How Does A Home Equity Loan Work For Home Improvements?

How does a home equity loan work?

Home equity loans are usually used to finance home improvements and repairs, but they can also be used to consolidate debt or to finance large expenses, like buying a vehicle or paying for educational expenses. These loans generally have fixed monthly payments and interest rates, making it easy for you to predict when and how you will pay back your loan.
In a sense, a home equity loan is a type of a second mortgage. Unlike a HELOC (a home equity line of credit), you'll receive your payment all at once instead of gaining access to an ongoing line of credit. It's ideal both for major renovation costs that need to occur all at once or for debt consolidation while a HELOC is better for minor renovations that will need to occur over a number of years. Plus, monthly payments are steady and predictable.
Home equity loans generally have lower interest rates since your home makes the loan secure. It's less risky for lenders to give you such a loan because it's your home on the line. It can help you save on your interest payments and improve your monthly cash flow.
Not only that, but home equity loans come with certain tax benefits. You can deduct the interest on home equity loans as long as the money is used to "substantially improve" your home.

How do you get a home improvement loan?

Before you think about applying, make sure you have your metaphorical ducks in a row. You'll likely need a credit score in the low to mid-600s or higher along with documents that verify your income, like W-2s, pay stubs, bank statements, and recent tax returns. You may also need to get an appraisal done on your house to determine its value and how much equity you have in the home, if you are using a secured loan.
Compare home improvement loans by shopping around and pre-qualifying. This will help you find the loan with the best interest rate, repayment terms,and other features. You'll want to take a close look at things like the loan term and amount, annual percentage rates, and the ability to add a co-borrower or co-signer, if necessary. Most home improvement loans come with interest rates sof anywhere between 4 and 36%, so it's a good idea to shop around to make sure you're on the lower end of that scale.
You can use a tool like Acorn Finance to find the best home improvement loan for your needs. That way, you won't have to worry about your "shopping around" causing any sort of hit to your credit score. You'll fill out one form and then receive dozens of pre-qualified offers in just a minute without having to do a hard credit pull. You can select the offer that works best for you and then complete the application process on the selected lender's website. It's a great way to see all the options that are out there!
Once you've chosen a ledner, you'll have to gather any requested documents if you have not already. Most large lenders offer an online application process to make things easier, though you can often also apply in person at smaller banks and credit unions. You should have a decision within a couple days of applying – and the funds for your home improvement project should be in your bank account in around a week.

What should you know about using a home equity loan for home improvements?

Before you use a home equity loan for home improvements, it's important to decide if this is truly the right method for you. Home equity loans are valuable if you know you need a lot of money quickly to finance an immediate renovation and want relatively low interest rates. They are also ideal if you want to tap into the tax benefits that come along with home improvements (and you're planning on doing a renovation that substantially increases the value of your home).
If you're thinking about using a home equity loan, first, make sure you have enough equity in your home to begin with. To figure out how much equity you have, subtract your mortgage balance from your home's current market value. You'll usually need around 20% equity in your home to qualify for this kind of loan, but it does vary. There are other requirements you'll need to meet, such as having a credit score that is in the mid-600s or higher and a low debt-to-income ratio.
When you use your home equity loan, it's important that you set a budget and stick to it. Unlike a home equity line of credit, a home equity loan is a one-time loan that's issued for a set dollar amount. Once the money has been used, it's gone – you can't get any more without applying for an additional loan. Therefore, you will want to get accurate estimates and discuss the scope of your project with professionals to make sure your budget is realistic. It's a good idea to give yourself 10 to 15% extra just in case the price of labor or materials goes up during your project.
If you're interested in using the home equity loan to fund a project that will increase the value of your home, it's important that you also understand the differences between equity and return on investment. Home improvements can increase your equity but not return 100% of what you spend – you might spend $25,000 remodeling your kitchen but it will only increase the value of your home by $15,000. These Financial projections are important to keep in mind – especially if you plan on selling your home.
Use a home equity loan only for home improvements that make sense. What are your current needs? How much do you really want – and need – to personalize? While your home improvements can certainly take into account your personal tastes and comfort levels, you should also be thinking about the tastes of potential buyers.

What is the difference between a home equity loan and a home equity line of credit?

Home equity loans and home equity lines of credit (HELOCs) are similar types of loans that can be used to fund home improvement projects. However, there are a few key differences to keep in mind.
Both allow you to receive funds if you have equity in your home and both use your home as collateral, meaning they are secured homes with better interest terms than credit cards, personal loans, and other kinds of unsecured debt. You can use these loans both for home improvements as well as for other expenses, like consolidating debt.
A HELOC is a revolving line of credit that comes with variable interest rates and payment amounts. With a HELOC, you can use funds from your line of credit as long as you continue to make interest payments. You won't be receiving the money in a lump sum but can instead withdraw money as long as you make the payments – up to a specific credit limit.
The major benefit of a HELOC is that the line of credit remains open until the term ends – you only pay when you use it and you can always pay it off in full and still be able to access it. You can choose how much or how little to use and the funds are available quickly, making it a good option for emergency repairs. That said, the interest rates are variable so they can change suddenly and without warning – something that can be challenging for people on fixed incomes who may not be able to manage large shifts in their monthly budgets.

Can you use a home equity loan for anything?

Home equity loans don't just have to be used for home improvements and repairs. They can be used for just about any expense, though there are some that aren't ideal.
Home improvements are the most obvious reason to take out home equity loans – and the best reason. These loans can finance large projects that will pay for themselves over time by increasing the value of your home. Plus, if you're making homes that substantially improve the value of your home, you can deduct the interest paid on them when you file your taxes.
You can also use home equity loans for things like:
Student loans
Emergency expenses
Wedding expenses
Business expenses
Consolidating debt

What is not a good use of a home equity loan?

You should avoid using a home equity loan if you are using it to pay for things that are not affordable with your current income and level of savings. Doing so can cause you to rack up bad debt and it's risky because your house is on the line. You could lose your home if you fail to repay the loan.
Although you can use a home equity loan to pay for a vacation, buy a car, pay for college or a wedding, or invest in real estate, you really shouldn't. Ideally, you should only use a home equity loan to pay for significant improvements or repairs to your home.
If you use a home equity loan to pay for something unnecessary, like a vacation, that's a good indication that you're living and spending beyond your means. Using debt to fund your lifestyle will only exacerbate existing financial problems. Although the interest rates on these loans are often cheaper than what you'll find with a credit card, remember – it's your house at stake here.
The same goes for using a home equity loan to fund a college education. Student loans usually have interest rates that are right in line with what you'd pay for a home equity loan – so there's no real reason to put your home on the line here.
Home equity loans sometimes make sense for emergency expenses – but if you're forced to tap into your home equity in an emergency, it might be time to reevaluate why you don't have an emergency fund set aside. This is a much better way to fund emergency expenses, so look toward creating one in the future.
Many people use home equity loans to pay down or consolidate debt, since the interest rates on home equity loans tend to be cheaper than most other kinds of loans. In theory, this is a smart financial move, but only works if you have the discipline to pay down the principal on the loan within a few years.

How do you get a home equity loan for home improvements?

First, decide whether you want to get a home equity loan, a home equity line of credit (HELOC), or a cash-out refinance, the latter of which is ideal if you want a loan that will replace your original mortgage with one that's worth more than what you owe (and allow you to receive cash for the difference).
Then, head to the bank or go online to find a home equity loan that works well for your financial situation. Once you find the right loan, you'll submit documents like your W2s and pay stubs. As soon as you are approved, you'll sign some final paperwork and start receiving your funds.

What are the requirements for a home equity loan?

For a home equity loan, you will need to have at least 15-20% equity in your home, depending on the lender. Again, this is the difference between how much you owe on the mortgage and the home's market value.
You should have good credit, usually a score in the mid-600s, but again, this varies depending on the lender. A debt-to-income ratio of 43% or lower is usually required, though some lenders may request a number that is anywhere between 36 and 50%.
Of course, you'll need sufficient income and a reliable payment history on your other bills, too.
There are often fees that you will need to pay as part of the home equity loan process, like closing costs, so be sure to have some money set aside from these (or plan on rolling them into the cost of your loan). It's sometimes possible to find lenders who will waive these closing costs and many other kinds of fees.

What are other types of loans you can use for home improvements?

A home equity loan isn't your only option when it comes to financing home improvements. You can also choose from options such as:
A home equity line of credit (HELOC)
Personal loan
Cash-out refinancing
FHA 203(k) rehab loan (ideal for individuals who have just purchased their homes and plan on making renovations within the first year)
Credit card loans

Is using a home equity loan for home improvement a good idea?

Home equity loans are a good idea if you want to take advantage of lengthier repayment terms and low interest rates. However, it's important that you compare a variety of types of loans to make sure you're getting the best interest rates and repayment terms – not just home equity loans.
Using home equity loans is the most beneficial when the market is up and the value of your home is more than what you paid for it – you'll have more equity to put back into the home. However, when the market is down, it can cause the value of your home to fall, leaving you with little or negative equity. Especially if you're remodeling an older or outdated home, a home equity loan is a wise choice because you can increase its value and earn more equity without having to spend as much money.
So are home equity loans right for you? Only you can be the judge of that. No matter what kind of loan you choose, always make sure you shop around to find the best loan for your needs, budget, and project.