Should You Use a HELOC for a Renovation?

By Realty Times Published Nov 25, 2020 09:42 am Updated Dec 2, 2020 09:46 am

A lot of people, thanks to low-interest rates, are thinking about home renovations right now. You have different options to pay for these projects if you’re not going to pay in cash. One option is a Home Equity Line of Credit or HELOC.

A HELOC is a way to borrow against your home’s equity, and it provides flexibility. With that being said, because of that flexibility, you need to be careful to stay on budget when you use funds.

The following are some things to know about a HELOC, particularly if you’re thinking about using it for a renovation.

How Does a HELOC Work?

With a HELOC, you’re spending in a way that’s similar to a credit card. You borrow up to a certain limit as defined by your lender. Then, you pay back whatever you borrow with interest. You can withdraw and make payments on whatever basis works best for you.

A lender gives you a draw period, which is the time you can withdraw money. When your draw period is ended, you may be able to renew the credit line.

If you don’t or can’t renew, you pay the outstanding balance either all at one time, or you do so over a repayment period.

HELOC lengths can run as long as 30 years.

The benefits of a HELOC and flexible repayment include the fact that you only borrow what you need, and many have no fees. The interest on a HELOC might be deductible if you use your funds for home improvements.

What Are the Risks?

While HELOCs can work well for funding a renovation, there are possible risks to be aware of before you borrow.

Since your home is your collateral, if you don’t make the payments, you could lose your home. Typically a lender will try to protect against this by limiting borrowing amounts, but it’s still a big consideration.

A lender can also freeze a credit line or reduce it. You’ll only see this usually if you haven’t made your payments or your home’s equity changes, but it’s something to think about.

The interest rates on a HELOC are variable, and they’re tied to the prime rate. If there are changes in the market, you may end up paying more so that uncertainty may not be ideal.

How Does a HELOC Compare to a Home Equity Loan?

A home equity loan is another financial product often used to fund renovations and home projects.

A home equity loan also involves borrowing against the equity in your home, which is used as collateral. A home equity loan differs from a HELOC because it’s a lump-sum loan rather than a revolving line of credit. You pay the loan back over its life plus interest, and you make those payments based on a set schedule. Most home equity loans have a fixed interest rate, which alleviates the worry of fluctuating market conditions impacting interest rates.

When is a HELOC the Right Choice?

If you’re deciding between a HELOC and a home equity loan, the loan might be better if you’re certain of the cost of your project. If you’re comfortable with a fixed monthly payment, a home equity loan could be the better option.

On the other hand, a HELOC might be right if you want a lot of flexibility in how much you borrow. Maybe you’re not sure about the scope of your project or what your budget will be.

The biggest differentiators between the two will come down to first, flexibility, and second, certainty. If you want flexibility, consider a HELOC. If you want certainty, think about a home equity loan.