How to Use Home Equity for Renovations & Home Improvements

Paying down your mortgage helps you build equity in your home—equity you can then use to pay for home improvements and repairs. 

Upgrades like new floors, a renovated bathroom, or an extended deck can help boost your home’s value and make it more appealing to potential buyers down the road. So what about using your home’s equity to fund these upgrades?

This guide will cover home equity loans for remodeling —how they work, when to use them, and which one to choose.

How does equity work on a renovation loan?

Home equity is the portion of your property you truly “own.” It’s the difference between your home’s current market value and the amount you owe on your mortgage. For instance, if your home is worth $300,000 and your mortgage balance is $200,000, your home equity is $100,000.

Lenders use terms like loan-to-value (LTV) and combined loan-to-value (CLTV) to calculate your home equity and determine how much you can borrow.

• LTV is the ratio of your current mortgage balance to your home’s value. In the above example, LTV is ($200,000 / $300,000) = 66.67%.
• CLTV includes the total of all loans secured by your house. If you want a home equity loan, lenders add the amount of that equity loan to your current mortgage to calculate CLTV. For instance, if you want a $30,000 home equity loan, your CLTV would be (($200,000 + $30,000) / $300,000) = 76.67%.

“The LTV measurement is used first to determine if you are eligible for a home equity loan or HELOC,” explains Erin Kinkade, CFP. “The CLTV is then used to determine how much you can borrow if you qualify.”

The required LTV percentage ranges among institutions and lenders, but it’s typically 75% and 85%, says Kinkade. 

“I suggest you determine the LTV accepted by the institution and lenders by comparing your current servicer and others to ensure you qualify,” she says. “It is also important to note that the equity in your home can fluctuate based on the current fair market value of your home.”

Evaluate home improvement financing options

There are three primary types of equity-based loans you can use for remodeling: 

• A home equity loan is often called a second mortgage. It’s a separate loan on top of your existing mortgage. You receive a lump sum of money upfront, which you pay back over a fixed term with a fixed interest rate.
• A home equity line of credit (HELOC) works similarly to a credit card. You have a credit limit you can borrow against, repay, and then borrow again. The interest rate is usually variable, so it can change over time.
• A cash-out refinance is where you replace your existing mortgage with a new, larger mortgage and take the difference in cash. Essentially, you refinance for more than you owe on your current mortgage and get the difference in a cash lump sum. The new mortgage has different terms than your original one.

How does a home equity loan work for home improvements?

Funding and repayment work differently for home equity loans, HELOCs, and cash-out refinancing. This table can help you quickly decide which might be right for you. 

Financing option	How funding works	How repayment works	Best for
Home equity loan	You borrow a lump sum of money by taking out a second mortgage	Fixed monthly payments over a set term, often 5 – 15 years	Major renovations with clear, upfront costs
HELOC	You get a revolving line of credit to draw money from as needed, much like a credit card	Variable payments based on the amount borrowed and current interest rates Interest-only payments during the draw period, often 5 – 10 years  Principal + interest payments during the repayment period, often 10– 20 years	Multi-stage projects with uncertain upfront costs
Cash-out refinance	You borrow a lump sum of money by refinancing your existing mortgage for a larger amount and taking the difference in cash	New mortgage with potentially different terms. Single, combined monthly payment	Major renovations when better mortgage terms are available

Pros and cons of home equity loans for remodeling

Using a home equity loan for remodeling has significant benefits, but there are also drawbacks. 

Pros

• You can increase your home’s value.

  Well-planned home improvements can increase your property’s market value and help you enjoy your living space more—a win-win!

• Interest rates are low.

  Compared to personal loans, credit cards, and other financial products, home equity loans and HELOCs come with lower interest rates.

• The interest you pay may be tax-deductible.

  As long as you use your HELOC or home equity loan to increase the value of your home, you can write off the loan’s interest on your annual tax returns. To learn more about this, check out our guide to home equity loans and tax deducting.

• Loan limits are high.

  While the specific amount you can take out will depend on how much equity you have, some HELOCs and home equity loans go as high as several million dollars.

• Lots of ways to use funds.

  You don’t just have to use a home equity line of credit or loan for renovations. You can also use them to consolidate debt, pay for unexpected medical bills, cover a large expense like a wedding, and more. 

Cons

• It puts your home at risk.

  Your property is the collateral on a home equity product, so if you fail to make your payments, the lender could seize your home.

• It increases your debt burden.

  A home equity loan increases your overall debt, which can add more stress to your life and make it harder to qualify for future loans. Also, if the housing market declines, you might end up owing more than your home is worth.

• Funding may take longer than other options.

  Home equity loans and HELOCs require significant documentation and have longer funding periods than credit cards and personal loans.

• You may need to cover closing costs.

  Just like with your first mortgage, you might have closing costs and fees to pay come closing day.

• You could over-improve your home.

  Investing too much in renovations can lead to “over-improving,” where the cost of improvements doesn’t proportionally increase your home’s value. 

“Make your own pros and cons list—write it down or type it out! For the most part, make sure the pros outweigh the cons while also considering your unique circumstances, economic environment, and the housing market where you live.” –Erin Kinkade, CFP

How to choose the best home equity lender for your renovation

Finding the best home equity loan or the best HELOC for your renovation involves a few key steps:

• Start by prequalifying with multiple lenders. This gives you an idea of the loan amount, rates, and terms you might qualify for, based on your credit profile, without impacting your credit score.
• Compare different offers. Look beyond a lender’s interest rates; consider fees, loan terms, and customer service. Online reviews and testimonials can provide insights into the lender’s service quality.
• Choose the right type of loan. Decide whether a home equity loan, HELOC, or cash-out refinance best suits your project. Consider factors like the amount needed, repayment structure, and how comfortable you are with variable rates (in the case of a HELOC). Choose a lender that aligns best with your financial situation.

Ask the expert

Erin Kinkade

CFP®

Variable rate is what it states—variable—which means the amount of interest you pay will increase and decrease as interest rates increase and decrease. This is unknown for the most part and can pose a greater risk than you might be willing or able to take on if interest rates were to dramatically increase. For those who desire a predictable payment, a fixed rate is definitely recommended.

How to apply for a home equity loan for home improvement

Applying for a home equity loan for home improvement typically involves these steps:

1. Navigate to the lender’s website.
2. Start the online application process and submit any requested financial documents like recent pay stubs, tax returns, mortgage statements, and proof of homeowner’s insurance. 
3. Indicate how you plan on using the funds, whether for renovations or something else. You may qualify for better terms if you use the money for home improvements.
4. Submit your application and wait for approval. 

The application process can take a few weeks to a couple of months, depending on the lender and your situation. The lender will conduct a credit check and may require a property appraisal to determine your home’s current market value.

Once approved, you’ll generally receive the funds for your loan within a few days to a week. For a HELOC, you might receive a line of credit card or checks to access your money.

Maximize the value of a home equity loan for renovation

Whether you choose a home equity loan, HELOC, or cash-out refinance, be strategic about maximizing its value for home renovations. Try these tips. 

First, focus on renovations that offer a high return on investment (ROI), especially if you plan on reselling in the future. Here are some of the best projects to take on, according to Remodeling magazine.

• Add a wood deck ($8,553 in resale value)
• Remodel your kitchen ($22,963 in resale value for a minor kitchen remodel, up to $48,913 for a major, upscale one)
• Renovate your bathroom ($18,270 in resale value)
• Add a master suite ($47,343 in resale value)
• Install stone veneer siding ($11,177 in resale value)

Second, create a detailed budget for your renovation project. Factor in materials, labor, permits, and a contingency fund for unexpected expenses. With a HELOC, be cautious about over-borrowing. The ability to draw funds as needed can lead to overspending. 

Lastly, don’t forget to avoid common pitfalls. Not vetting contractors properly can lead to subpar work that may not add the desired value to your home. Failing to consider the total cost of your home equity loan (including interest and fees) can worsen your financial situation.

Alternative financing options for home improvement

Home equity loans, HELOCs, and cash-out refinancing are just a few ways to cover home improvement costs. In some situations—like when you have insufficient home equity or don’t want to put your home at risk—these alternative financing options may be a better fit.

Personal loans

Personal loans can be a good option if you need fast funding for small or medium-sized projects, or if your credit score is less than stellar. They also don’t put your home at risk.

On the downside, personal loans can have much higher interest rates than other options. Check out our guide to the best home improvement loans to learn more about using personal loans to improve your property.

Credit cards

Credit cards are an option if you need quick cash for small-scale or DIY projects. They often have much higher interest rates than home equity loans, so look for a card with a 0% introductory period. Ensure you can pay off the card before the introductory rate expires. Rates often jump once the intro period ends.

Retailer financing

Many home improvement stores like Home Depot and Lowe’s offer financing options like credit cards or installment loans. They may also come with special terms like deferred interest or no interest if paid in full within a certain period. 

Similar to regular credit cards, rates may jump after the intro period (if there is one). But retailer financing can be useful for specific purchases like new appliances or materials for DIY projects. 

FAQ

What happens to my home equity loan if I sell my house?

You’ll have to repay your home equity loan if you sell your house. Usually, the proceeds from the sale will first pay off your mortgage, then your home equity loan. Any remaining money is yours. Selling doesn’t forgive the loan; it must be fully repaid upon sale.

What if my remodeling costs exceed the home equity loan amount?

You’ll need additional funding if your remodeling costs exceed your home equity loan amount. You can go to your home equity lender and see if you can increase your loan amount. 

If not, other options include using personal savings, finding another type of loan (such as a personal loan), or reducing your project scope. 

Does using a home equity loan for remodeling affect taxes?

The interest paid on a home equity loan may be tax-deductible if you use it to “buy, build, or substantially improve” your home. 

But there are limits. The total mortgage debt eligible for an interest deduction can’t exceed $750,000 for joint filers or $375,000 for separate filers. This includes your primary mortgage and any home equity loans or HELOCs. 

If you use part of the home equity loan for other purposes, like paying off credit card debt, that part of the interest isn’t tax-deductible.

Does using a cash-out refinance for remodeling affect taxes?

Interest on a cash-out refinance might be tax deductible when you use it for home improvements. But similar to a regular home equity loan, this deduction applies only to the funds you used for home renovations.