Find out how a renovation can affect the value of your home equity, and whether borrowing money is a good idea when you’re taking on a renovation project.
When Renovations Increase Your Home Equity
Various home improvement projects can add equity to your home by improving its value, but some are better at accomplishing that than others. For instance, upgrading an outdated kitchen might make more sense (and appeal more to buyers) than adding an in-ground pool. Before diving into a home improvement project, check with a local real estate agent or contractor to find out which kinds of projects are sought by local buyers and would most benefit your home equity. If you decide to proceed with a project, consider whether you can do it yourself or need to hire a contractor. If you head down the DIY path, you might be able to cut costs and increase your home’s equity even more.
Renovation Projects With the Best ROI
A 2021 report from Remodeling magazine pinpoints the 10 projects with the greatest payoffs, based on averages from 150 U.S. markets: A 2022 study from the National Association of Realtors and National Association of the Remodeling Industry offers a different take on the home improvement projects that deliver the most bang for the buck. The study looks at interior and exterior remodeling projects. Here, we list the top five in each category.
Not All Projects Add Equity to Your Home
In some cases, you may want to skip a home improvement project that might not align with future buyer preferences and, therefore, could be a drag on your home’s equity. Here are three projects you may want to put on the to-don’t list.
New Pool
A new backyard pool might not make the kind of splash you hope it will. Some potential buyers might not want to deal with the hassle of pool maintenance. Others, particularly families with small kids, might view a pool as a safety hazard. And if you live in, say, a chilly climate like Minnesota, a pool may be far less of a selling point than it might be in sunnier places such as California and Florida.
Luxury Upgrades
Marble tile might look nice in the entryway or bathrooms, but prospective buyers might frown on it. Why? Because they simply don’t want to pay extra for what they may perceive to be an unwanted and unnecessary amenity. In many instances, high-end upgrades fail to deliver the kind of boost in equity that you might think they would.
Garage Conversion
A typical buyer wants to park cars in the garage or use the space for storage. That’s why many may be turned off with a home that has a garage that’s been turned into living space. You may be better off maintaining the original purpose of a garage.
How To Finance a Renovation
Several financing options are available for home renovations designed to boost your home’s value.
Home Equity Loan
A home equity loan allows you to tap into the home’s equity to borrow a lump sum of money for a home renovation or another big expense. A borrower normally repays the loan over a certain period of time through equal monthly payments. Many lenders will let you borrow up to 80% of your home’s equity. The interest rate for a home equity usually is fixed. However, the rate is often higher than it may be for a home equity line of credit (HELOC). Your home will serve as collateral for a home equity loan. If you don’t keep up with the loan payments, the lender might foreclose on your home.
Home Equity Line of Credit (HELOC)
A HELOC is a revolving line of credit, much like a credit card. You can borrow from the line of credit as needed, as long as you don’t exceed the credit limit. As opposed to a home equity loan, the interest rate for a HELOC typically fluctuates. In other words, it can go up or down, potentially creating unpredictability in terms of your monthly payments. One big difference between a HELOC and a home equity loan is how the interest is charged. With a HELOC, you pay interest only on the amount you actually use, and not on the amount that you’re able to use (the credit limit). When you take out a home equity loan, you pay interest on the entire loan amount. Furthermore, the annual percentage rate (APR) for a HELOC is based only on the interest you’ll pay. By contrast, the APR for a home equity loan includes fees and other closing costs.
Cash-Out Refinance Loan
A cash-out refinance loan is also backed by your home. This type of loan pays off your existing mortgage and sets up an entirely new mortgage. Once the mortgage and closing costs are covered, you will have access to whatever is left in the form of a lump-sum amount of cash. Fixed-rate and adjustable-rate refinance loans are available with this type of loan.
Home Improvement Loan
A home improvement loan is a personal loan designed solely for home renovations and upgrades. To qualify for a home improvement loan, you may need to show a lender that you’ve hired a contractor and supply a project overview as well as cost estimates. A personal loan doesn’t involve collateral. In other words, it’s an unsecured loan. Because it’s unsecured, a home improvement loan usually features a higher interest rate and lower borrowing limit than other loans do. Both fixed and variable interest rates are available. The amount you can borrow depends partly on the nature of your project as well as the value you have in your home. For instance, you might be able to get a bigger loan for an interior project than you can for an exterior project.
Credit Card
Unless you’re able to score a 0% introductory rate or other special financing, a credit card usually charges higher interest rates than other lending options available for home improvements. Additionally, a credit card’s interest rate may vary over time, while the interest rate for a home equity loan typically is fixed.
How Much Should I Borrow for a Renovation Project?
Depending on the lending option you choose, the amount of equity you’ve got in your home may restrict the amount of money you can borrow for a renovation project. The amount of existing debt you have, along with your credit history and credit score, also will play roles. But the key question here might be this: How much debt do you feel comfortable assuming to tackle a renovation project—and to hopefully boost your home equity?
Will the Investment Pay Off?
One of the things you’ll need to weigh is how well your investment will pay off. In other words, it might be wiser to take on debt to pay for a new garage door or new wood flooring (which studies show offer a high return on investment) than to use a loan or credit card to cover the cost of a new pool or garage conversion (both of which aren’t as likely to lift up your home equity).
Can You Afford the Project?
You’ll also want to look at the cost of the project compared with how much you can afford to pay out of pocket and what you will need to borrow. As such, the addition of a bedroom might be out of reach financially compared with a lower-cost but still substantial project like the replacement of your roof.
What Is Your Situation?
Give some thought to what your other needs are. Is one of your kids going to college? Are you struggling to pay off a big medical bill? Those expenses may take priority over a home renovation project. On top of that, figure out how long you plan to stay in your home. That could tip the balance between whether to sink money into a home improvement project and to put off the project or even erase it from your to-do list.
The Bottom Line
In the end, the bang for the buck that a renovation project delivers might not be the only factor in figuring out how much money to borrow, but it is certainly key when it comes to the cost versus the potential increase in equity. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!
