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These days, it’s hard to buy a new home without breaking the bank. Mortgage rates are up and home prices are high. So a better bet may be to simply work on renovating your current home to make it more comfortable.
Recent data from TD Bank shows that homeowners are looking to make renovations. And 38% of those who plan to renovate their homes in the next two years are using or plan to use a home equity loan or line of credit (HELOC) to finance that work. But while there’s an upside to tapping home equity to pay for renovations, there’s also a very big downside to consider.
A potentially easy way to get a loan
As of mid-2023, the average U.S. homeowner had about $200,000 of equity to work with, according to Black Knight. Since home values are up right now, it could be a good time to tap your equity. And doing so could make it easier to qualify to borrow.
You need a decent credit score to qualify for a home equity loan or HELOC, and the exact number will be determined by the lender you use. But you may find that if your credit is only fair, that you have an easier time qualifying for a home equity loan or HELOC than a personal loan.
The reason? Personal loans are unsecured, which means that there’s no specific asset that’s used as collateral for them. Home equity loans and HELOCs, on the other hand, are secured by the property whose equity is being tapped. That tends to give lenders more reassurance. If you were to default on a home equity loan or HELOC, your lender could eventually force the sale of your home to get repaid.
The problem with borrowing against your home
When you borrow against your home equity, you leave yourself with less equity. It’s kind of like when you tap your $10,000 savings account to the tune of $4,000, thereby leaving yourself with only $6,000 left.
But that alone isn’t necessarily problematic. What is problematic is that if you fail to keep up with your home equity loan or HELOC payments, you could eventually risk losing your home. That would put you in a terrible spot.
Now, there can be very dire consequences to falling behind on a personal loan, too. Your credit score could take a serious dive if you become delinquent, making it extremely difficult for you to borrow money the next time you need to. But you don’t run the same risk of losing your home as you do in the context of failing to repay a home equity loan or HELOC.
Ultimately, you may decide to tap your home equity to finance your next renovation. But before you do, make sure you’re in a position to keep up with your payments. Also, you may want to potentially sit tight a bit until interest rates come down across the board, since they’re pretty high right now.
Otherwise, aim not to overborrow in home equity loan or HELOC form. You may have more options with property values being up. But the more money you borrow, the greater your risk of struggling to make your payments and falling behind.
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