Home Equity Loan for Remodel

For most Americans, their home is their largest asset, so it makes sense there is an interest in ensuring the property is well maintained and the home’s finishings are current. This ensures the property value will continue to increase over time. 

But what if your home is not up-to-date and you don’t have the available cash funds to remodel? A home equity loan for remodeling is your solution to unlocking your home’s full potential.

A competitive interest rate with flexible terms is what you’ll find with a home equity loan for remodeling.

Utilizing your equity, you can obtain the necessary funds to remodel your home via a home equity loan. Once the remodel is complete, your home’s equity could increase significantly, provided you updated the areas with the biggest return and did not overspend.

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What is a home equity loan?

A home equity loan is a type of home loan that allows a homeowner to borrow against the equity they have in their home. A home equity loan is a second mortgage obtained after a homeowner obtains a first mortgage and is a lump sum payment from the lender to the homeowner at the time of closing.

Your home’s equity is the difference between the value of the home and the amount you currently owe on the home.

For example, if your home is worth $600,000 and you owe $400,000 on a first mortgage, your home equity is $200,000.

Home equity loans are usually fixed interest rate loans with 10, 15, 20, or 30-year repayment terms. The monthly payments are a combination of interest and principal (they do not have interest-only payments). It’s rare, but some home equity loans do have pre-payment penalties.

Choosing a lender

Selecting the ideal lender for a home equity loan demands thorough research and consideration of various factors. First, compare interest rates and fees across multiple lenders to ensure you qualify for competitive rates and terms. This can take hours and require you to have your credit pulled multiple times to get accurate rate quotes.

Some homeowners engage with a financial advisor or broker that offers personalized advice, tailoring their choice and unique needs. These advisors or brokers ensure the lender’s requirements align with your financial profile to facilitate a smooth approval process.

Choosing the right lender takes time and full of gotchas. This is why House Numbers exists — within just a few minutes, you’ll receive a personalized rate quote and offer tailored to your specific financial situation. Get started today to see how much home equity you can access.

Home equity loan requirements

Home equity loans are not standardized like conforming loans or FHA loans. Home equity loan requirements will vary from lender to lender. However, home equity loans have some general industry requirements you will likely see with most lenders:

• Credit score of 640 or higher
• 10% or more equity in the home
• A debt-to-income ratio under 50%
• Residential property, one to four units

If you have a low credit score, I suggest you repair your credit before applying for a home equity loan.

Having less than 10% equity in the home might be allowed with some lenders; however, the benefits of a home equity loan for remodeling will be limited due to higher rates and less available funds.

If your debt-to-income ratio is higher than 50%, you’ll need to lower it before applying for a home equity loan. The debt-to-income ratio calculation is simple: take all your monthly debt payments (including your mortgage) and divide that by your gross income if you’re a W-2 employee and your net income if you are self-employed, then multiply that number by 100. For example, if your total debt payments are $3,000 and your income is $8,000 per month,

$3000 / $8000 = .375 x 100 = 37.5%

For this example, your debt-to-income ratio is 37.5%, below the recommended 45% level.

Home equity loan benefits

Here are the seven main benefits of a home equity loan for remodeling that a homeowner might see.

1. Fixed-rate
2. Fixed monthly payments
3. Competitive interest rates
4. Flexible terms and use of funds
5. Potential tax benefits (consult your tax professional)
6. You’ll have quick access to funds so you can remodel your home
7. If you have an existing mortgage with a low rate, you don’t have to give that up

These seven home equity loan benefits can substantially impact a homeowner’s long-term financial path.

In a high-interest rate environment, having a stable fixed rate and monthly payment provides safety and stability. Interest rates for home equity loans are competitive to first-rate mortgage loans, and the terms provided by lenders are usually flexible. The homeowner avoids changing the terms of their first mortgage via a cash-out refinance.

A homeowner can use the funds for remodeling without restriction, and you might see a tax benefit (you must consult your tax professional to determine if there is a tax benefit).

The process of obtaining your loan is generally quick, and the best thing is you won’t have to touch your first mortgage. This is helpful if the rate on your first mortgage is below current market rates.

Home equity loan cons

Home equity loans are not for everyone and are not the right solution for every situation. Here is a list of home equity cons homeowners should consider before doing a home equity loan for remodeling.

• You generally have to do an appraisal of your home
• Closing costs can be high with some lenders
• No interest-only payment available during the repayment period
• Some home equity loans have a pre-payment penalty for an early payoff
• When priced at the same time, rates are higher than first mortgage rates
• Not all lenders offer a 30-year repayment term; some only offer a ten or fifteen-year repayment term. This means your payment might be higher than you want.

If your home equity loan lender has a pre-payment penalty, has high closing costs, and/or doesn’t offer a 30-year repayment term, I suggest you get additional quotes.

Home equity loan closing costs

Home equity loan closing costs are usually paid by the borrower however, sometimes a lender will provide a small credit to help cover some of the closing costs

Home equity loan closing costs might include lender fees, discount points, and third-party fees.

Lender fees

Examples of lender fees include underwriting and credit report fees. Usually, this will range from $400 – $700. Another lender fee you might see is an origination fee. An origination fee is an amount charged by the lender to cover services rendered.

Origination fees are usually expressed in the form of a percentage of the loan amount. Paying origination fees is fairly standard on home equity loans.

Discount points

Discount points are a cost a homeowner pays to lower their interest rate. Like the origination fee, the amount is usually expressed in the form of a percentage of the loan amount. Your loan officer should provide an option with and without discount points so you can decide on which loan structure is better.

Home equity loan third-party fees

Home equity loan third-party fees are comprised of anyone outside of your lender who contributed to the processing and closing of your transaction. Such as an appraiser, closing agent, and homeowners insurance.

Government recording fees

Government recording fees are the amount you’ll pay to your local or state governments to record the mortgage-related documents as public records. The amount a homeowner will pay will vary from one transaction to the next and usually depends upon the number of pages recorded.

Pro tips for finding and working with a lender

Navigating the process of obtaining a home equity loan for remodeling might seem daunting and a bit overwhelming. Searching online for lenders that offer a home equity loan will result in thousands of results. Then there’s the actual loan process of completing a loan application, getting an underwritten approval, and closing your loan.

Here are my pro tips for finding and working with a lender.

Keep your search simple

I’m a big advocate for using online resources to find a lender. The problem is most homeowners don’t know how to effectively utilize the internet to find a lender to work with.  Most homeowners that use Google to find a lender will search for a generic term such as “best lender to work with,” and the results Google provides are for websites that excel at search engine optimization.

So what should a homeowner do?

Your first step is to visit the Better Business Bureau website and locate mortgage companies with an A or A+ rating. You can go one step further and request your search only provide “accredited” mortgage companies.

You should also use Business Consumers Alliance, Zillow, and Yelp. Then, go to Google and research the lender if you need additional information.

Choosing to work with a mortgage company that has been around for more than just a few years and a loan officer with experience and a verifiable reputation is important. Let the loan officer know you are looking to do home improvements and how you arrived at your estimated amount needed.

Another review website is TrustPilot. That’s what House Numbers uses for reviews and you’ll notice they have a handful of 5-star reviews:

Avoid getting too many quotes

Some homeowners feel the need to get more than three or four quotes; however, when you get too many quotes, you’ll most likely hit information overload and waste a lot of time. If you’ve done the legwork before getting quotes, you don’t need to get more than two to four quotes unless you’re not finding what you’re looking for. Your quotes should include at least one or two top-rated mortgage brokers since these companies typically have access to multiple funding sources.

Working with your lender

The key to making sure your loan process is smooth and efficient comes down to the following;

• Know your loan
• Be responsive to requests
• Have clear expectations on your timeline
• Make sure your lock covers your timeline and then some

Even after 17-plus years in the mortgage industry, it still surprises me when someone trying to find an alternative to the lender they’ve been working with doesn’t know exactly the terms they applied for. Everyone knows the rate, but few can answer the question of what the total amount of fees are, including points, lender, third party, and government recording fees.  

It’s imperative that you know exactly what you are signing up for, including both the rate and the total amount of fees you must pay. 

During the process, you’ll have to turn in your documentation. Make sure you turn that in on time, and make sure it’s complete. Never substitute a document before you talk to the loan officer to confirm a substitution.

When you apply for the loan, get the loan officer’s timeline for closing in writing. I don’t just mean “we’ll close in about thirty days.” Get an actual timeline.

Week one: gather documentation, complete an application, order the appraisal, and turn the file into the underwriter. Week two: complete the appraisal inspection and obtain the underwritten conditional approval. Week three: appraisal report is due, and final loan approval is obtained. Week four: sign loan documents and close the loan.

Top three remodels a homeowner should consider

You should focus on three areas when obtaining a home equity loan for remodeling: your kitchen, bathrooms, and bedroom addition. When it comes to bathrooms, focus on the master bathroom first, then either the secondary or common bathroom for visitors.

And if you have kids and plan on remodeling their primary bathroom, examine your spending. Why? Ask any family with teenagers what happens to the kid’s bathroom over time. Take it from a Dad with two teenage boys: durability is more important than style.

Kitchen remodel

A home improvement project that includes a kitchen update will get you the biggest bang for your buck when it comes to a remodel. When considering a kitchen remodel, focus on simplicity and keeping your costs low. Avoid overcomplicating the remodel (that can get costly), and don’t buy into the latest hype that will push your budget up 10-20%.

Social hype around a kitchen design doesn’t always last and might be outdated within two to three years. I suggest going with a kitchen remodel that is both modern in style and functionality. A design that will stand the test of time.

From the flooring to the cabinets to the appliances, ensure you align with neighborhood norms to avoid wasting money.

Bathroom remodel

A bathroom remodel is generally your easiest and usually costs less than a complete kitchen remodel. The same rules for a kitchen remodel apply: focus on simplicity and keeping your costs low. Make sure you are using materials that are typically found in renovated bathrooms in your neighborhood.

Adding a bedroom

Adding a bedroom can be costly but also provide significant value. If most homes in the neighborhood have three bedrooms (or four), and your home only has two, then adding a bedroom might be your best bet for remodeling your home.

Keep the materials and size of the bedroom within the neighborhood norms to ensure the most return on your investment.

When it comes to remodeling, avoid vanity spending

Funds you receive from a home equity loan for remodeling should be used wisely. Wasting money on vanity improvements provides little long-term value to the property. What are examples of vanity improvements? 

Putting in a pool that is over the top and significantly more “grand” than other pools in the neighborhood. While going big on a pool might add to your backyard fun and give you something to brag about, it will not help the value of your home as much as you think (if no other homes in the area have a similar-sized pool with all the same bells and whistles).

Another vanity improvement is using significantly higher-end materials than typically found in the neighborhood. For example, if most of the higher-end homes in your neighborhood are getting their materials from a local home improvement store like Home Depot, that is what you should do. 

If you decide to go big on your remodel and import marble from Italy and furnishings from a boutique manufacturer in France, you will not get the return you expect from spending the extra money on high-end furnishing (if that differs from the neighborhood standard). It may look nice, and like the pool, you’ll be able to brag to your neighbors, but that’s about all the benefit you’ll get.

Additional vanity improvements include raising ceilings above neighborhood norms and backyard improvements that are significantly “better” than what is available in the neighborhood. Just because a homeowner spends $40,000 on a new pergola, polished concrete, and a BBQ pit does not mean the homeowner will get anywhere near a $40,000 increase in value (unless other homes in the area also have that).

How to handle regentrification of a neighborhood

What if you have no updated homes in the area and the neighborhood is undergoing a regentrification process? That’s a great question, and my best advice is to proceed cautiously.

Unfortunately, you’ll have to make your best guess as to how you will remodel the home and how much you will spend since there are few to no sales in the neighborhood with updated homes.

You can use this suggestion as your guide, look at nearby neighborhoods that have undergone a regentrification process, and remodel your home to similar standards. When in doubt, keep it simple and use materials considered middle-of-the-road to ensure you’ll see a return on your investment and not overspend.

Top three inexpensive remodels

If your home equity loan for remodeling is less than you had hoped for, there are three inexpensive remodels you can do to improve the value of your home. 

• Paint
• Carpet
• Faucets and handles

It’s amazing what a fresh coat of paint can do to the feeling and your home’s equity. A can of paint, a tarp to cover the flooring, and a brush are usually under $75.

Another inexpensive option is carpet. At under $5 a square foot installed, you can generally carpet an entire house (outside of where there are no carpet areas like kitchens and bathrooms) for a minimal amount of money and a relatively short period of time.

Faucets and handles (cabinets and doors) are a great way to improve your home for a minimal amount of money. If you are updating your cabinet and door handles, don’t forget to update the hinges as well. Having your door handle one color/style and your door hinges another takes away from the update and looks incomplete.

Home equity loan alternatives

A home equity loan for remodeling is not always the right choice for a homeowner. Here are some alternatives a homeowner might consider.

• Cash-out refinance (first mortgage)
• Unsecured personal loans
• Credit Cards
• Borrow money from family or friends
• Home Equity Line of Credit

Cash-out refinance

In a low-interest rate environment, a cash-out refinance of your first mortgage might be a good alternative to a home equity loan. In this scenario, you would refinance the entire loan amount you currently owe and add on the amount of cash you need for your remodel.

But a cash-out refinance should only be considered an alternative if current rates are near, at, or below your current first mortgage rate.

Unsecured personal loans

Over the last five years, there has been a surge in unsecured personal loan offerings from banks and consumer lenders. Provided the unsecured personal loan is from a reputable source, this is a solid alternative if you need a small amount of money for your remodel. Repayment terms on unsecured personal loans are generally two to five years, so your payment will most likely be unaffordable if you have a large loan amount.

Credit cards

Credit cards are a go-to alternative if you need a small amount and you get one of those 0% offers. Just keep in mind this important rule: only borrow what you can pay back before your 0% rate expires.

Loan from family or friends

When getting a loan from a family member or friend, tread carefully and put the terms in writing (this is a must). You never want to jeopardize your relationship with a family member or friend due to a failure to document the terms of your loan.

HELOC Vs. Home equity loan for remodeling

Here are the key differences between a home equity line of credit (HELOC) and a home equity loan.

A home equity line of credit is also known as a credit line and is a solid alternative to a home equity loan. Closing costs between the two are similar; however, the repayment period usually differs.

Previously, I discussed the repayment schedule for a home equity loan (fixed principal and interest payments for the entire life of the loan). With a home equity line of credit, you have a draw period in which you can access the credit line, and during this time, you have a minimum monthly payment based just on interest.

After the draw period, you revert to a regular amortized loan where you pay both principal and interest. Usually, your draw period is five or ten years, and your repayment schedule for principal and interest is over twenty-five or twenty years.

You can read our article to learn more about the differences between a HELOC and Home Equity Loan. 

Final points on a home equity loan for remodeling

A home equity loan for remodeling is a great way to utilize your home equity to improve the value of your home. The requirements for a home equity loan will vary from one traditional lender to the next, but there is some uniformity across the mortgage industry. A home equity loan provides cash for whatever home improvement projects you have planned.

Disclaimer: The above is provided for informational purposes only and should not be considered tax, savings, financial, or legal advice. All information shown here is for illustrative purpose only and the author is not making a recommendation of any particular product over another. All views and opinions expressed in this post belong to the author.