Eying a renovation this spring? Don’t tap your equity without reading this first

With American homeowners collectively sitting on a whopping $17.3 trillion in home equity, you may be considering tapping your own equity to create the home you’ve always wanted. While rates are falling, the average home equity loan interest rate still hovers around 7.90%.

Here’s how to weigh the overall costs and risks associated with borrowing against your home — including when it makes sense to get a home equity loan or home equity line of credit (HELOC) and alternative financing options for upgrading your home.

Is it a smart idea to use your home equity for renovating?

Whether you should tap your equity depends on how you plan to use it. Many homeowners choose to finance remodeling and renovations with home equity loans or HELOCs, which typically have lower interest rates compared to unsecured financing options like personal loans and credit cards.

That’s because home equity loans and HELOCs are secured by your home, which reduces the lender’s risk. It also means you risk losing your home to foreclosure if you fail to keep up with the repayments.

On the plus side, the interest on a home equity loan or HELOC may be tax-deductible as long as you can show to the IRS that the funds were used to “buy, build or substantially improve” the home that secured the loan.

✏️ How to calculate your available home equity

Your home’s “tappable” equity is the difference between its current market value and any outstanding balance on your mortgage:

home equity 🟰 [your home’s value] ➖ [remaining mortgage balance]

Many lenders require that you maintain an additional 15% to 20% equity at all times outside of your mortgage or any other secured loans.

Here’s an example that illustrates how it works:

• Say the value of your home is $400,000

• And your current mortgage balance is $250,000

• Lenders might require you to maintain 20% of your home’s equity — or $80,000

• Which means your available equity is $70,000 — or your home’s value ($400,000) less your mortgage balance ($250,000) and the 20% home equity cushion ($80,000)

In this case, you could borrow up to $70,000 through a home equity loan or HELOC, although the exact amount depends on your lender and financial situation.

🔍 Read more: Home equity vs. home improvement loan: Which is a better choice?

How to use home equity to renovate or upgrade your home

Choose from three main products for accessing your home’s equity for renovations: home equity loans, home equity lines of credit (HELOCs) and cash-out refinancing. Each has its own features and benefits to weigh against your needs and budget.

🏡 Home equity loan

Best for single, large-scale renovation projects with defined costs

Think of a home equity loan as a traditional second mortgage, providing a lump sum loan at a fixed interest rate with predictable monthly payments over a set term — typically five to 30 years. Home equity loans are best for borrowers who know exactly how much they want to borrow and want to lock in a fixed-rate loan with payments that won’t fluctuate with the market like a HELOC

Main features of a home equity loan:

• One-time lump sum distribution with fixed monthly payments

• Repayment terms range from 5 to 30 years

• Fixed interest rates may be lower than a HELOC’s

• Low or no closing costs, depending on your loan

🏡 Home equity line of credit (HELOC)

Best for ongoing renovations or projects with uncertain costs

A HELOC works like a credit card that’s secured by your home, offering a variable-rate credit line you can draw from and repay as needed. Most HELOCs have a 10-year draw period and a 20-year repayment period, making them ideal for projects with uncertain costs or changing timelines. The variable line of credit means that as borrowing rates continue to trend down, your HELOC payments are likely to follow suit. (However, in times of higher interest rates, you could end up paying more than you bargained for.)

Main features of a HELOC:

• Draw money as needed during draw period — usually 10 years of interest-only payments

• Converts to 20-year repayment period with fixed payments after draw period

• Some HELOCs allow you to “fix” the variable rate to a fixed rate

• Low or no closing costs, depending on your loan

Cash-out refinance

Best for securing a lower rate on a larger mortgage, receiving the difference as cash

A cash-out refinance replaces your existing mortgage with a new, larger mortgage, allowing you to “cash out” the difference. Because you’ll likely pay closing costs when refinancing, this option is best if you want a lower interest rate and access funds for renovations at the same time.

Main features of a cash-out refinance:

• Replaces existing mortgage with new, larger loan

• Requires re-qualifying for new mortgage

• Closing costs range from 2% to 6%

• Often requires 20% equity remain after refinancing

💡 Refinancing tips: Because the primary benefit of refinancing is to secure a lower rate than what you’re currently paying, it’s best to refinance when mortgage rates are low and you plan to stay in your home longer than three years to recoup any closing costs.

Should you use a personal loan instead of home equity to finance renovations?

It depends. Rates for the best personal loans can rival those for home equity products without using your home as collateral or dealing with extensive paperwork. But you’ll need a good credit score of 740 or higher to qualify for the lowest rates, and unlike home equity products, the interest on a personal loan isn’t tax-deductible. If you’re using the funds for something else, a personal loan is worth looking into.

Start by comparing home equity loans with a marketplace like Lending Tree or Rocket Mortgage, and weigh rates against personal loans from digital lenders like Lending Club and Prosper, which often extend lower rates than traditional banks.

🔍 Read more: Cash-out refinance vs. home equity loans: Which is best in today’s market?

Benefits of using home equity to remodel or renovate

Home equity loans offer competitive interest rates, potential tax benefits and larger loan amounts, making them a useful way to pay for a home upgrade.

Lower interest rates

Among the most compelling reasons to use home equity for renovations is the potentially lower cost of borrowing compared to other financing options. Home equity loan rates are typically lower than credit cards or personal loans, and you can choose from variable- and fixed-rate options.

Many big-bank lenders — including Key Bank, TD Bank and Bank of America — are known for offering “relationship” discounts on their home equity products. If you’re an existing customer and meet specific requirements, you might save 0.25% or more on your quoted rate.

Potential tax write-offs

Home equity loan and HELOC interest is tax-deductible if used to improve, buy or build your primary or secondary residence. Using these loans for personal expenses (like consolidating high-interest credit cards) makes the interest non-deductible.

Speak to a tax advisor or trusted financial advisor to learn how to document your expenses and stay within the law when filing your tax return.

💡 Expert tip: You must itemize deductions on Schedule A of IRS Form 1040 to claim these benefits.

Larger loan amounts

Home equity loans may provide access to larger amounts than other financing options, giving you the flexibility to tackle major renovation projects — like building a new room from scratch. Some lenders may even allow you to borrow up to 85% of your home’s equity, although you’ll want to make sure payments fit your budget.

Increased home value and quality of life

Strategic renovations can build greater long-term equity while enhancing your daily living. For instance, adding features like wider doorways, curbless showers and first-floor bedrooms can increase your comfort while allowing you to age in place gracefully.

🔍 Read more: 5 tax breaks for homeowners that don’t require a mortgage

Risks of using home equity for home upgrades

While home equity can be a useful tool for financing renovations, it’s important to understand the general risks of borrowing against your home and the challenges that come with renovation projects.

General home equity risks

Several risks come with any home equity borrowing, regardless of how you plan to use the funds:

• Your home serves as collateral

• You face potential foreclosure if you can’t repay on time

• You reduce your overall home equity

• It could affect your ability to qualify for other loans

• Market value fluctuations could lead to negative equity — or being “underwater” — meaning you owe more than your home’s value

Remodeling-specific risks

Renovation projects come with a unique set of challenges and potential pitfalls that could impact both your project’s success and your financial stability. And it’s not just that nearly 80% of homeowners go over budget when upgrading their homes.

• Project costs may exceed estimates

• Renovations might not return expected value

• Construction complications could increase expenses

• Your improvement might be larger than your neighborhood’s standards

• Extended project timelines can affect loan costs

🔍 Read more: 5+ home upgrades that can lower your homeowners insurance premiums

What to weigh before tapping your home’s equity

While remodeling with home equity has many benefits, borrowing against your home should be a thoughtful decision. Questions to ask before going down this route:

• Can you recoup renovation costs when you sell your home?

• Can you comfortably afford monthly payments, even if rates rise?

• Are you over-improving, exceeding the standards for the neighborhood you live in?

• Do you have a detailed renovation plan?

• Do you have multiple contractor bids to compare?

• Can you pay extra, if the project goes over budget?

• Have you shopped for the best rates?

🔍 Read more: The truth about no-appraisal home equity loans: What borrowers need to know

Other ways to pay for home improvements

If you’re hesitant to borrow against your home’s equity or want to explore other financing options, consider these alternatives when paying to upgrade or remodel your home.

• Personal loans. If you have good to excellent credit, a personal home improvement loan offers a competitive rate with no collateral required and faster approval times and processing than a home equity loan or HELOC.

• FHA 203(k) rehabilitation loan. With a 203(k) rehabilitation mortgage, you roll a home purchase or refinance and renovation costs into one loan with a lower down payment. You also get government insurance protection by using approved contractors.

• Title I Property Improvement Loan. This FHA-insured loan is designed for home improvements, even if you have little or no equity in your home. Qualified renovations substantially protect or improve the basic livability of your property.

• Contractor financing. You may be able to apply for financing right at the contractor’s office. But watch out — you face steep rates after any promotional rates end and fees if you pay it off early.

• Government programs. You might qualify for local renovation grants, energy efficiency rebates or income-based assistance from HUD, depending on your situation.

🔍 Read more: Do you qualify for homebuyer assistance? You might — even if you’ve owned a home

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Do I need an appraisal for a home equity loan?

While many home equity loans require an appraisal to determine your home’s current value, if you’ve recently bought your home and have excellent credit, you might be able to find a lender that offers no-appraisal home equity loans. These loans use digital tools and hybrid models that assess your home’s features and recently sold homes in your neighborhood, among other factors, to determine your home’s value. Start with specialty digital lenders like Lending Tree or Rocket Mortgage. And learn how they work and what to expect in our guide to no-appraisal home loans.

What types of home improvements add the most value?

New garage doors, entry doors and manufactured stone veneer tend to have the highest ROI — or return on investment — of all home improvement projects. Yet you’ll also want to balance resale value with comfort, safety and the ability to age in place. Learn more about home improvements in our guide to the top home renovations offering bang for your buck and peace of mind as you age.

I’m moving soon. Is it a bad idea to take out a home equity loan?

Taking out a large home equity loan before an upcoming move can be risky. If property values decline, you could be stuck with two loans to pay off at closing — your first mortgage and the home equity loan — potentially wiping out your equity. You’ll also face possible prepayment penalties, and the pressure of two loans could force you to sell quickly at a less-than-optimal price.

Do lenders offer autopay discounts for home equity loans?

Some lenders offer interest rate reductions of 0.25% to 0.50% if you sign up for autopay — or automatic payments from a bank account. Call the bank or credit union directly to ask about autopay or any other discounts you might be eligible for.

How long does approval on a home equity product take?

While timelines vary by lender, you can expect a wait time of around two to six weeks or longer after you’ve submitted your paperwork. Online lenders tend to have the fastest processing times.

Are there prepayment penalties on a home loan?

Yes, some HELOCs and some equity loans charge a fee for paying off your loan early, so be sure to ask your lender specifically about prepayment penalties before taking on the loan.

About the writer

Kat Aoki is a finance writer who’s written thousands of articles to help people better understand technology, fintech, banking, lending and investments. Her expertise has been featured on sites like Lifewire and Finder, with bylines at top technology brands in the U.S. and Australia. Kat strives to empower consumers and business owners to make informed decisions and choose the right financial products for their needs.

Article edited by Kelly Suzan Waggoner

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