What You Need To Know About Using A Home Equity Loan For Your Home Remodel

As a homeowner, you may be considering a home equity loan as a way to secure a home renovation loan or tap into your home equity.

This leaves you to wonder if taking home equity out on your home is worth it.

There’s no need to wonder any longer!

Finding an ideal financing solution for your home remodeling project can feel like assembling an intricate puzzle. Lucky for you, amidst this intricate puzzle, has emerged a standout option: the home equity loan—specifically, The RenoFi Home Equity Loan, a home improvement loan game-changer.

We’ll answer all your questions in this expert guide and make sure you understand the ins and outs of a home equity loan before you apply.

What is a Home Equity Loan 

A home equity loan, also known as a second mortgage, allows you to borrow against the equity in your home.

But, before you can truly understand what a home equity loan is, you must first understand how home equity works.

Home equity refers to the portion of a property’s value that the homeowner truly owns, calculated by deducting the outstanding mortgage balance from the current market value of the property. It represents the accrued financial stake the homeowner has built in their property over time.

Example: Let’s say you own a house with a market value of $300,000, and your outstanding mortgage balance is $200,000.

Your home equity would be $100,000 ($300,000 - $200,000). This amount is an asset that you can potentially access through a home equity loan or line of credit, for purposes like home improvements.

Home equity increases as you make mortgage payments and the property’s value appreciates, offering you a valuable resource for achieving your financial goals by way of a home equity loan and HELOCs.

Home Equity Loan Expert Tip: Lenders often assess your home’s worth to determine your borrowing potential. Investing in home improvements can not only enhance your living space but also increase your home’s equity. Keep track of market trends and focus on projects that provide the best return on investment to maximize your home equity and loan options.

A RenoFi Loan is a new type of home renovation solution that offer home equity loans (and HELOCs) that combine the best bits of a construction loan with the simplicity of a home equity loan, whilst letting you borrow at the lowest possible interest rate and avoid the need to refinance.

RenoFi Loans allow you to borrow based on what your home’s value will be after your renovation is complete. Essentially, you’re tapping into that increase in equity right now and borrowing more at a low fixed interest rate.

Home Equity Loan Eligibility & Requirements

To get a home equity loan, you will need to go through an application process that is similar to the process for getting a traditional mortgage. Overall it can take anywhere from 2 weeks to 2 months to get a home equity loan. To qualify for a home equity loan, you will need to meet certain eligibility requirements, such as having a good credit score and a loan-to-value ratio within acceptable limits.

“Among the key factors for qualifying for a home equity loan, a crucial one is maintaining a solid credit score, generally above 700. One common mistake borrowers make is underestimating the significance of their credit score in the approval process. A strong credit score not only improves your chances of qualifying but also helps secure more favorable interest rates, potentially saving you thousands over the life of the loan.” says Tom Yoswa, Sr. Loan Advisor at RenoFi.

This may include providing documentation of your income, assets, and debts, as well as a home appraisal to determine the current value of your home based on the following;

• 15-20% home equity: Most lenders require that you have at least 15-20% equity in your home before you can qualify for a home equity loan. Yet, with RenoFi you can obtain 90% of your after-renovation value, which can supersede what most loans offer. 
• 620 credit score: Lenders typically look for a credit score of 620 or higher, though some may require a score of 700 or more for the best interest rates.
• 43% debt-to-income ratio: Lenders want to ensure that you have enough income to comfortably repay the loan, so they typically look for a debt-to-income ratio of 43% or less.
• Stable income and employment: Lenders want to see that you have a steady source of income and stable employment history to ensure that you can make the loan payments.
• Property value: Lenders may require a home appraisal to determine the current market value of your home.
• Other factors: Lenders may also consider other factors such as your loan amount, the purpose of the loan, and any existing liens or mortgages on your home.

Who Should Consider a Home Equity Loan?

For many homeowners, a home equity loan could be the best choice to finance your home renovations or any major expenses you have. But it isn’t necessarily right for everyone. Here are some common criteria of homeowners that benefit most from these loans. 

• You have equity built up in your home. 
• You have a good credit score that will make qualifying easy. 
• You have a great low-interest rate locked in on your current mortgage. 
• You’re looking to use these funds for home improvement projects. 
• If you’re in need of large sums of money

Home Equity Loan Expert Tip: A home equity loan does not strictly have to be used for home improvements. While a home equity loan can serve various purposes like debt consolidation and education financing, experts such as Dave Ramsey advise against using home equity loans for debt consolidation due to potential financial challenges.

Conversely, channeling a home equity loan into home renovations is generally seen as a more prudent decision. This strategy lets you invest in improving your property’s value, potentially leading to lasting financial advantages and improvements in the quality of your home life.

Expert Tips for a Smooth Home Equity Loan Application Process

Although getting a home equity loan is not necessarily hard, if you do not prepare for a home equity loan it may be harder to get approved. Preparing for a home equity loan application can help make the process smoother and increase the chances of approval.

Here are some steps to take months ahead of applying:

• Get a loan advisor: Loan advisors will help you research lenders that offer home equity loans and compare their interest rates, fees, and eligibility requirements. Choose a lender that offers favorable terms and a smooth application process. Also, they are free of cost!
• Check your credit score: Your credit score is a critical factor in determining your eligibility for a home equity loan and the interest rate you’ll be offered. Check your credit report for errors and take steps to improve your score if needed. Aim for a credit score of at least 620 to qualify for most home equity loans.
• Determine your home’s value: A home equity loan is based on the amount of equity you have in your home. Determine your home’s value by obtaining an appraisal or using an online tool to estimate your home’s worth.
• Calculate your equity: Calculate your equity by subtracting your outstanding mortgage balance from your home’s current value. Lenders typically require at least 15-20% equity to qualify for a home equity loan.
• Gather necessary documents: Gather the necessary documents for your loan application, such as W-2 forms, tax returns, and proof of income. Lenders may also require documentation related to your home, such as property insurance and a title search.
• Apply for the loan: Complete the loan application and provide all required documentation. Be prepared to answer questions about your credit history, income, and the purpose of the loan.

Is it a Good Idea To Get A Home Equity Loan?

If you’re in need of funds, a home equity loan is a good idea because you won’t lose the rate you already have on your first mortgage.

And if you’re wondering if home equity loans are wise to use for home improvements - the short answer is yes!

Using home equity for home improvements can be a sensible financial strategy. Home equity loans or home equity lines of credit (HELOCs) can provide you with access to funds at generally lower interest rates compared to other types of home improvement loans, like personal loans.

According to the new Zillow Housing Aspirations Report “Given a choice between spending money on a down payment for a new home or using that same money to fix up their current home, 76 percent of Americans choose to renovate.”

And a Home Equity Loan is the best way to do it!

Home equity loans are one of the best home renovation loans because they not only have lower interest rates than most other traditional renovation loan options, but they also offer large loan amounts that help homeowners tackle more of their project wishlist in one shot.

RenoFi Home Equity Loans take that even further by increasing the amount of equity you can draw from by basing your borrowing power off the after-renovation value (ARV) of your home versus the current value.

Home Equity Loan Pros & Cons

Pros:

• Lower interest rates: Home equity loans typically offer lower interest rates than credit cards, personal loans, or other forms of unsecured debt.
• Large loan amounts: You can borrow a substantial amount of money with a home equity loan, which can be useful for major expenses like home renovations or debt consolidation.
• Fixed interest rate and predictable monthly payments: A home equity loan has a fixed interest rate, which means that your monthly payments will remain the same over the life of the loan. This can help you budget more effectively.
• Potential tax benefits: The interest you pay on a home equity loan may be tax-deductible, which can lower your overall tax bill.
• Closing costs and fees: Fees tend to be lower than traditional cash-out refinance

Cons:

• Loan is secured by the home: A home equity loan is secured by your home
• Closing costs: There are often fees and closing costs associated with getting a home equity loan, which can add to the overall cost of the loan.
• Taking on more debt: Taking on more debt can increase your overall financial burden, but keep in mind that timely payments can help improve your credit. 

2023 Home Equity Loan Interest Rates

When it comes to interest rates and repayment terms, home equity loans can vary widely depending on factors such as your credit score and the lender you choose. It’s important to shop around and compare rates and terms from different lenders to find the best deal for your situation.

Home equity loans typically have fixed rates. Home equity loan interest rates are typically set lower than that of other types of loans, such as personal loans. The interest rates for a Home Improvement Home Equity Loan can vary depending on a variety of factors, such as the borrower’s credit score, the loan amount, the loan term, and the lender’s policies. However, as of August 2023, here’s what you should expect according to Bankrate:

• Home Equity Loan (General): The typical interest rates for a home equity loan falls around 8.57%, with a range spanning from 7.97% to 9.84%. This rate serves as a benchmark for borrowers seeking a lump-sum loan against the equity in their property.
• 10-Year Fixed Home Equity Loan: For those seeking a shorter loan term, a 10-year fixed home equity loan carries an average interest rate of approximately 8.71%. The interest rate range for this option varies between 7.84% and 9.81%. This loan structure is favored by borrowers who aim to pay off their loan within a decade and lock in a fixed interest rate.
• 15-Year Fixed Home Equity Loan: A 15-year fixed home equity loan offers a longer repayment timeline. The average interest rate for 15-year fixed home equity loan option hovers around 8.68%, and the interest rate range spans from 7.86% to 10.68%. Borrowers who opt for this loan are seeking the balance of a lower monthly payment while paying off their loan over a more extended period.

Home Equity Loan Expert Tip: Remember, the interest rates for home equity loans are shaped by a range of ever-changing economic factors and your personal financial situation. Things like your credit score, the amount you’re borrowing, the ratio of your loan to your home’s value, and your overall financial health all contribute to the interest rate you’ll be offered. Lenders tend to assign higher rates to borrowers who might pose a higher risk. So, it’s wise to keep your finances in order to snag the most favorable rates available

How Home Equity Loans Work For Home Improvements

A home equity loan works by assessing the equity you’ve built in your home in order to provide you a lump sum of cash, which is to be paid back based on a fixed interest rate over the span of 5 to 20 years. Home equity loans finance a portion of a home’s total value, but require you to use the property as collateral.

Equity is a key factor in understanding how a home equity loan works because this will determine how much you can borrow.

To calculate home equity, you have to find the difference between the current value of your home and the outstanding balance on your mortgage.

For example, if your home is currently valued at $500,000 and you still owe $300,000 on your mortgage, you have $200,000 in equity. You will be able to borrow against the $200,000 you’ve built in equity.

Home Equity Loan Expert Tip: When considering a home equity loan, it’s vital to understand the concept of usable equity.

Usable equity refers to the portion of your home’s equity that lenders typically consider available for borrowing based on your loan-to-value ratio. While your home may have accrued significant equity over time, lenders usually factor in a certain percentage—often around 80%—of this equity as usable.

This means you can borrow against this calculated usable equity without risking overextension. Knowing your usable equity helps you gauge how much funding you can access through a home equity loan while maintaining a prudent financial balance.

RenoFi Loans remain the indsutry’s best kept secret because RenoFi allows you to borrow based on what your home’s value will be after your renovation is complete. Hence, you will have more usable equity using a RenoFi Loan than you would with most traditional lenders whom base borrowing limits exclusively on loan-to-value-ratio.

How Much Can You Borrow on a Home Equity Loan For a Home Remodel?

How much you can borrow on a home equity loan depends on, you guessed it: how much home equity you’ve built (or what it’s currently worth minus your existing mortgage). But other factors will play a role too — like your credit score. Usually, you’ll be able to borrow between 80% and 90% of your equity.

As an example, if your home is worth $500k and your current mortgage balance is $375k, a home equity loan could let you borrow up to $75k (90% multiplied by $500k, minus $375k).

But to figure out the best financing option for your renovation, you need to understand how equity works. The bigger the difference between the amount you owe on your mortgage and the value of your home, the more home equity you’ve built. And as you continue to make monthly payments, your mortgage balance decreases, and your equity increases.

But your home’s value can go down, as well as up.

Property prices change regularly, and when the market is performing well and prices are on the rise, your equity will increase. But when the market is down, this can decrease the value of your home and reduce your equity. In very rare circumstances, you could even end up with negative equity, which is where you owe more on your mortgage than your house is worth.

If you want an answer to how much can you borrow on a home equity loan right now, use a personalized Home Equity Loan Calculator or contact one of our Renovation Advisors today.

How Closing Costs Work

Closing costs for a home equity loan typically range from 2% to 5% of the loan amount. These costs can vary based on factors such as the lender, location, and loan amount.

Closing costs for a home equity loan, especially for renovations, can vary depending on the lender and the specifics of your loan agreement.

Some common closing fees associated with home equity loans for renovation projects include:

• Application Fees: These cover the cost of processing your loan application and can range from a few hundred to several hundred dollars.
• Home Appraisal Fees: To determine the current value of your home, an appraisal is conducted, and you’ll be responsible for this fee.
• Origination Fees: Also known as processing or underwriting fees, these fees cover the administrative costs of processing your loan. They can typically range from 1-3% of the loan amount.
• Title Search and Title Insurance: These fees ensure that the title to the property is clear and that the lender’s interest in the property is properly protected.
• Credit Report Fees: Lenders may charge a fee to pull your credit report during the application process.
• Recording Fees: These fees cover the cost of recording the loan documents with the appropriate government office.
• Attorney Fees: In some cases, legal representation may be required, leading to additional attorney fees.
• Notary Fees: These fees cover the cost of a notary public certifying the validity of your loan documents.
• Insurance: Depending on your loan type and the lender’s requirements, you may need to pay for homeowner’s insurance or mortgage insurance.

Home Equity Loan Expert Tip: Some lenders might offer “no-closing-cost” home equity loans, but this often means the closing costs are rolled into the loan amount or are covered by slightly higher interest rates. Always carefully review the Loan Estimate and Closing Disclosure provided by the lender to understand the specific closing costs associated with your home equity loan for renovation.

How Home Equity Loan Draw and Repayment Phases Work

A home equity loan works by assessing the equity you’ve built in your home in order to provide you in a sum of cash in what is called the “draw phase”. This is to be paid back in monthly installments based on a fixed interest rate over the span of 5 to 20 years - known as the repayment period.

• Draw Phase: During the draw phase, you receive the approved loan amount either as a lump sum or in installments as needed for your renovation project. This provides you with the funds to cover your home improvement expenses.
• Repayment Phase: Once the draw phase ends, you enter the repayment phase. This is when you start making regular monthly payments to repay the loan. These payments typically cover both the principal amount borrowed and the interest.

Home Equity Loan Expert Tip: It’s crucial to understand that home equity loan repayments kick in right after the loan is disbursed. This means you’ll need to manage repayments while working on your renovation. The good news is that these payments are predictable and generally more manageable compared to other financing methods for home improvements. Being aware of this timeline will help you stay on track with your project and budget effectively

Using Home Equity Loans For Remodel

Home equity loans provide a means to tap into the accumulated equity in your property, making it an attractive option for funding renovations. These loans typically allow you to borrow a portion of your home’s appraised value minus the amount you still owe on your mortgage.

What sets renovation-focused home equity loans apart, such as the innovative RenoFi loan, is their consideration of your property’s after-renovation value. This forward-thinking approach means that you could potentially access a larger loan amount based on the increased worth of your home after improvements.

Renovating is expensive. In fact, it’s not uncommon for an entire renovation wishlist to cost $100k or more, and this means that the most common methods of financing (a home equity loan or cash-out refinance) aren’t available to recent homebuyers who haven’t yet built up equity.

Using a home equity loan or a future value cash-out-refinancing loan is the better choice for larger projects (cost over $20,000). Although a cash-out refinance is a common alternative, many homeowners don’t want to refinance, as this will mean losing any great rate that they’re currently locked into. Home Equity loans help you to take equity out of your house without refinancing.

How much you can borrow depends on home equity (and other factors like credit score). Usually, you’ll be able to borrow between 80% and 90% of your equity (what it’s currently worth minus your existing mortgage).

As an example, if your home is worth $500k and your current mortgage balance is $375k, a home equity loan could let you borrow up to $75k. (90% multiplied by $500k, minus $375k)

Using a home equity loan is a far superior choice for larger renovations because you’ll also find that you have limited borrowing power when refinancing.

Traditional “cash-out refinances" aren’t even really designed for renovations at all. While they can be a good option for long-term homeowners (having lived in their home for 10+ years), they aren’t the right type of loan for recent homebuyers who haven’t yet built up equity.” says -Justin Goldman, Renovation Loan Expert and RenoFi CEO

The RenoFi home equity Loan makes it easier for you to borrow against your home’s future equity and complete your renovation wishlist straight away by granting you larger loan amounts at lower interest rates than most refinance and traditional home equity loans. 

See how the RenoFi Loan still comes out as the best way to borrow to finance your renovation if you’ve only got limited equity and have a wishlist of projects you’re itching to get going on.

Home Improvements You Should Use A Home Equity Loan To Finance

Here are some of the best ROI renovation projects to finance through a home improvement home equity loan. The home improvements below will help you add equity to your home:

• Kitchen Remodel: A kitchen remodel is one of the most popular home renovation projects that can significantly increase the value of your home. Kitchen remodeling can be costly, but upgrading appliances, countertops, cabinets, and flooring can give your kitchen a fresh look and make it more functional, and offer a high ROI making it an ideal choice for a home equity loan.
• Bathroom Renovation: Another popular renovation project that can add value to your home is a bathroom renovation. Upgrading the bathroom fixtures, such as the sink, shower, and toilet, can give your bathroom a new look and improve its functionality.
• Outdoor Living Spaces: Outdoor living spaces such as decks, patios, and outdoor kitchens are becoming increasingly popular. These areas are perfect for entertaining guests or just relaxing outdoors. Adding an outdoor living space can also add value to your home, making it great for home equity loans use.
• Basement Remodel: Remodeling your basement can be a great way to add extra living space to your home. Finishing your basement can create a new living room, game room, or home theater, which can also add value to your home due to its ROI potential.
• Energy-Efficient Upgrades: Upgrading your home’s insulation, windows, and HVAC system can be a great way to save money on energy bills while also increasing the value of your home. Energy-efficient upgrades can also be attractive to potential home buyers if you decide to sell your home in the future.

Using Home Equity Loans vs HELOCs for Home Renovations

Home Equity Loans differ from a home equity line of creditHELOCs allow you to borrow against your home’s equity as needed, similar to a credit card. Yet still, both HELOCs and home equity loans use your home as collateral if you default on the loan. 

Home Improvement Loan Alternatives

Personal Loans

Personal loans are unsecured loans that do not require any collateral, such as a home or car. They may have higher interest rates compared to home equity loans, but they can be a good option for smaller home improvement projects.

Pros of Using Personal Loans for Home Improvement 

• No collateral required: Personal loans are unsecured, which means you don’t have to use your home as collateral.
• Fast approval process: Personal loan applications are typically processed much faster than home equity loan applications, so you can get the funds you need sooner.

Cons of Using Personal Loans for Home Improvement:

• Higher interest rates: Personal loans generally have higher interest rates than home equity loans because they’re unsecured, so you may spend much more than you had in mind.
• Lower borrowing limits: Because personal loans are unsecured, lenders may be more cautious about how much they’re willing to lend. This means you may not be able to borrow as much as you would with a home equity loan and run the risk of being unable to afford your renovation project.
• Shorter repayment terms: Personal loans typically have shorter repayment terms than home equity loans, which means your monthly payments may be higher.
• Limited tax benefits: Unlike home equity loans, interest paid on personal loans is not tax deductible.

Credit Cards 

Credit cards can be a convenient option for financing smaller home improvement projects. However, they typically come with higher interest rates than other loan options.

Pros of Using Credit Cards for Home Improvement:

• Convenience: Credit cards are easy to use and widely accepted, making them a convenient option for smaller home improvement projects (under $15,000).
• Low or no interest rates: Some credit cards offer introductory periods with low or even 0% interest rates on purchases, making them an attractive financing option for those who can pay off their balance quickly before the introductory period ends.
• Rewards: Many credit cards offer rewards, such as cashback or points, for purchases. This can help offset the cost of home improvement projects.

Cons of Using Credit Cards for Home Improvement:

• Fees: If you don’t pay off your credit card balance in full each month you may stack up a considerable amount of fees. 
• High-interest rates: You may end up paying far more for your renovation project due to high fees
• Credit Score: You may negatively impact your credit score with high balances. 

Cash-Out Refinancing 

Cash-out refinancing involves refinancing your existing mortgage and taking out a larger loan than you currently owe. The extra cash can be used for home improvements. However, this option may come with higher interest rates and fees.

Pros of Using Cash-Out Refinancing for Home Improvement:

• Simplified payment: With a cash-out refinance, borrowers only have to make one mortgage payment per month, instead of a mortgage payment and a separate payment for a home equity loan.
• Large loan amounts: Cash-out refinancing allows homeowners to borrow a larger amount of money than a home equity loan, which can be useful for major home improvement projects.

Cons of Using Cash-Out Refinancing for Home Improvement:

• Higher closing costs: Refinancing a mortgage comes with closing costs that can range from 2% to 5% of the loan amount, which can add up to thousands of dollars in upfront costs.
• Risk of foreclosure: When refinancing, homeowners are taking on a larger mortgage payment, which can put them at risk of foreclosure if they’re unable to keep up with the payments.
• Longer repayment terms: A cash-out refinance can extend the length of time it takes to pay off a mortgage, which means that homeowners may end up paying more in interest over the life of the loan.

Home Equity Loan Expert Tip: Contrary to a common misconception, a home equity loan is not the same as refinancing. While both involve using your home’s equity, they have distinct purposes. A home equity loan is a separate loan allowing you to borrow against your accumulated home equity, while refinancing involves replacing your existing mortgage with a new one. If you’re considering using your home’s equity for remodeling, be cautious about refinancing, as it could mean losing your current favorable interest rate on the primary mortgage.

Construction Loans

A construction loan is a specialized type of loan designed to finance the construction or renovation of a property. Unlike traditional mortgages, which provide a lump sum upfront, construction loans disburse funds in stages as the project progresses. These loans are typically short-term and require specific documentation and monitoring to ensure that the construction is proceeding according to plan.

Pros:

• Tailored Funding: Construction loans are designed to match the unique needs of your project, ensuring you receive the right amount at the right time.
• Interest-Only Payments: During the construction phase, you often only need to pay interest on the funds disbursed, easing initial financial strain.

Cons:

• Complex Application: The application process can be more intricate compared to standard loans, involving project plans, contractor agreements, and more.

• Higher Interest Rates: Interest rates for construction loans can be higher than those for traditional mortgages or home equity loans.

• Shorter Repayment Period: Construction loans usually have shorter repayment terms, leading to higher monthly payments.

  Home Equity Loan Expert Tip: Many homeowners overlook the fact that while a construction loan serves as an alternative financing option, it’s primarily designed for new constructions. Construction loans don’t align well with most home renovation projects.

The Problem With Using a Home Equity Loan For Remodeling

The real problem with using a traditional home equity loan or line of credit to pay for a renovation for many homeowners is that their borrowing power is limited by the equity available to tap into.

And for recent homebuyers, this often isn’t sufficient to complete their full renovation wishlist.

Just take a look at this scenario from our client The Darla family:

The Darla family was planning a home improvement project that will cost $250k.

They purchased their home five years ago and want to do the two-story addition and kitchen remodel they’d been discussing since they moved in. Their home was currently worth $500k, and they owed $350k on their mortgage. We expected that the value of their house would grow to $750k after the renovation was complete. 

Let’s compare how much they would have been able to borrow with a home equity loan or HELOC:

The $250K remodel loan that the Darla family wanted was out of reach; despite a home equity loan and a HELOC letting them borrow $100k, they were still $150k short.

That was frustrating, especially when you consider that the remodel is going to add value, But most types of financing didn’t acknowledge that.

So what was their solution? They became a RenoFi client. 

We were able to get them a home equity loan amount that was 90% of their after-renovation value ($675K) towards their renovation project, which was more than what they needed to finish their renovation project.

For more information on RenoFi loans and how we can help finance your renovation in the smartest way possible whenever you’re ready, contact us today!

Home Equity Loan & HELOC FAQs

Home equity loans and lines of credit can be confusing, we get it.

To help you out, here are answers to some of the most commonly asked questions about these two renovation financing options.

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(This information is designed to provide general information regarding the subject matter covered. It is not intended to serve as tax, legal, or other financial advice related to individual situations. Because each individual’s tax, legal, and financial situation is different, you should seek advice based on your particular circumstances from your own accountant, attorney, and/or other advisor regarding your specific situation.)