Key takeaways
Rising home prices, low inventory and high mortgage rates have homeowners choosing to renovate their homes instead of moving.
Two popular options for tapping into home equity for renovations include a home equity loan or a home equity line of credit (HELOC), each of which has its pros and cons.
Before using a home equity loan or HELOC for remodeling, consider if the project will add value to your home and develop a budget/schedule for paying the funds back.
Fewer homes are available for sale. Prices are climbing. Mortgage rates are ticking up. Small wonder that homeowners who want to trade up are rejecting the idea of packing and moving -- choosing to stay put and renovate their homes instead.
And to pay for these pricey remodels and repairs, they're tapping the equity they have in their homes: using home equity loans and lines of credit (HELOCs) to turn their ownership stake into ready cash. The rise in property values has sent equity stakes soaring, up 11 percent to a collective $16 trillion in 2023. That equals nearly $300,000 per mortgage-holding homeowner.
"It's an interesting time where all signs point to modifying your existing home," says Jackie Frommer, head of lending at Figure Technology Solutions, the parent of Figure, a HELOC lender. "We're seeing a ton of interest because of that. And then because of the home price appreciation that has happened, the equity is there to tap, as opposed to doing something on an unsecured basis."
By using your home equity to fund renovations, you are essentially using your home's worth to improve its worth. But, while a shrewd strategy, it has its drawbacks too, and evaluating the advantages and disadvantages is crucial before you draw on your ownership stake.
Here's how it all works, and smart ways to use your home equity for remodeling, renovations or repairs.
Aspiring homeowners must earn at least $110,871 a year to afford a median-priced home in the U.S., according to Bankrate's Housing and Income Study.
Among Americans willing to make sacrifices to find affordable housing, 34% say would buy a fixer-upper, according to Bankrate's Home Affordability Survey.
Bankrate's Down Payment Survey found 54% of aspiring homeowners say their income is not high enough to afford closing costs and a down payment for a home.
42% of Americans believe now is a bad time to buy a home, per Bankrate's Down Payment Survey.
62% of renovating American homeowners plan to stay in their home 11 or more years, up from 59% in 2021.
83% of Americans believe their home equity has increased within the last year.
According to ICE Mortgage Technology, as of year-end 2023, the average American has $299,000 in home equity, with $193,000 available to tap. ("Tappable equity" is the amount you can withdraw while still maintaining a 20 percent equity stake, which most lenders require you to do.)
$24,000
The average amount of equity U.S. homeowners gained in Q4 2023 over Q4 2022
Source:
CoreLogic
Homeowners have been using those substantial equity gains to fund renovations. According to a late-2023 survey by TD Bank, more than one-third (38 percent) of homeowners who are renovating in the next two years are planning to use a home equity loan or HELOC to pay for the projects. Renovations are among the most common uses for home equity loans and HELOCs. Kitchens and bathrooms are the most popular rooms to tackle, the survey found.
In addition, 57 percent of respondents who previously or never had a HELOC or HE Loan said they are likely to apply for one in the next 18 months, up 9 percent from 2022.
"People are saying that they might be in a position where it's best to stay where they are and make the changes to the home that they want to make," says Jon Giles, senior vice president and head of strategy and support for TD Residential Lending. "They want to retain that two-point or three-point [mortgage] interest rate, where moving out of that home is probably going to get you in the ballpark of seven (percent) or maybe slightly below."
Admittedly, HELOCs and home equity loan rates have climbed along with regular mortgage rates; now hovering around 9 percent, they are more expensive than the purchase loans. Still, they tend to be a more cost-effective option than other financing routes like home improvement loans, personal loans or credit cards.
Bankrate's housing market predictions for 2024 notes that elevated home prices, low inventory and high mortgage rates will continue to be a factor for sellers and buyers this year.
There are two primary ways to tap your home equity: home equity loans and HELOCs. With both methods, the amount you can borrow is based on how much equity you have -- how much of it you own outright.
Key terms
Home equity
Home equity is essentially the difference between what your home is worth and what you owe on your mortgage.
Home equity loans function similarly to mortgages: You borrow a lump sum at a fixed interest rate. Repayments start immediately and cover both interest and principal over a term ranging from five to 30 years.
HELOCs provide a line of credit, typically with a variable interest rate, though some lenders offer fixed-rate versions. HELOCs generally have a draw period spanning around 10 years, during which you can access funds, usually making minimal, interest-only payments (with the option to repay more). After the draw period, you can no longer access the funds -- you enter a repayment period of 10 to 20 years, paying back the debt in monthly installments.
The amount you can borrow is typically determined by the size of your ownership stake and the loan-to-value ratio (LTV), which compares the loan size to the property's value. Generally, lenders limit your borrowing capacity to around 80 percent or 85 percent of your equity. However, specific limits can depend on factors like your credit score, annual income and payment history.
23%
Percentage of higher-budget home projects (costing $50,000 to $200,000) that are financed with secured home loans
Source:
2024 U.S.Houzz & Home Study
Home equity loans and lines of credit (HELOCs) offer comparatively lower interest rates because they are secured loans: that is, they are backed by your home as collateral. They parallel mortgage rates, running slightly higher (sometimes several percentage points in the case of HELOCs). But they tend to be far lower than credit cards or personal loans. Of course, individuals with good credit scores have access to the most competitive rates.
You can deduct the interest you pay on home equity loans and HELOCs annually on your tax return. But certain conditions apply. To qualify for the deduction, the funds obtained must have been used to purchase, repair or make significant improvements to the home securing the loan.
Keep in mind: As of 2024, single and joint filers can deduct interest on up to $750,000 of eligible loans, while married couples filing separate returns can deduct interest on up to $375,000. (These limits apply collectively to all your mortgages and home-related loans, by the way.) You must itemize your deductions to take advantage of this benefit.
Using your home equity to invest in your home can be a smart financial move. Expanding the livable space, adding amenities, modernizing systems and fixtures, improving appearance and curb appeal -- all these things enhance a property's worth. If you're considering selling your house, renovations might help it sell quickly and for more money. If you stay put, they'll help it appreciate (or at least not depreciate) in the long term. And of course, improve your quality of life in the meantime.
The major downside of home equity financing: the potential of losing your home if you can't keep up with the loan payments. In such cases, the lender may initiate foreclosure proceedings, and you could lose your home.
Home equity financing is typically larger: five-figure sums at least. Often, lenders have minimum borrowing requirements -- the benchmark loan that Bankrate tracks is for $30,000, for example -- which means you may need to borrow a substantial sum of money, potentially more than what you require. You could repay the excess early, but there might be penalties for doing so.
Obtaining a home equity loan involves additional expenses. Since it is a second mortgage, you will incur closing costs and fees, ranging from 2 percent to 5 percent of the loan amount. These costs can include charges like an origination fee and appraisal fee. When evaluating whether the loan is financially viable for your specific situation and needs, it is essential to factor in these fees and include them in the overall cost.
Home equity loans and HELOCs have numerous similarities: They both leverage the equity in your home, they both require your home as collateral, and they typically enable you to borrow up to 80 percent or 85 percent of your home's value, minus the remaining balance on your mortgage. However, despite these resemblances, the two have significant distinctions, each with advantages and disadvantages.
Home equity loans resemble traditional mortgages, following a predetermined payment schedule that includes the principal and interest. Essentially, they act as second mortgages and are typically available for 10, 15, 20 or 30 years. They can be a good financing tool if you know how much your renovation will cost, and it's a single, relatively short-term job -- like remodeling a bathroom, for example.
Pros
Structured payments: Home equity loans have scheduled payments that begin immediately, allowing for easier budgeting and financial planning.
Fixed interest rate: These loans often come with a fixed interest rate, ensuring that your monthly payment remains relatively stable or only experiences minor fluctuations.
Earning potential: If you don't intend to begin remodeling right away, you can transfer the loan funds into an interest-bearing account and earn additional income on the borrowed money.
Lump sum disbursement: With a home equity loan, you receive the entire loan amount upfront, making it an ideal choice for improvement projects that require a significant upfront investment or whose exact cost you know.
Increase the value of your home: Some renovation projects will likely increase your home's value, which in turn, will increase, over time, your equity and may mean a higher sale price when you are ready to sell.
Cons
Risk of spending the renovation money elsewhere: Since you receive a lump sum, it can be tempting to divert the loan funds toward other expenses, especially if the renovation gets delayed or is dragging on.
Negative equity if home value drops: If home values drop suddenly, it could leave you in a situation where you owe more on the loan than the actual worth of your home, a state of negative equity.
Difficult to budget project: Home improvement projects' total costs can be unpredictable, and your loan could fall short. Or it could be too much (meaning you incurred interest charges you didn't need to have).
HELOCs are structured with a draw period and a repayment period. During the draw period, you can borrow money from the line of credit; you only pay interest on the actual amount you borrow, and typically, you are required just to make interest-only payments. Once this period concludes, you can no longer access funds, and you must commence repayment of both the principal amount borrowed and the interest. HELOCs are well-suited for multi-faceted, ongoing projects, and/or ones in which the overall cost is uncertain.
Pros
Flexibility: With a HELOC, you can use as much or as little money as you need, and can draw it whenever you need it. That's ideal for long-term renovation projects, where you typically pay contractors at set intervals.
Limited interest: You are only obligated to repay the amount of the credit line you have utilized, and you only pay interest on the amount you've withdrawn.
Suitable for the unpredictable: HELOCs can be ideal if you're unsure how much your projects will ultimately cost or how long they'll take. Since the balance is replenishable, you're less likely to fall short in case of cost overruns, too.
Cons
Variable interest rates: The interest rate will fluctuate, affecting your monthly payments and potentially leading to increased costs. If your project's dragging on and interest rates rapidly climb, as they did in 2023, repayments could get expensive.
Big debt burden: Since you can borrow from your HELOC multiple times and typically don't have to start repaying the principal immediately, it can be easy to accumulate a big balance and encounter sticker shock when payments start including both interest and principal.
Annual fees: Many lenders charge an annual fee to maintain an open HELOC account, regardless of whether you use the line of credit.
If utilizing your home equity for home improvements is not your preferred route, there are alternative options available to consider:
Home improvement loans: These are personal loans. While rates are higher (up to 36 percent) and the repayment period is shorter, they often are quicker and easier to get than home equity loans. And -- since they are unsecured -- you do not risk losing your home if you default on the loan.
Credit cards: If you possess excellent credit and have discipline in managing your finances, you may qualify for a credit card with a 0 percent interest rate for a specific period. Taking advantage of such a promotional offer means you can finance your home improvement project without incurring any interest, provided you can pay off the balance before the promotional period ends. However, it is crucial to know that interest rates can escalate significantly if you miss or delay payments.
Cash-out refinance: With a cash-out refinance, you replace your existing mortgage with a new one that exceeds your current outstanding balance, allowing you to receive the difference in ready money. As with HE Loans and HELOCs, the amount you can borrow is based on the size of your home equity stake (so there are limits on the sum you can cash out). Cash-out refis carry lower interest rates than home equity loans and of course, having just one big debt may be more convenient than juggling two. However, cash-out refis work best if you can secure a lower interest rate on your mortgage.
Before you renovate, you must figure out how much you can borrow from your home's equity for your project. Lenders typically let you borrow up to 80 percent of the equity in your home, although some may allow you to borrow more, up to 85 or even 90 percent.
If you qualify for a home equity loan or line of credit, the lender will look at your home's loan-to-value status. If you want to find out how much home equity you can borrow, use a home equity calculator online to get a general idea.
The amount you get-- along with the interest rate and other terms -- will depend on your credit score (mid-600s, at least), and debt-to-income ratio, or DTI (no more than 43 percent). The higher your credit score and the lower your DTI, the more likely you'll be able to borrow. And your lender will likely order an appraisal of your home, to determine its worth. All the calculations will stem from that figure.
Learn more:
How to calculate your home equity
Before committing, it's smart to carefully weigh the goals and consequences of pursuing a HELOC or home equity loan for home improvements. Here are crucial questions to ask yourself.
Will tapping into your home equity eventually pay itself back, increasing your home's worth? Renovations can vary significantly in their return on investment -- anywhere from over 100 percent to 30 percent. Frankly, the majority don't recoup their costs. And even if the returns are positive, don't assume that because you put in an $80,000 swimming pool you have bumped your home's fair market value by $80,000, either.
Consult a real estate agent or an appraiser on which renovations enhance a home's value and appeal to buyers and what projects offer the most bang for the buck -- especially in your local real estate market. Generally, a more modest redo offers a better return than a deluxe one.
Of course, home value isn't purely measured in monetary terms. You can tailor the changes by remodeling your home according to your family's tastes and needs. Whether creating a spacious kitchen with a large island that accommodates your culinary adventures or incorporating a practical drop zone with ample storage for multiple children, you can customize the renovations to suit your lifestyle and desires.
It's also important to carefully budget how much you can afford to borrow in the form of a home equity loan or HELOC, and how long it will take to repay what you borrow. Remember: Renovations almost always take longer and cost more than initially anticipated. Forecasting these numbers can help you make a more informed decision and prevent borrower's remorse that can occur if you can't pay your bills.
"What are you comfortable making as a monthly payment today and what do you believe you'll be comfortable with in the future? Any job changes? Do you plan on buying another car in a year or two and taking on a car loan for that? Understand your personal situation, make a budget and make sure the home renovations and the borrowing you're doing to support those renovations fit within your personal budget," says Giles.
Many lenders in the mortgage industry provide home equity financing, ranging from bricks-and-mortar banks to online-only, non-bank institutions. However, availability may vary by state, particularly for HELOCs. While most mortgage lenders offer home equity options, there are specialized firms that focus solely on home equity financing without offering purchase mortgages.
Explore multiple lenders to secure the most favorable terms. Even a slight variation in the interest rate can result in significant savings over the long term. Taking the time to compare offers from the best HELOC lenders and best home equity loan lenders can save you thousands of dollars in the coming years.
If you're considering home renovations and need funding, leveraging the equity you have in your home can be a viable option. But these redos and remodels should involve serious money, at least five figures. If you have smaller-scale projects or renovations planned, it may not be practical to opt for a loan that entails high minimum borrowing amounts, involves closing costs, and requires your home as collateral.
"Home equity might be the best option today. It's likely one of the lowest cost ways to borrow given this environment" of high mortgage rates and low housing inventory, says Giles. Still, if you're planning to do major remodeling, "Do understand the different options and balance those against your situation."
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