Should You Use a HELOC for Home Improvement? (2024)

HELOCs are a type of revolving credit that allows homeowners to tap into the equity they’ve built in their property. HELOCs provide homeowners with a predetermined credit limit from which they can borrow money as needed.

What sets HELOCs apart is their flexibility — borrowers can access the funds at their discretion during the “draw period,” which is often around 10 years. As you repay the borrowed amount, the credit becomes available again, much like a credit card. The interest rates on HELOCs are usually variable and tied to a benchmark like the prime rate.

When financing home improvement projects, HELOCs can offer a convenient avenue. Homeowners can use the funds from a HELOC to undertake a wide range of upgrades, from minor renovations like kitchen remodeling or bathroom updates to more substantial projects like adding an extension or renovating the entire house. Since you have the flexibility to access money as needed, you can manage the project’s expenses over time.

“A HELOC can be a beneficial financial tool when you need liquidity from your home’s equity in order to pay for home improvements or additions that will increase the value of your home,” said Dana Menard, CFP®, founder and lead financial planner of Twin Cities Wealth Strategies.

Using a HELOC to finance your home improvement project can offer advantages and disadvantages. Let’s look at the pros and cons to help you make an informed decision that aligns with your financial goals and renovation aspirations.

Pros of Using a HELOC for Home Improvement

• Flexibility in money usage: HELOCs allow you to access funds as needed during the draw period, giving you the flexibility to manage various stages of your home improvement project.
• Potentially lower interest rates: HELOCs often come with lower interest rates compared to other unsecured forms of borrowing, potentially helping you save on financing costs over time.
• Tax benefits: In some cases, the interest paid on a HELOC used for home improvements can be tax-deductible, providing potential financial relief come tax season.
• Tailored borrowing: HELOCs offer a credit limit based on your home equity and creditworthiness, enabling you to borrow an amount that suits your project size without overextending your finances.
• Incremental payments: With interest-only payments during the draw period, you can manage your cash flow more effectively, focusing on the interest while keeping the principal amount untouched until you’re ready to repay it.

Cons of Using a HELOC for Home Improvement

• Variable interest rates: Though some lenders offer fixed-rate HELOCs, most products feature variable rates which can fluctuate over time, potentially leading to higher payments and increased borrowing costs if market rates rise.
• Risk to home equity: Since a HELOC uses your home as collateral, defaulting on payments could put your property at risk of foreclosure if repayment becomes unmanageable.
• Long-term debt risk: Extending your repayment timeline with a HELOC could result in carrying debt for an extended period, potentially affecting your financial freedom.
• Payment shock: Once the draw period ends, you’ll transition into the repayment phase, which includes principal and interest. If you’re not adequately prepared, the larger monthly payments might catch you off guard.
• Potential over-borrowing: The accessibility of funds might tempt you to borrow more than necessary, leading to unnecessary debt accumulation that could strain your finances.

Deciding whether to use a HELOC for your home improvement project hinges on various factors unique to your financial situation. In this section, we’ll guide you through essential considerations to ensure you make an informed choice that aligns with your needs and goals.

Project’s Scope and Cost

Before jumping into a HELOC for your home improvement, it’s a good idea to thoroughly assess the scope and cost of your planned upgrades. Begin by outlining the details of your project — whether it’s a minor renovation, a room expansion or a comprehensive overhaul. This will help you estimate the required materials, labor and potential permits. Creating a detailed project plan can prevent surprises and give you a clearer picture of the financial commitment involved.

Budget considerations are equally important. Determine your available funds and evaluate how much you will allocate from your own resources. While a HELOC can provide additional financing, it’s generally wise to ensure that your existing budget can cover a portion of the project’s cost.

Additionally, you may factor in a buffer for potential cost overruns or unforeseen expenses. Keeping a cushion within your budget can help you manage unexpected twists without stretching your finances to their limits. Responsible planning and setting realistic expectations are fundamental steps in ensuring your home improvement endeavor is financially viable.

Potential Return on Investment (ROI)

Understanding the potential ROI is vital before using a HELOC for home improvement. To estimate ROI, research the value added by similar renovations in your area. For instance, if a $20,000 kitchen remodel could raise your home’s value by $30,000, the ROI would be 50%:

ROI = (Net Gain from Improvement / Cost of Improvement) * 100 ROI = ($30,000 – $20,000) / $20,000 * 100 ROI = 50%

Remember, actual ROI can vary based on market fluctuations, local real estate trends and the quality of the renovation. Conduct thorough research and consider consulting a real estate professional to refine your ROI estimate to ensure you make a financially sound decision.

Your Budget

When considering a HELOC for home improvement, recognize that your property is at risk if you cannot meet the required payments. Ensuring that you have ample room in your budget to accommodate these payments is essential. Failing to make payments on time could jeopardize your homeownership, underscoring the significance of meticulous financial planning and a budget that comfortably accommodates your borrowing obligations.

Alternatives

While a HELOC can be a viable option for home improvement financing, it’s worth exploring alternative avenues that may better suit your circ*mstances before making a final decision.

1. Personal loans: Embarking on a smaller project with a defined budget and timeline? A personal loan’s fixed interest rate and structured repayment plan can offer stability without the risk associated with a HELOC.
2. Savings: If your renovation expenses align with your existing savings and won’t compromise your emergency fund or other financial goals, using your savings might eliminate the need for borrowing.

If you anticipate selling your home in the near future, evaluating the current real estate market can also help you determine whether the potential increase in home value from your renovation justifies the borrowing costs.

Ultimately, the decision hinges on your financial situation, project scope and risk tolerance. By carefully assessing these factors and considering alternatives, you can confidently choose the financing option that best aligns with your goals and financial well-being.

A structured approach is essential when obtaining a HELOC to finance your home improvement project. In this section, we’ll walk you through the key steps to help you navigate the process with confidence and clarity.

Check Your Eligibility

Before proceeding with a HELOC application, assessing your eligibility is crucial. Lenders typically consider several factors to determine whether you qualify for a HELOC. One primary aspect is your credit score — a higher credit score often increases your chances of approval and favorable terms. Additionally, your loan-to-value (LTV) ratio will be evaluated and calculated by dividing your outstanding mortgage balance by your home’s current value. A lower LTV ratio is generally preferable, indicating a higher level of equity in your home.

The lender may also require a property assessment to determine your home’s current value. This assessment ensures that the loan amount you’re requesting aligns with the property’s worth. Remember that each lender might have specific eligibility criteria, so inquire about these requirements beforehand.

Research Lenders

When seeking a HELOC for your home improvement project, explore various lenders to find the best match for your needs. Different types of financial institutions offer HELOCs, including traditional banks, credit unions and online lenders. You can even check with your current mortgage company. Each option comes with its own set of advantages and considerations.

As you research lenders, consider critical factors beyond the interest rate. Pay attention to fees: application fees, annual fees and any potential closing costs associated with the HELOC. A lender with transparent and reasonable fee structures can significantly impact the overall cost of your borrowing. Additionally, consider the lender’s reputation for customer service, responsiveness and online accessibility. A lender that offers an intuitive online platform can simplify the application and management process.

Get Prequalified

Prequalifying for a HELOC is a preliminary step that helps you gauge your potential borrowing capacity and allows you to compare offers from different lenders. It estimates how much you can borrow based on your financial situation and it’s a valuable tool to streamline your HELOC search.

To get prequalified:

1. Gather financial information: Gather your income, credit score, outstanding debts and property value. Having this information on hand will help you accurately assess your eligibility.
2. Choose lenders: Research and select a few lenders you’re interested in. This could include traditional banks, credit unions or online lenders.
3. Submit basic information: Visit the lender’s website or contact their representatives to initiate the prequalification process. You’ll need to provide basic personal and financial information.
4. Wait for a response: The lender will review your information and assess your preliminary eligibility. They will provide you with an estimate of how much you can qualify for and the terms you can expect.
5. Compare offers: Consider factors like interest rates, fees, repayment terms and customer service quality.

Fill Out a Loan Application

The next step is to proceed to the formal application process, which typically involves:

1. Completing the application form: Start by filling out the lender’s application form. This will require you to provide detailed personal, financial and property information.
2. Gathering documentation: Commonly required documents include recent pay stubs, tax returns, W-2 forms, property assessment reports and proof of insurance.
3. Property appraisal: The lender might initiate a property appraisal to determine your home’s current value. This step is crucial in calculating the maximum credit limit for your HELOC.
4. Credit check: The lender will perform a credit check to assess your creditworthiness. A higher credit score can lead to more favorable terms.

Close on Your HELOC

The timeline for obtaining a HELOC can vary based on factors like the lender’s processing speed, the complexity of your financial situation and the completeness of your application. Once you’ve submitted all necessary documents, the lender’s underwriting team will review your application. They will assess your financial stability, credit history, property value and other relevant factors. Typically, the entire process — from application submission to loan approval — can take a few weeks to a couple of months.