Is a mortgage the best way to finance major home repairs?
You can pay for a major home repair like a new roof or a renovation like a kitchen remodel in a variety of ways. Among them, a real estate equity loan gives you access to your real estate equity and generally offers lower rates than other loan rates.
Using your home ownership has a number of advantages, but it also has downsides to consider. Essentially, when you use your home as collateral, you risk losing it to foreclosure if you can’t pay off the loan.
Learn more about how to use a home equity loan to pay for major home repairs, as well as more about the pros and cons of this financing strategy.
- Home equity loans are installment loans that are secured by your home.
- One advantage of using home purchase 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 purchase line of credit (HELOC), a personal loan, or a credit card.
What is a home equity loan?
A home equity loan is an installment loan secured by your home equity. Equity is basically the value of your home minus any debt such as a mortgage, or the value of your home that you own without any other claims.
You build equity when you pay off the principal of your mortgage and when the value of your property goes up. Real estate loans tend to offer lower interest rates than personal loans or credit cards, for example, because your home is used as collateral. So if you fail to make the payments, the lender will likely recoup any losses by foreclosing your home.
Home equity loans generally offer fixed payments with fixed interest rates over periods of five to 30 years. They are usually paid in a lump sum after closing, making them ideal for large repair projects or large purchases.
Home ownership lines of credit (HELOCs) are a similar product often used to finance a home improvement or home repair project. Unlike equity loans, HELOCs generally have variable interest rates, resulting in unexpected monthly amounts. It’s also a revolving line of credit, so you can only get 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 borrowing and paying interest. You can also avoid using your home to secure a loan, which puts you at risk of losing it if you can’t make the payments.
However, many homeowners do not have the money available for a large project. Home equity loans, or HELOCs, are a good alternative to cash because they can offer lower interest rates. Using a product with a higher interest rate such as a credit card can add significant interest costs, as well as harm 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 about $3,000 to $6,000, while a new water heater can cost about $1,000.
Home improvement projects can also be very expensive, with costs varying by project type, size, and materials, among other factors. A bathroom remodel, for example, can range in price from about $6,600 to $16,600, and a kitchen remodel can range from about $13,400 to $38,300.
Home improvement projects can increase the value of your home. So this financial advantage can often offset the downsides of getting a loan.
Home Equity Loans vs Credit Cards
If borrowing money is your best option for financing your major home repair project, you’ll need to weigh the pros and cons of a home equity loan against other products, such as credit cards.
While credit cards may offer more flexibility, they also have much higher interest rates. The average credit card interest rate was 19.62% as of August 3, 2022, according to Investopedia data. On the other hand, interest rates on home purchase loans range from around 3% to 10%. You may have some closing costs with a loan to buy a home, but they likely won’t exceed what you’ll pay in compound interest on credit card debt.
For example, if you finance a $15,000 bathroom renovation with a credit card with an interest rate of 17% and pay it off within five years, you will accrue interest of $7,367. Paying off the same project with a home purchase loan at an interest rate of 5.25% over the same term will result in $2,087 in interest with no risk of interest rate hikes.
Home equity loans have a fixed interest rate with predictable payments, making it easy to budget for. In contrast, interest rates on consumer credit cards are variable and depend on the Federal Reserve’s prime rate. Your credit card interest rate can change depending on market conditions.
Some credit cards offer promotional interest rates that can be as high as 0% for a specified period of time, such as one year to 18 months. However, if you fail to pay your balance by the end of the promotional period, the original rate will be applied to the remaining balance.
How much can I borrow from a home purchase loan?
Most lenders will allow you to borrow a certain percentage of the principal in your property, such as 80% of your equity. This limit protects the lender from declining home values and reduces the risk of not getting their money back in the event of a default.
Should I Use a Home Equity Loan for Home Improvement?
You can use a home purchase loan for any purpose. There are no restrictions on your real estate loan, so you can use it, for example, to buy property, pay for weddings or finance a child’s education.
What credit score do I need for a home purchase loan?
Most lenders look for a credit score above 660, but higher credit scores will earn better interest rates. Lenders look at your on-time payments history and low use of credit to determine if you’re likely to make your loan payments.
A home equity loan can be a good financing option for people who have a large home equity but do not have the cash to finance a major home repair. These loans offer competitive interest rates and fixed and predictable payments. Consider these advantages as well as the potential downsides of using your home as collateral when deciding if this loan is right for you.