Is a Home Equity Loan the Best Way to Finance Major Home Repairs?

You can pay for a major home repair like a new roof or a renovation like a kitchen remodel in a number of ways. Among them, a home equity loan allows you to access your home equity and provides generally lower rates than the rates on other loans.

Using your home equity has a number of advantages, but it also has downsides to consider. Mainly, when you use your home as collateral, you risk losing it to foreclosure if you can’t repay the loan.

Learn more about how to use a home equity loan to pay for major home repairs, as well as more about the pros and cons of this financing strategy.

Key Takeaways

  • Home equity loans are installment loans secured by your home.
  • One advantage of using home equity loans to finance a home improvement project is that they generally offer low, fixed 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 essentially the value of your home minus any debt like your mortgage, or the value of your home that you own with no other claims.

You build equity when you pay down the principal of your mortgage and as the value of your property rises. Home equity loans tend to provide lower interest rates than, say, personal loans or credit cards because your home is used as collateral. So if you fail to make payments, the lender can potentially recoup any losses by foreclosing your home.

Home equity loans generally offer fixed payments with fixed interest rates over terms that range from five to 30 years. They’re typically paid out in a lump sum after closing, making them ideal for large repair projects or major purchases.

Home equity lines of credit (HELOCs) are a similar product often used to finance a home improvement or home repair project. Unlike home equity loans, HELOCs generally have variable interest rates, resulting in unpredictable monthly payment amounts. They are also a revolving line of credit, so you can take out only 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 to use cash because you can avoid taking on 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 add significant costs in interest, as well as potentially harming your credit score.

The cost of home repairs can vary widely depending on the type of home repair. For example, replacing a HVAC system can cost about $3,000 to $6,000, while a new water heater can cost about $1,000.

Home improvement projects can also be expensive, with costs varying by project type, size, and materials, among other factors. The price for a bathroom remodel, for example, can range from about $6,600 to $16,600 and a kitchen remodel can range from about $13,400 to $38,300.

Home improvement projects can potentially increase your home’s value. So this financial benefit can often offset the downsides of taking out a loan.

Home Equity Loans Versus Credit Cards

If borrowing the money is your best option for financing your major home repair project, you’ll want to weigh the pros and cons of a home equity loan versus other products, like credit cards.

While credit cards may offer more flexibility, they also have much higher interest rate. The median credit card interest rate was 19.62% as of Aug. 3, 2022, according to Investopedia data. Interest rates on home equity loans, on the other hand, range from about 3% to 10%. You may have some closing costs with a home equity loan, but they likely won’t exceed what you would pay in compound interest on credit card debt.

For example, if you financed a $15,000 bathroom remodel using a credit card with a 17% interest rate and paid it off in five years, you would accrue $7,367 in interest. Paying for the same project with a home equity loan at a 5.25% interest rate over the same term would accrue $2,087 in interest with no risk of rising interest rates.

Home equity loans have fixed interest with predictable payments, which makes it easier to budget for them. Consumer credit card interest rates, in contrast, are variable and based on the Federal Reserve’s prime rate. Your interest rate on a credit card could change depending on market conditions.

Some credit cards offer promotional interest rates that can be as low as 0% for a set period of time, such as a year to 18 months. However, if you fail to pay off your balance by the end of the promotional period, the original 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 safeguards the lender against falling house values and lowers the risk they will not recoup their money in the event of a default.

Do I Have to Use a Home Equity Loan on Home Improvements?

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 weddings, or finance 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 earn better interest rates. Lenders look for a history of on-time payments and low credit utilization to determine if you are likely to make your loan payments.

The Bottom Line

A home equity loan can be a good financing option for people who have ample home equity but do not have the cash to fund a major home repair. These loans offer competitive interest rates and fixed, predictable payments. Consider both these advantages as well as potential downsides of using your home as collateral when you decide whether this loan is right for you.

admin