How a HELOC works for home renovations
Home equity lines of credit work much like a consumer credit card. To start, a lender will grant you a credit limit based on the equity in your home. During the initial “draw period,” you’ll only pay interest on the money you actually use. When the draw period ends you make regular amortized monthly payments until the debt is repaid.
Caution should be taken when considering a HELOC. Many HELOC programs have balloon payments due and payable in full at maturity. This means that the remaining balance must be paid or a new loan taken out to refinance the remaining balance.
Homeowners can use a HELOC as a flexible way to cover a series of smaller home renovation expenses, which can be particularly helpful if you’re not sure about the final cost of your project. A HELOC can also work well if you are expecting a large lump sum payment, bonus, commission, or gift that you can use to repay the HELOC as you go.
Advantages of a HELOC
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Line of credit, not a lump sum
Even if you set a budget for your home renovations, it’s not often that your final costs match your initial estimates. A line of credit may make more sense for these types of projects, giving you the flexibility you need to meet the costs of each phase of the project.
A HELOC can be advantageous when you need to cover the costs of different project phases or variable costs such as materials or contract labor.
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Line of credit stays open until term ends
A line of credit can be used repeatedly during the initial draw period. You will need to pay down or pay off your balance to reuse the line of credit, much like a credit card.
Typically, the draw period lasts for five to ten years, during which time your HELOC generally provides flexible interest-only payments or very low payment options. Some lenders offer draw periods that go considerably longer, but most home renovation projects are completed quickly enough for a standard HELOC.
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Depending on your lender and your financial history, you may qualify for a HELOC that offers interest-only payments during the initial draw period. This means that you’ll only repay the interest on the money you borrow, not the actual principal.
While you can repay the principal without being penalized, in order to reuse this line of credit, you won’t be required to repay the principal until the interest-only draw period ends. After this, you’ll make both principal and interest payments during the repayment period.
A HELOC option can be an advantage if you’re making improvements to sell your property since you’ll use the profits of the sale to repay the loan.
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Tax-deductible interest
If you use a HELOC to substantially increase the value of your home, the interest you pay may be tax-deductible. Single or Married Filing Separately IRS Tax Filers can deduct interest on the first $375,000 of indebtedness, while joint filers can deduct interest on the first $750,000 of indebtedness. Higher limits apply if the mortgage debt was incurred before December 16, 2017, refer to the IRS code for your tax professional or particulars.
Just be aware that to claim this benefit, you must itemize your tax deductions, though this can still be a helpful way to improve your home while reducing your tax burden. Check with your tax professional to ensure that you meet all guidelines.
Disadvantages of a HELOC
Despite the advantages, you might need to be cautious about using a HELOC for home renovations. While none of these drawbacks are insurmountable, they may require additional planning and preparation to navigate.
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Variable interest rate
A HELOC offers an adjustable-rate mortgage (ARM), which means that the exact amount of interest you’ll pay each month will fluctuate over the life of the loan. Unlike the predictability of a fixed interest rate, a variable interest rate means that borrowers must leave some breathing room in their monthly budgets to accommodate changing repayment costs.
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Payments increase once interest-only period is over
After the interest-only draw period is over, you’ll be required to make regular monthly principal and interest payments. This means that the shorter repayment period will result in higher payments since you’ll be paying the principal as well as any remaining interest over a shorter remaining term of the loan.
If you failed to keep track of how much you were using during the draw period, you could be in for an unwelcome surprise when it comes time to repay the money you’ve been using.
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Line of credit is secured by your home
When you use a HELOC, your home itself becomes the lender’s collateral. If you miss payments, they could result in a default on your loan. Not only can you damage your credit history and credit score but also risk losing your home in foreclosure.
Other home improvement financing options
Other available options that you may want to consider are a cash-out refinance or, for a much larger project, a renovation loan.
- A cash-out refinance is a refinance of your existing home loan and converting the available equity into cash in hand. If you are choosing this option, you will be making principal and interest payments for the life of the loan and you will need to manage the disbursement of the funds from your personal account where you deposit the loan proceeds.
- A renovation loan is a convenient and economical means for borrowers considering home improvements for repairs and full renovations. This is a single close first mortgage that enables the purchase or refinance of a home in need of repairs AND includes the necessary funds for the renovation. Renovations must be completed within 12 months of the note date. The minimum renovation loan amount is generally $100,000.
Renovation HELOC
CrossCountry Mortgage proudly offers a renovation HELOC. With access to flexible financing, you can make renovations that increase your home’s overall value or create the kitchen or bathroom you’ve always dreamed of.
To learn more, contact the experienced team at CrossCountry Mortgage today. We can evaluate your financial history and home equity to connect you to the financing option that fits your goals and budget.
