The Pros And Cons Of Using Home Equity Loans For Improvements

Anyone who owns a home knows that unless you built it from the ground up and didn’t move in until you were completely satisfied, the home improvement projects are never really done. There’s always a new problem or a renovation that’s financially out of reach. The constant flow of contractors and weekend trips to the hardware store are enough to make anyone a little crazy – maybe even crazy enough to take out a home equity loan and get it all done.

When it comes to renovations, is a home equity loan a good way to pay for your projects or are you asking for trouble? The truth is that, while a home equity loan can help you get your home looking great, whether or not it’s a good financial choice depends largely on the type of project, the state of the real estate market, and your overall financial status.

Functional Considerations

The first question you should ask when it comes to taking out a home equity loan for a renovation project is why you need to do the project. If you’re taking out the loan due to a structural emergency – for example, your roof is leaking or the foundation is cracked – then, by all means, take out the loan. Ignoring these kinds of problems will just lead to much bigger expenses down the road and you should take care of them right away.

Another good reason to take out a home equity loan is if you’re going to sell your home and want to do a few projects that will increase the resale value. For example, a kitchen renovation is a pricy project, but will also add a significant amount to your home’s resale value. In fact, it’s one of the few projects that will get you more on the market than you invest in the work.

Beyond emergencies and resale-related circumstances, it’s best to save your money or take out a smaller loan instead of borrowing based on your home value. Because the real estate market is volatile, you risk borrowing against something that could lose value, digging you deeper into debt.

Old Homes And Hidden Hazards

Somewhere in between emergency circumstances and resale improvements are home equity loans that can only improve your home’s value, even if you have no intention of selling right now. This is often the case if you live in an older home with newspaper insulation or out-of-date wiring. It’s livable, but not really safe or sustainable.

Under these circumstances, a home equity loan can really work to your advantage. Use the money to install energy efficient insulation or upgrade the wiring so it doesn’t pose a fire hazard. Because these are such baseline improvements, you’re unlikely to lose money on such an investment since your home is worth a lot more if it’s not a firetrap.

One alternative to a home equity loan for homes that have significant functional issues like these is a Title I loan from the FHA. This loan is meant to make your home more useable, so while it doesn’t need to be used only for emergency renovations – you can apply a Title I loan for everything from disability renovations to built in appliances – it can’t be used for luxury items. The best thing about these loans, though, is that they insulate the borrower from financial loss.

Consider The Losses

Though taking out a home equity loan is risky, there are other financial repercussions you should consider before you rule out the option. One of these is your current mortgage rate. If you got a fixed-rate mortgage at a great time and currently have a low interest rate, you may choose to renovate with a loan rather than lose a great mortgage rate. What you’ll spend on the renovations, even if substantial, will more than make up for keeping that great rate.

Similarly, consider resale projects carefully before you take out a home equity loan. While you may see an increase in resale value as a net good, is it really that valuable if you aren’t getting a solid return on investment? Unlike a kitchen renovation, many home improvement projects don’t actually recoup their cost during the sale. You have to decide whether the sale price or the net income is what matters to you.

Ultimately, no matter how you choose to pay for home improvements, remember that there are always serious costs involved if you don’t pay cash. While a home equity loan can save you from exacerbating the damage caused by an emergency, it can also put your home on the line. On the other hand, a cut-rate contractor can do more harm than good. Do your research and borrow carefully; your financial future may depend on it.