How to use your home equity to fund a home improvement

When you’re ready to make home improvements, you may be able to tap into the equity you’ve build in your home to fund your new kitchen, bathroom or much-needed fix. A home equity loan or home equity line of credit (HELOC) is a common way to pay for updates when your assets are tied up in your property.

Home equity loans for remodel

A home equity loan is sometimes called a second mortgage. And like a mortgage, you may be required to pay between 2% and 5% of the amount you borrow in closing costs when tapping into your equity for a remodel.

These types of equity loans come with a fixed interest rate and repayment schedule, so you’ll have the same monthly payments for the life of the loan. But your rate will most likely be higher than what you could get at an adjustable rate. Lender requirements vary, though you can expect to need at least 15% equity in your home to be approved.

While many home equity lenders advertise waiving application and origination fees, you’ll likely still need to pay third-party fees, such as those for title insurance.

Funding can take anywhere from two to six weeks, and you get the money as a lump sum to use at your discretion.

HELOCs for home improvement

A HELOC is a revolving line of credit that’s similar to a credit card. You’re approved for a set line of credit that can be up to 80% of your home’s equity, and you borrow against that amount as much as you need during a draw period of five to 10 years, depending on the loan.

During the draw period, you make interest-only payments on the amount you draw. But a HELOC comes with a variable interest rate, causing your payments to fluctuate as interest rates rise and fall with the market.

When the draw period ends, your HELOC payments are amortized to include principal and to ensure you can pay off the entirety of what you borrowed within the repayment period, which is typically 20 years.

HELOC vs. Home equity loan for remodeling

Tax considerations

You may be able to write off the interest on your HELOC or home equity loan — as long as it meets two key rules:

• The total borrowed between your mortgage and home equity loan doesn’t exceed $750,000.
• Funding is used to build onto or “substantially improve” your home.

Home improvements must be more substantial than paint or wallpaper to qualify for the deduction, though cosmetic changes that are part of a larger remodel may still qualify. The IRS qualifies substantial improvements as those that:

• Add to your home’s value.
• Prolong the life of your home.
• Adapt your home for new uses.

Some home improvements can be written off in full. For example, you can qualify for the Renewable Energy Tax Credit for installing energy-efficient equipment like solar panels. And if you spend more than 7.5% of your adjusted gross income on improvements to your home for medical reasons, such as those for disability access, you may be able to take a tax deduction on your remodel expenses.

Talk with a tax professional who understands your personal financial details to understand the write-offs and credits you can qualify for.

How to qualify for a home equity loan or HELOC to improve your home

You must meet lender eligibility requirements to access your home’s equity, though you’re better positioned to qualify if you meet four key criteria:

• You’ve built up at least 15% to 20% equity in your home.
• Your debt-to-income (DTI) ratio is under 50%.
• You have a FICO score of 620 or higher — or at least 720 for the strongest rates.
• You’re able to repay based on your income, assets, monthly expenses and credit history.

Can I be approved for home equity financing if I have credit card debt?

Yes, though the amount of debt that’s acceptable to a lender depends on the your income. Lenders typically look for a DTI that’s under 50%, though 43% is the standard. That means that your combined debt should only be 43% of your income. If you already have a personal loan or another type of installment credit, you could have trouble getting approved — the inflexible payments can affect your ability to stay current on your new loan.

How to get the most out of your remodel

When you’re using your hard-earned home equity to fund a renovation project, you want to get as much out of it as possible. Some home improvements add more value to your home than others, according to the Journal of Light Construction’s Cost vs. Value report. Here are national averages to use as a guide when planning your home updates.

Renovations

High-value renovations enable you to recoup 70% or more of your investment by increasing the resale value of your home. Mid-value projects allow you to recoup 50% to 69% of your investment.

Renovation jobs you could do yourself

The biggest advantage of DIY renovations is saving money. If there are jobs you can do yourself, why waste money hiring a contractor to do them? As long as you’ve got enough time to invest in the project, doing the job yourself is a win-win, as you have complete control over the scheduling and completion of the project. We’ve listed some of the jobs you should DIY below:

• Painting. It’s simple to do, there’s no safety risk and any mistakes you make can be painted over. There’s also no need for any specialized or expensive equipment, so painting is one job you should definitely DIY.
• Minor demolition work. Pulling up carpet and removing tiles and wallpaper are all easy, low-risk tasks that an amateur renovator can handle without expert help.
• Outdoor work and landscaping. Putting in a new garden bed? Painting the driveway? Adding a front gate? These are all jobs you can probably take on yourself.
• Plastering. DIY plastering is relatively easy. There are plenty of useful how-to guides explaining all the ins and outs of completing the job yourself, and there’s little risk of causing any significant damage to your home.
• Cosmetic renovations. Painting cupboards, changing door and drawer handles and even resurfacing a bench top can all be done on your own and can all make a noticeable difference.
• Manual labor. If you’re prepared to put your back into it and get your hands dirty whenever it may be required, your project will be finished a whole lot quicker.

Renovation jobs that should be left to the experts

There are some jobs that, if done badly, could cause serious and expensive damage to your home. This could not only be a substantial setback for your renovation project but could also affect your home’s value. And if you make a mistake while performing major electrical work, for example, the consequences could be fatal.

If any job requires a special permit or license, that’s usually a good sign that it’s beyond the reach of a DIYer.

• Electrical work. Electricians need to be certified before carrying out any work, so unless you have the right qualifications, it’s time to find a good electrician. Compare quotes and make sure whoever you choose meets all the necessary licensing requirements in your state.
• Plumbing. In most states, it’s compulsory to have a compliance certificate before completing any plumbing work. There’s a big safety risk with taking on any plumbing jobs yourself, not to mention the potential to cause costly damage to your home.
• Gas fitting. If you want to be cooking with gas in your new kitchen or using a gas hot water heater for your new shower, you’ll need to get a licensed gasfitter to take care of it for you. The good news is that many plumbers are also licensed gasfitters.
• Structural work. Any structural work on a renovation project needs to be done by a qualified licensed builder. Don’t even think about taking it on yourself — that’s a recipe for disaster.
• Major demolition work. Any heavy-duty demolition work or any demolition jobs on a property where asbestos could be an issue should be left to the professionals.
• Roofing. While there may be some roofing jobs you can do yourself, such as replacing a few damaged tiles, this type of work is generally best left to the professionals. In addition to the danger involved in working at heights, a roof leak can cause substantial and costly damage to the rest of the property.

Alternatives to home equity financing for home improvements

For other ways of funding your next home remodel using your home equity, look to two options:

• Reverse mortgage. If you’re ages 62 or older and own your home outright, you may qualify for a reverse mortgage that supplements your retirement income with payments from your home’s equity. The loan repayment is due in full when you die, move out or sell the house.
• Cash-out refinance. Refinance your mortgage for more than you owe and take the difference as a lump sum of cash. A cash-out refinance typically allows you to borrow up to 80% of your home’s value.

Other ways to borrow include:

• Personal loans. Applying for a loan for a home improvement allows you to pay for updates without risking your home’s equity as collateral.
• Credit card. You can leverage a 0% or low-APR intro rate for the flexible spending of a HELOC without using your home equity — and without high interest.
• Government grants and programs. Depending on the repairs or improvements you’re making, you may qualify for federal or local government programs to assist with your remodel. Start by checking the home improvement section of usa.gov to see which available resources may fit your situation.

Bottom line

Using your home equity to improve your home — and in doing so, increase your home’s equity — can be a great strategy. But you’re putting your home up as collateral. So make sure you use the right option for your project, and that the new payment is well within your budget.