When you Should Use Home Equity to Pay for Renovations

Home equity is often used for a number of reasons, and one of the most prevalent is home renovations. While there are many instances where using home equity to pay for renovations can be advantageous in the long run, there are also situations in which it’s best not to tap in.

When you take out a home equity loan or line of credit, it’s a major financial decision that can potentially be disastrous if you don’t think it through carefully. Is it easy to obtain? In some situations it is, but being easy to access doesn’t mean it’s going to benefit you when all is said and done. If you’re thinking about using your home’s equity to finance renovations, here are some important dos and don’ts

1. Do: if you need to fix a serious problem that can wreck your entire home.

If you have a roof with leaks or major problems, a foundation that should’ve been replaced years ago, or you need to have repairs done after an emergency such as a fire or flood, using home equity is a good option. These types of repairs are not only costly, but if you don’t get it taken care of it can spell the eventual destruction of your home’s structure. After the needed repairs are finished, you’ll add value to your home that will pay off should you decide to sell in the future.

2. Don’t: if you know you don’t have the financial ability.

A home equity loan or line of credit is much like any other loan, and if you truly can’t afford it then it’s best to avoid tapping into your equity. If you have an urgent home repair that needs attention, there are alternatives to home equity. Many contractors will allow payments in installments, as will home improvement stores that offer lines of credit. You should particularly avoid a home equity loan if your renovations are about aesthetics rather than a serious need — going into debt to put in a new bathroom or addition that you can’t pay for will ruin your credit and could end up with you losing your home altogether.

3. Do: if you have excellent credit and stable income.

On the other hand, if your credit is excellent and your income is such that you’ll have no problem paying off a home equity loan, go for it. Having a better credit status means you can secure a pretty decent rate. If you have good credit and want to go through with renovations, the same applies: if your job is stable, go ahead and shop around for the best rate. Of course, your loan will probably cost more than it would someone with excellent credit, but it won’t be a huge difference.

4. Do: if the renovation will increase your home’s value.

When trying to decide whether or not to tap into your equity for home renovations, ask yourself whether the change or addition will increase the value of your house. There are certain renovations and repairs that tend to do this no matter what, such as getting a new roof, windows, foundation, or finishing out an attic or basement.

Other renovations can add value, but you’ll need to be smart about it. For instance if you update your bathroom it could add to your home’s value if you don’t allow the costs to get out of hand. A $10,000 renovation for a bathroom in a $175,000 home is reasonable and will pay off over time.

5. Don’t: if the ROI isn’t there.

When home renovations become too costly is when the ROI — return on investment, or how much you’ll recoup from the project into your home’s value — decreases. In the above example, putting $10,000 into a bathroom renovation is worth it with a home that has a value of $175,000. However, if you put in the most expensive tile and flooring, extravagant fixtures, and all manner of decorative accessories and the entire project ends up costing $55,000, that’s not a good use of a home equity loan. What’s more, you’re not going to see most of the cost of the renovation reflected in your home’s value. Always take ROI into account when you’re thinking of getting a home equity loan for non-essential renovation projects.

6. Don’t: if you plan to move in the next few years.

Though some real estate experts suggest making improvements to a home before getting ready to sell it, that doesn’t mean you should take out a home equity loan to do so. A fresh coat of neutral paint, thorough cleaning, and replacing any worn out fixtures will suffice and be much easier on your finances. You certainly don’t have to put in all-new cabinetry, flooring, and decorative accents if you’re going to sell your home in the near future, and it’s best not to — let the new owners of the house decorate and renovate it to their liking while you keep most of the selling price. Remember: the less equity that you have when it’s time to sell, the less money you’ll see at closing.

7. Don’t: just to upgrade aesthetics on a whim or do seasonal decorating.

We’ve all longed to get a certain type of flooring, counters, exterior accents, or super high tech additions featured in magazines, home decor shows, and sites like Pinterest. However, going into more debt and taking out a home equity loan to get the picture perfect house of your dreams isn’t a wise choice, especially if those dreams are unrealistic. There are so many ways to refresh your home and make it look stunning without spending tons of money or getting a loan, so don’t do home renovations using equity just to give yourself something pretty to look at.

8. Do: to increase your home’s energy efficiency, within reason.

The more energy efficient your digs are the more money you stand to save in the years to come. However, while some energy upgrades are worth taking out a home equity loan, others aren’t. For example, if you have windows that are inefficient and making your heating and cooling costs go sky high, replacing them is a smart idea if you can afford to pay back a home equity loan. The same goes for plumbing and HVAC system replacements. However, if your utility costs are under control and you simply want to get an uber modern smart home system with all the bells and whistles, that’s not a good reason to tap into your equity.