You bought your dream home a while back, but now it’s time to give it a refresh. Perhaps you bought a dated fixer-upper with the intent of saving for future upgrades, or maybe your home was once perfect, but age, a growing family, or lifestyle changes have necessitated renovations. No matter the reason, remodeling your home can improve the living space and property value at the same time.
If you don’t have enough cash available to fund your remodeling project, taking out a home equity loan to renovate your house can give you the boost you need. What exactly is a home equity loan, and how does it work? At Capital Credit Union, we want to help you realize the full potential of your home’s value, so we’ve detailed key steps to help guide you through the process. From planning to applying to receiving your loan, we have you covered!
What Is Home Equity?
Before we break down how a home equity loan can fund home renovations, it’s important to first understand what home equity is. Home equity is the difference between the amount you owe on your mortgage and the current market value of your home. Essentially, home equity is the amount of your home that you own outright.
To calculate your home equity, simply subtract your principal balance (how much you still owe on your mortgage) from the current market value of your home. For example, if your home is currently worth $500,000 and you have an outstanding balance of $300,000 on your mortgage, then your home equity is $200,000. As your home rises in value and you pay down more of your principal balance, your equity increases.
Leveraging Your Home Equity for Home Renovations
Home equity loans allow you to tap into the value of your home without having to sell your property. The equity is converted back into debt in exchange for cash that can then be used for home renovations. To access your equity, you can take out a home equity loan or a home equity line of credit (HELOC). What is the difference between a home equity loan and a HELOC? A home equity loan is paid as a single lump sum with a fixed interest rate, while a HELOC allows you to draw from an approved line of credit with a variable rate (similar to a credit card).
Both are useful options. Which option is right for you is largely determined by your financial goals and budget. With either route, you can unlock your home equity for cash to fund your remodeling projects.
How Does a Home Equity Loan work?
When you use a home equity loan to renovate your home, you have a set period of time to repay the loan. Typically, this term ranges from 5 to 10 years, though some lenders may offer up to 15-year terms. Keep in mind, however, the longer the term, the more interest you will pay over the life of the loan. Shorter terms accrue less interest with higher monthly payments, while longer terms allow for lower monthly payments but with higher overall interest costs. Evaluate your financial goals and choose which term best supports your goals and monthly budget.
How much you can borrow will depend on how much equity you have built in your home, your financial health (such as your credit score, debt-to-income ratio, and loan-to-value ratio), and the rates and terms offered by your lender. In general, most lenders will allow you to borrow up to between 80 and 85 percent of your home’s value, minus the mortgage. Each lender is different, so make sure to compare rates and terms before applying.
Let’s use the same example as above; if your home is worth $500,000 and you owe $300,000, simply multiply your home’s value by the percentage you can borrow. Then, subtract the amount you still owe from the value of your home. If you can borrow 80 percent of your home’s value, you will set up your equation like this:
($500,000 x 80%) – $300,000 = $100,000
Using this simplified example, the approximate maximum sum you can borrow is $100,000.
Using a Home Equity Loan for Home Renovations, Step-By-Step
Before applying for a loan, do your research and create an actionable plan. Consider what renovations you want to make, how much they’ll cost, how much equity you have, and what type of loan is best for your specific financial situation. Then, shop around for the best rates and terms so you can reach your financial goals faster. Plan to:
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Get quotes from contractors for the work you have planned.
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Get an appraisal of the current value of your home.
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Create a realistic and comprehensive budget, allowing for unforeseen surprises during the renovation process.
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Weigh the pros and cons of a home equity loan versus a HELOC and choose which one best fits your goals, budget, and financial situation.
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Shop around for lenders with the best rates and terms. Capital Credit Union offers competitive rates with exceptional service you can count on.
Once you’ve found your preferred lender and chosen your loan type, it’s time to apply. For your application, you will need the following information for yourself and any co-borrowers:
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Full legal first and last names
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Social Security number
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Employer contact information
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Estimated income, assets, and liabilities
Once you’ve filled out your application and provided the necessary documentation, review the loan terms carefully before signing.
Remember: Only share sensitive information, like your Social Security number, with trusted sources through secure and encrypted channels provided by your lender.
Once the loan is approved, you will begin the closing process:
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Your lender will send you a closing date with instructions for how closing will proceed. Most loan closings are held in person, but some lenders offer a virtual option.
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Sign all loan documents and lender disclosures detailing costs and terms of the loan.
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The funds will then be issued as a lump-sum payment to your designated account.
Your home equity loan must be repaid within the agreed-upon term. Payments are expected in monthly installments made to your lender and are separate from your regular monthly mortgage payments.
The benefits are many. Using your home equity for renovations can:
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Increase property value: Home improvements can boost the appeal and marketability of your home, increasing your return on investment (ROI).
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Improve living spaces: Upgrade high-traffic areas such as bathrooms and kitchens, improving their functionality. Make needed repairs and live more comfortably in your home. Making repairs to roofing, plumbing, windows, and central cooling and heating can help you save on energy bills.
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Lower interest rates: Home equity loans typically offer lower interest rates than alternative financing options, such as personal loans and credit cards.
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Tax benefits: In some states, if your funds are used for qualified home renovations, the interest paid on a home equity loan is tax-deductible.
When you’re ready, Capital Credit Union is here for you. Simply apply online or contact us to speak with a lending expert. We’ve been working with our members in the community since 1934 and are ready to help you achieve financial freedom.
All loans are subject to approval. Membership eligibility and credit qualifications apply. Terms and conditions may vary based on individual circumstances. Consult a tax advisor for information regarding the deductibility of interest.