Paying for Home Renovations

A home equity loan is like a mortgage: It’s issued for a specific amount, and you must repay it over time with fixed monthly payments. A HELOC, on the other hand, is a line of credit that you can use as needed, up to your credit limit. With a HELOC, you’ll still make monthly payments, but you may be able to make interest-only payments for a period of time. Here are some questions you may want to consider asking and answering if you’re currently weighing a home equity loan vs. a HELOC to fund your home remodeling project:

This may be a bitter pill for many homeowners to swallow, but if you have other debt, especially debt that carries a high interest rate, you may want to evaluate and calculate whether you have the ability to take on additional debt at all. HELOCs and home equity loans need to be paid back.

“Any time you borrow, you have to look yourself in the mirror and truly assess why it is that you’re borrowing the money,” says McBride. “If you’re borrowing money simply because you’re not able to afford it based on your earnings, or if you’re carrying credit card debt, the last thing you need to be doing is borrowing more. Focus on getting that debt down.

”Barring immediate, necessary repairs, many renovations are elective.

If you don’t have 20 percent equity in the home, you may want to think twice about borrowing against it. There are a few reasons for this. First, if you recently purchased the home and are still making your way to 20 percent equity, you may be paying private mortgage insurance or PMI. You may want to work toward eliminating that payment first.

Second, most lenders still want you to have some stake in the home, so many will not allow you to borrow under that 20 percent threshold (though McBride notes that some lenders are getting looser about this number).

Finally, you may want to think twice before putting yourself in a financially unstable situation if home values drop and you lose a significant amount of equity.

Because getting a home equity loan involves start-up costs similar to getting a mortgage—including an appraisal, an application fee, and closing costs—you may want to ensure that the amount you’re borrowing is worth the cost of borrowing it. You may also be charged additional fees for maintaining the loan.

Also remember that many home equity loans carry adjustable rates, so your monthly payment may go up and become less affordable over time.

If you have a significant amount of equity in your home, but not a lot of cash—you are investing your income, for example, and are protective of your emergency fund—then getting a HELOC or home equity loan may not be a bad option. Interest rates are low, so for many, this is one of the most cost efficient ways to borrow money right now.

If you have a lot of cash (and healthy emergency savings), you may want to consider whether it’s smart to borrow unnecessarily.