Is an equity loan the best way to finance major home repairs?

You can pay for a major home repair like a new roof or a remodel like a kitchen remodel in several ways. Among them, a home loan gives you access to your home equity and provides generally lower rates than other loans.

Using your own equity has a number of benefits, but it also has drawbacks to consider. Mainly, when you use your home as collateral, you risk losing it through foreclosure if you fail to repay the loan.

Learn more about how to use a home loan to pay for major home repairs, as well as learn more about the pros and cons of this financing strategy.

Key takeaway

  • Home equity loans are installment loans secured by your home.
  • An advantage of using home loans to finance a home improvement project is that they generally offer low, fixed interest rates.
  • Alternatives to using a home equity loan include a home equity line of credit (HELOC), personal loan, or credit card.

What is a home loan?

A home equity loan is an installment loan secured by the equity in your home. Equity is essentially the value of your home minus any debt such as your mortgage or the value of your home that you own with no other credit.

You build equity when you pay off your mortgage principal and when the value of your property rises. Home equity loans tend to provide lower interest rates than, for example, personal loans or credit cards because your home is used as collateral. So if you don’t make the payments, the lender can potentially recoup any losses by foreclosing your home.

Home equity loans generally offer fixed payments with fixed interest rates over terms ranging from five to 30 years. They are typically paid in a lump sum after closing, making them ideal for large repair projects or major purchases.

Home Equity Credit Lines (HELOCs) are a similar product often used to finance a home improvement or home repair project. Unlike home equity loans, HELOCs generally have variable interest rates, resulting in unpredictable monthly payment amounts. They are also a revolving line of credit, so you can only withdraw the amount you want to use when you need it.

The best way to pay for home repairs

Of course, the best way to pay for home repairs is to use cash because you can avoid getting into debt and paying interest. You can also avoid using your home to get a loan, which puts you at risk of losing it if you can’t pay.

However, many homeowners don’t have the money to spare for a large project. Home equity loans or HELOCs are a good alternative to cash because they can offer lower interest rates. Using a higher interest rate product like a credit card can add significant interest costs, as well as potentially hurt your credit score.

The cost of home repairs can vary greatly depending on the type of home repair. For example, replacing an HVAC system can cost anywhere from $ 3,000 to $ 6,000, while a new water heater can cost around $ 1,000.

Home improvement projects can also be expensive, with costs varying based on the type of project, size, and materials, among other factors. The price for a bathroom remodel, for example, can range from around $ 6,600 to $ 16,600, and a kitchen remodel can range from around $ 13,400 to $ 38,300.

Home improvement projects can potentially increase the value of your home. So this financial advantage can often offset the disadvantages of taking out a loan.

Home loans against credit cards

If borrowing money is your best option to finance your major home repair project, we recommend weighing the pros and cons of a home equity loan against other products, such as credit cards.

While credit cards may offer greater flexibility, they also have much higher interest rates. The average credit card interest rate was 19.62% as of August 3, 2022, according to data from Investopedia. Interest rates on home loans, on the other hand, range from about 3% to 10%. You may have some closing costs with a home loan, but they likely won’t exceed what you would pay in compound interest on credit card debt.

For example, if you financed a $ 15,000 bathroom renovation using a credit card with a 17% interest rate and paid it over five years, you’d accumulate $ 7,367 in interest. Paying for the same project with a home loan at an interest rate of 5.25% over the same period would accrue $ 2,087 in interest without any risk of interest rate hikes.

Home equity loans have fixed interest with predictable payments, which makes budgeting easier for them. Consumer credit card interest rates, on the other hand, are variable and based on the Federal Reserve prime rate. Your credit card interest rate may change depending on market conditions.

Some credit cards offer promotional interest rates that can go as low as 0% for a set period of time, such as from one year to 18 months. However, if you are unable to pay the balance by the end of the promotional period, the original rate will be applied to the remaining balance.

How Much Can I Borrow On A Home Loan?

Most lenders will allow you to borrow up to a certain percentage of your property’s equity, such as 80% of your equity. This limit protects the lender from falling property values ​​and reduces the risk that they will not get their money back in the event of insolvency.

Do I have to use an equity loan for home improvements?

You can use a home loan for any purpose. There are no restrictions on your home loan, so you can use it, for example, to buy property, pay for a wedding, or finance a child’s education.

What Credit Score Do I Need For A Home Loan?

Most lenders look for a credit score above 660, but higher credit scores will earn better interest rates. Lenders look for a history of on-time payments and low credit usage to determine if you are likely to make loan payments.

The bottom line

A home equity loan can be a good financing option for people who have ample home equity but don’t have the money to finance a major home repair. These loans offer competitive interest rates and fixed, predictable payments. Consider both of these benefits and the potential drawbacks of using your home as collateral when deciding if this loan is right for you.

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