Financing a Home Renovation: When Is It Worth It?

Financing a Home Renovation: When Is It Worth It?

The rise of TV shows like Fixer Upper and Flip or Flop have many homeowners and potential buyers considering renovation as an option to generate value and equity in their home. DIY projects can be exciting, but do they really add value to the home? How do you know when it makes sense to put the sweat and financial equity back into the home? Understanding how the process works, when to update, and how to fund can be the difference between pretty aesthetics with no value and an equity increase through renovation.

What is A HELOC?

A HELOC is a Home Equity Line of Credit that allows borrowers to borrow additional funds using the home’s equity as collateral against the loan. Lenders look at the appraised value of the home to determine the borrowing limit. HELOCs are like a credit card or a line of credit in business. The money is in escrow to be used as needed.

HELOC Versus Home Equity Loan

HELOCs are different from a home equity loan. Home equity loans provide a lump sum of the approved amount and a payment is due every month for this loan. A line of credit is revolving, meaning the borrower can pay on the amount used and continue to pull money from that account up to that limited amount. Again, this is like a credit card. HELOCs have variable interest rates compared to home equity loans which are based on fixed rates.

Home equity loans are pushed by many companies, but the issue with these loans is that the appraised value of the home is dependent upon outside factors other than the home. If the buyer plans to sell the home and the home appraises under the value of the existing loan totals, then the buyer is now responsible for the difference of the loan. Many fell victim to this prior during the 2008 crash.

Example of a HELOC Rate:

In theory, a home that was sold for $308,000 and has equity of $100,000 needs a renovation. The borrower can reach out to the mortgage lender for a HELOC. The loan officer determines the home is valued at $308,000. The lender can loan on the equity total, less 20% of the home’s value of $308,000. The 20% total is $61,600. So, $100,000-$61,600 equals $38,400. The loan officer can provide a HELOC in the total amount of $38,400 for updates.

When Should HELOCs Be Used?

  • Is this your forever home? If the buyer plans to stay in this home for an extended period, a HELOC can make sense. The loan is a revolving line of credit that must be paid by the buyer, regardless of the value of the home after completion of projects. This eliminates the risk of the home appraisal value dropping and the difference being owed. If the homeowner feels this is not the forever home and still wishes to complete updates, it may make more sense to save for these versus borrowing.
  • Can you budget for renovations? Projects often can extend past the expected budget, which can cause issues for borrowers. If the borrower has properly reviewed the project budgets, a HELOC is a great option.
  • More room: In love with your home, but have outgrown the space? HELOCs are a great option for those planning to stay in the home for years to come that need additional space for family, work or fun additions.