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Using a HELOC for home improvements: is it a good idea?
Using a HELOC for home improvements can be a good idea and there are several advantages, including a tax benefit, when you use the money to make home improvements.
If you are approved for a HELOC, it's important not to overspend or lose focus and spend the funds on things other than home improvements. A HELOC is a second mortgage and your home will be used as collateral. Borrowing against your home equity can put your home at risk of foreclosure if you are late with making payments or cannot repay the loan.
Read on to learn more about using a HELOC for home improvements.
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What is a HELOC?
A Home Equity Line of Credit (HELOC) is a type of “revolving” credit that is provided by a lender which has a credit limit, a variable interest rate, and which is secured by the equity in your home. Most HELOCs have a 10-year “draw period” during which money can be borrowed, followed by a repayment period.
There are HELOC pros and cons to consider. One of the advantages of a HELOC is that you can take out money as you need it, and you will only pay interest on the amount you use.
How to use a HELOC for home improvements
Applying for a HELOC is like applying for a mortgage and will require the borrower(s) to provide the lender with W2s/1099s pay stubs, tax returns, and other documentation.
Approval for a HELOC will require sufficient home equity as well as meeting the lender's HELOC eligibility requirements.
If you are approved for the loan, your HELOC funds will be deposited into an account that comes with checks and a debit card so you can start making those home improvements you've been planning.
Advantages of using a HELOC for home improvements
There are several advantages of using a HELOC for home improvements.
High loan limits. Qualified borrowers with ample home equity may be able to get approved for amounts up to $1,000,000, ideal for significant home improvement projects. This is a higher loan limit than personal loans or credit cards provide.
Flexible spending. Use only the amount you need and pay interest on only the amount you use.
Lower interest rates. HELOCs start with a low variable interest rate that typically stays in effect for a 10-year draw period, during which you can withdraw from your line of credit. The interest rate on a HELOC may be lower than interest charged on credit card purchases and personal loans.
Tax benefits. According to the IRS, interest paid on home equity loans and lines of credit are deductible only if the borrowed funds are used to buy, build, or substantially improve the taxpayer’s home that secures the loan. The loan must be secured by the tax-payer’s main home or second home (qualified residence) and meet other requirements.
Interest-only payments during the draw period. During the draw period most HELOCs charge interest-only on the amount of the loan you use. After the draw period ends and the repayment period begins, you'll be required to start paying back any outstanding principal, as well as interest.
Disadvantages of using a HELOC for home improvements
Before you take out a HELOC for home improvements, there are some disadvantages to be aware of.
Time-consuming to obtain. As with a traditional mortgage, you will need to complete an application. How long it takes to get a HELOC will depend on how quickly you supply the lender with the required documentation and the time it takes the lender to process the loan application.
Closing costs. Depending on the lender you choose, a HELOC may have closing costs. Closing costs are paid by the loan applicant(s) at the time the loan is granted and cover various costs associated with processing the loan application and transaction.
Variable interest rates. HELOCs typically start with a variable interest rate which may change to a higher variable rate after the promotion ends or may convert to a fixed rate.
As the rate goes up, some borrowers find it difficult to repay the loan at a higher rate. Failure to repay a HELOC means the lender could foreclose and take possession of your home.
Potential to overborrow. Having easy access to money makes it tempting to borrow more than you need for your home improvement project or spend the money on luxury purchases. Be sure to use your HELOC for the original intended purpose of making home improvements.
Payment increases after the draw period ends. All HELOCs have a draw period during which the interest rate will be variable for part or all that timeframe (typically 10 years). After the draw period ends, the interest rate will increase. How often HELOC rates change depends on the lender and other factors.
Tips for using your HELOC for home improvements
Making home improvements can be fun and exciting, however, using a HELOC for home improvements requires focus and responsibility. Afterall, a HELOC is a second mortgage that must be repaid according to the lender's terms.
Know how much you need to spend. Get several estimates from contractors, so you know how much of a HELOC you will need.
Only borrow what you need. If you have good credit and sufficient home equity, you may get approved for a higher loan amount than you need. Before you accept a HELOC for home repairs create a project budget and match it to your loan amount.
Determine if you really need the extra money. Looking at your project budget, consider whether you really need a HELOC for home improvements. Is it possible you can get the money you need from your savings account?
Pull funds in phases. If you get approved for a HELOC for home improvements, using the funds in phases prevents overspending, helps with budgeting your monthly payments, and keeps money available in your line of credit as your home improvement project progresses. As you pay back your HELOC, the funds will be replenished.
How do HELOCs compare?
To help you decide which type of loan or credit is best for your home improvement project, here are examples of how a HELOC for home improvements compares to other lending options.
HELOC Vs. home equity loans. A home equity loan provides the loan amount in a lump sum. Most home equity loans have a fixed interest rate for the life of the loan that’s charged on the entire lump sum amount you receive, whether or not you use any of the funds. With a HELOC, you only pay interest on the amount you use.
HELOC Vs. cash-out refinance. A cash-out refinance is when a homeowner refinances their mortgage to a new mortgage (typically at a lower interest) and borrows more than what is owed on the current mortgage. The first mortgage is paid off in this process and the homeowner gets a lump-sum payout of the extra cash amount at closing. If you currently have a low mortgage interest rate, you don't want to lose it in a refinance, so a HELOC may be the better option.
HELOC Vs. personal loans. Personal loans provide a lump-sum payment that you will need to repay in monthly installments. When it comes to HELOC vs. personal loan rates, HELOC rates may be lower than personal loan interest rates, depending on whether the personal loan is secured or unsecured.
HELOC Vs. credit cards. For simplicity, a credit card can be a good option for making home repairs. Many credit cards offer a promotional 0% APR (annual percentage rate) for a fixed period, usually 12 months. After the promotional rate expires, there will be a new higher rate applied to the outstanding balance.
HELOC Vs. regular savings. Savings accounts are typically used for saving money, rather than paying debts. However, if you need to make urgent home repairs, taking money from your savings account is a quick and easy option.
Why Savvy Consumers Choose CU SoCal
For over 60 years CU SoCal has been providing financial services, including HELOCs, car loans, personal loans, mortgages, credit cards, and other banking products, to those who live, work, worship, or attend school in Orange County, Los Angeles County, Riverside County, and San Bernardino County.
Please give us a call today at 866.287.6225 today to schedule a no-obligation consultation with one of our HELOC experts.
Get Started on Your Home Equity Line of Credit Today!
