amounts as needed.
Despite the federal tax law changes, you can still claim a tax deduction for the interest paid on your home equity line of credit as long as you use the proceeds for a remodeling project. Just as with the home equity loan, the line of credit also puts your home at risk if you can no longer make your monthly payments.
Using a home equity line of credit to fund your remodeling improvements is relatively inexpensive and has unique tax benefits, but you should always consider the risks associated with having your home as the collateral.
How to Tell if Remodeling Is a Good Investment
If you are concerned about whether or not a remodeling project is a good investment, do some research. Remodeling Magazine publishes an annual report about the cost versus value of different home improvements.
You can look at the data on the national level as well as the specific data for your region of the country. You can also look at the differences in cost and value based on the quality of the remodeling project by evaluating low-range, mid-range, and upscale improvements. For example, an upscale garage door replacement had a 98.3 percent return on investment.
Local real estate agents can also be a good source of general information about remodeling projects. They will be able to tell you what buyers are currently looking for and what they might be willing to pay for a remodeled home.
Alternatives to Consider for Remodeling
You might also consider using credit cards or personal loans to finance your remodeling improvements. When you use a credit card, you don’t have to go through a lengthy application process in order to get the money for your remodeling project. The interest rates, however, may be around three times higher than those on a home equity loan or line of credit.
Most borrowers can’t get as much credit with a personal loan as they can with a home equity loan or line of credit. The interest rates on personal loans are usually lower than they are on credit cards, but home equity interest rates are still much lower.
If you use a personal loan to finance your remodeling improvement, you do not put your home at risk if you can no longer make the payments. You do, however, miss out on the extra federal tax deduction.