Using a HELOC for home renovations: Pros, cons and considerations

As home values have continued to rise, so has the appeal of tapping into home equity for major expenses like renovations. In fact, according to CNBC, U.S. homeowners saw their home equity surge by $1.5 trillion in the first quarter of 2024 alone. This growing wealth has made home equity lines of credit (HELOCs) an increasingly popular option for those looking to fund home improvements without resorting to high-interest loans or credit cards.

But while HELOCs can offer a flexible and potentially lower-cost way to fund your home improvement projects, HELOCs also come with a few risks that shouldn’t be overlooked. Let’s explore the pros and cons of using a HELOC for home renovations and discuss important considerations to keep in mind before tapping into your home equity.

What you’ll learn

• HELOC basics
• Pros of using a HELOC for home renovations
• Cons of using a HELOC for home renovations
• How to responsibly use a HELOC for home renovations
• Is a HELOC right for you?

HELOC basics

A HELOC allows you to borrow against the equity you’ve built in your home, providing a revolving line of credit that you can access as needed. During the draw period, which typically lasts five to 10 years, you can borrow and repay funds multiple times, making it an ideal option for staggered renovation projects. After the draw period ends, the HELOC enters the repayment phase, where you’ll start paying back both the principal and interest, usually over a period of 10 to 20 years.

Compared to other types of home equity-based loans, HELOCs offer a unique level of flexibility. Unlike a home equity loan, which provides an upfront lump sum with a set interest rate, a HELOC allows you to borrow in stages, making it ideal for projects that may evolve over time. However, HELOCs typically come with variable interest rates, meaning your payments could rise if market rates increase.

Pros of using a HELOC for home renovations

There's a reason why HELOCs have become such a popular funding option for home renovations. Here are some of the key advantages of using a HELOC for your next project.

• Lower interest rates: Compared to other forms of credit, such as personal loans or credit cards, HELOCs generally offer lower interest rates, which can lead to significant savings over the life of your loan.
• Flexibility: Unlike traditional loans, a HELOC gives you the ability to borrow as little or as much as you need, when you need it. This can be particularly beneficial for projects that are completed in phases or have unpredictable costs.
• Tax benefits: If you use your HELOC for home improvements, the interest payments might be tax-deductible.⁷³ This potential tax break can help offset some of the costs associated with your renovation.
• Increased home value: Renovations funded by a HELOC can enhance your home’s appeal and market value, potentially offering a good return on investment when it comes time to sell.
• Lower monthly payments: Because HELOCs allow you to repay only the interest during the draw period, your initial monthly payments can be lower compared to traditional loans that require both interest and principal payments.

Cons of using a HELOC for home renovations

While there are many advantages to using a HELOC for home renovations, it’s important to also consider a few potential drawbacks.

• Variable interest rates: Unlike fixed-rate loans, HELOCs typically come with variable interest rates, meaning your monthly payments could increase if market rates rise.
• Risk to your home: Since your home is used as collateral for the HELOC, failing to make your payments could result in foreclosure, putting your home at risk.
• Decreased home equity: Borrowing against your home reduces its equity, which could limit your financial options in the future, particularly if home values decrease. In the worst case, it could even lead to owing more on your home than it's worth, also known as being “underwater.”
• Fees and closing costs: Some HELOCs come with fees and closing costs, including application fees, appraisal fees, and even yearly maintenance fees. These expenses can add up and increase the overall cost of your renovation project, which is why it’s worth comparing different lenders and their fees before signing on the dotted line.
• Potential for over-borrowing: With a HELOC, you can continue drawing funds from the available credit line as long as you make your minimum payments. This could tempt some homeowners to overspend and rack up more debt than they can afford to repay. It’s important to carefully consider your budget and limit your spending to what you can comfortably pay back.

How to responsibly use a HELOC for home renovations

Using a HELOC to finance your home renovations can be a strategic way to manage costs, especially if your renovation plans are extensive or will take place in stages. Here are some steps to ensure you use it effectively and responsibly.

1. Determine the scope of your project: Before applying for a HELOC, have a clear understanding of the renovations you want to undertake. This will help you estimate how much financing you’ll need and whether a HELOC is the best option for your specific project.
2. Estimate the cost: Once you’ve determined the general scope of your project, create a detailed budget to get a more accurate idea of how much money you’ll need. This will also help guide your borrowing decisions and prevent overspending.
3. Compare interest rates and terms: Shop around for different HELOC options to find the best interest rate and repayment terms for your specific financial situation. It’s important to consider not just the initial interest rate, but also how it may change over time and if there are any prepayment penalties.
4. Use the funds wisely: Once you have access to the funds, use them only for your renovation project. It can be tempting to dip into the money for other expenses, but this can quickly lead to overspending and difficulty in paying back the loan.
5. Keep track of withdrawals and repayments: It’s important to keep track of how much you withdraw from your HELOC and make sure you are making timely repayments. Falling behind on payments can result in additional fees and even damage your credit score.
6. Monitor interest rates: Since HELOCs typically have variable interest rates, it’s important to keep an eye on them and be prepared for any potential changes in your monthly payments. If interest rates rise significantly, you may need to adjust your budget or consider refinancing.

Is a HELOC right for you?

Ultimately, the decision to take out a HELOC for your renovation project should be based on careful consideration of your financial situation and goals. If using your home as collateral for a loan makes you uncomfortable, alternative financing options such as a personal loan may be a better fit for you. On the other hand, if you have a solid plan for your renovation project and are confident in your ability to make timely repayments, a HELOC may be the most flexible and cost-effective financing solution. Here’s some factors to consider.

• Your current credit score and history
• The total cost of your project and potential borrowing options
• Your ability to make timely repayments
• How long you plan on staying in your home
• Interest rates and potential changes in the future

With the right approach and a reputable lender, a HELOC can be an essential step in helping you turn your renovation dreams into reality.