If you own a home, chances are you're thinking of ways to add value to it. According to the 2018 Houzz & Home Study from Houzz.com, more than half of homeowners surveyed (51 percent) said they were planning beginning or continuing a home renovation. And with a median spend of nearly $10,000, those improvements can make a significant dent in a family's budget.
But what's the right approach to paying for home renovations? For many homeowners, the answer is credit cards, but that may not be the best approach. With home values at all-time highs, a better option for many may be a home equity loan.
Home equity is the difference between your home’s value and what you owe on it. A home equity loan is secured with your house and is based on the amount of equity you have built up over time. Typically, these loans have a low, fixed interest rate, which means that the payment doesn't change each month. They also offer a fixed term to repay the loan, often ranging from 5 to 15 years.
A home equity loan is a better option than incurring a large credit card balance. Here’s why:
Promotional rates don’t last
Many people are lured into using credit cards for home renovations with the promise of a zero percent interest rate for an initial period. With this approach, you may be able to spread out payments on your home renovation over multiple months, instead of having to pay it all at once.
However, if you’re not able to pay off your balance before the introductory period ends, you’ll be stuck with a high interest rate on the remaining balance. Also, if you are ever late on a payment, most credit cards immediately end introductory rates as a penalty. And if you find yourself with a balance when a credit card’s regular rates hit, your debt can quickly add up.
Consider this: having just $10,000 when your credit card flips to its regular interest rate of 17 percent will cost you $2,830 in interest over three year years. Using a home equity loan at a 5.49 percent interest rate, even with a larger $15,000 balance, will cost less than half that in interest over the same three year period.
It’s easier to have a single loan that covers all costs
Even if you have good credit and can access credit cards with high spending limits, the cost of a large renovation can easily exceed the limit for most single cards. In order to access all of the money you would need, you would have to open multiple cards –– with multiple payments, different due dates, and varying interest rates.
A home equity loan, on the other hand, can often provide all the money you need for your renovation at a lower, fixed interest rate.
The limit to how much you can borrow is contingent on the combined loan-to-value ratio of your home or CLTV. The CLTV is determined by adding your current mortgage balance to your potential home equity loan amount, then dividing the sum by your home value. The lower the CLTV, the better. If you have good credit, you may be able to borrow up to 80 percent of your home’s equity. Depending on the value of your home, this can be a sizeable amount.
No surprise fees or costs
Credit card transactions sometimes have hidden fees, which can end up costing you more than any benefits you might receive from the card. What’s more, not all contractors accept credit card payments. If they do, there are often fees associated with the payments. A series of payments that seem small at first could, over time, accumulate significant transaction fees. While contractors are warming up to the idea of accepting credit card payments, the security of having cash on hand is best when you are dealing with the uncertainty of a renovation project.
Home equity loans potentially provide tax benefits
One more excellent reason to choose a home equity loan over a credit card to pay for your renovation? You may be able to deduct the interest from your home equity loan from your taxes in much the same way you do with your mortgage interest.
There are a few special rules for deducting home equity interest based on the new tax law, so be sure to consult with an accountant first. Certified financial planner Amy Jucoski explains in an interview with Realtor.com that if you use the loan to pay for home improvements, it's considered acquisition debt, which is tax deductible.
"It's a home equity debt if the proceeds are used for something other than buying, building, or substantially improving a home," says Jucoski, which means you shouldn't expect tax benefits if you use a home equity loan to pay for a trip to the Bahamas.”
Ultimately, how you choose to pay for your renovation depends on what makes the most sense for your unique financial situation. However, in a market where property values are at all-time highs, tapping into the existing equity of your home is one of the best and most sensible options to consider.
Turn your dream home into a reality. Lock in a Figure Home Equity Line today. It only takes a few minutes to apply and if you qualify, you can get same-day approval and funding in as few as five days**.