You can pay for a major home repair like a new roof or a renovation like a kitchen remodel in several ways. Among them, a home equity loan allows you to access the equity in your home and offers rates that are generally lower than the rates of other loans.
There are a number of advantages to using your property’s equity, but there are also disadvantages to consider. Typically, when you use your home as collateral, you risk losing it if you can’t repay the loan.
Learn more about how to use a home equity loan to pay for major home repairs, and the pros and cons of this financing strategy.
Key points to remember
- Home equity loans are installment loans secured by your home.
- One of the advantages of using home equity loans to finance a home improvement project is that they usually offer fixed, low interest rates.
- Alternatives to using a home equity loan include a home equity line of credit (HELOC), a personal loan, or a credit card.
What is a home equity loan?
A home equity loan is an installment loan secured by the equity in your home. Equity is basically the value of your home less any debt like your mortgage, or the value of your home that you own without any other claims.
You accumulate equity when you pay down your mortgage principal and the value of your property increases. Home equity loans tend to offer lower interest rates than, say, personal loans or credit cards because your home is used as collateral. So if you fail to make the payments, the lender can potentially recoup the losses by foreclosing on your home.
Home equity loans typically offer fixed payments with fixed interest rates over terms ranging from five to 30 years. They are usually paid in a lump sum after closing, which makes them ideal for large repair projects or large purchases.
Home equity lines of credit (HELOCs) are a similar product often used to finance a home renovation or repair project. Unlike home equity loans, HELOCs typically have variable interest rates, resulting in unpredictable monthly payment amounts. It’s also a revolving line of credit, so you can only withdraw the amount you want to use when you need it.
The best way to pay for home repairs
Of course, the best way to pay for home repairs is with cash, as you can avoid going into debt and paying interest. You can also avoid using your home to secure a loan, which puts you at risk of losing it if you can’t make the payments.
However, many homeowners don’t have the cash on hand for a major project. Home equity loans or HELOCs are a good alternative to cash because they can offer lower interest rates. Using a higher interest rate product, like a credit card, can incur significant interest charges and hurt your credit score.
The cost of home repairs can vary greatly depending on the type of home repair. For example, replacing an HVAC system can cost between $3,000 and $6,000, while a new water heater can cost around $1,000.
Home improvement projects can also be expensive, with costs varying depending on the type of project, size, and materials, among other factors. The price of a bathroom remodel, for example, can range from around $6,600 to $16,600 and a kitchen remodel can range from around $13,400 to $38,300.
Home improvement projects can potentially increase the value of your home. Thus, this financial advantage can often outweigh the disadvantages of taking out a loan.
Home Equity Loans vs. Credit Cards
If borrowing money is your best option for financing your big home improvement project, you’ll need to weigh the pros and cons of a home equity loan versus other products, like credit cards. .
Although credit cards can offer more flexibility, they also have a much higher interest rate. The median credit card interest rate was 19.62% as of August 3, 2022, according to data from Investopedia. Interest rates on home equity loans, on the other hand, range from around 3% to 10%. You may have closing costs with a home equity loan, but they probably won’t exceed what you’d pay in compound interest on credit card debt.
For example, if you financed a $15,000 bathroom renovation using a credit card with an interest rate of 17% and paid it off in five years, you would accumulate $7,367 in ‘interests. Paying for the same project with a home equity loan at an interest rate of 5.25% over the same term would earn $2,087 in interest without the risk of rising interest rates.
Home equity loans have fixed interest with predictable payments, which makes it easier to budget for. Consumer credit card interest rates, on the other hand, are variable and based on the Federal Reserve’s prime rate. Your interest rate on a credit card can change depending on market conditions.
Some credit cards offer promotional interest rates that can be as low as 0% for a fixed period of time, such as one year to 18 months. However, if you do not pay your balance at the end of the promotional period, the initial rate will apply to the remaining balance.
How much can I borrow on a home equity loan?
Most lenders will allow you to borrow up to a certain percentage of the equity in your property, such as 80% of your equity. This limit protects the lender against falling home values and reduces the risk that they will not get their money back in the event of default.
Should I use a home equity loan to improve my home?
You can use a home equity loan for any purpose. There are no restrictions on your home equity loan, so you can use it to, for example, buy property, pay for a wedding or fund a child’s education.
What credit score do I need for a home equity loan?
Most lenders look for a credit score above 660, but higher credit scores will fetch better interest rates. Lenders look for a history of on-time payments and low credit usage to determine if you’re likely to repay your loan.
A home equity loan can be a good financing option for people who have sufficient equity but lack the cash to finance major repairs. These loans offer competitive interest rates and fixed, predictable payments. Consider these advantages as well as the potential disadvantages of using your home as collateral when deciding if this loan is right for you.