Hey Taylor – I’ve been toying with the idea of remodeling my bathroom into something more lavish, both for personal satisfaction and for the value of the home. I’m wondering if you have any feelings about home equity loans and whether or not it’s worth it. – Micaela
Hey Micaela – When used properly, home equity loans can be great. When used improperly, they can be pretty problematic. You have to consider this type of borrowing from every angle to figure out if it’s the right move.
–1. Loan size vs existing equity. At face value, home equity loans can be one of the better ways to borrow. You typically get a good rate and have the trust of the lender since you’re borrowing against an asset. Problems arise after people play the home equity card when they only own 10% of their house and still have a massive mortgage outstanding. Even with a favorable rate, it might be worth considering how that impacts your overall debt-to-wealth ratio. If you’re only in for $30,000 on a $500,000 home and you want to do $25,000 worth of bathroom remodeling, it’s probably not the best move. If you’ve got 50% equity in the house and aren’t feeling overleveraged, that’s a different story.
–2. Asset vs liability. It’s wise to do things that might increase the value of your home. That said, until you decide to sell the house you’re living in, it’s more of a liability than an asset. No matter how much it’s worth, you’re not making money off of it while you’re living in it. That doesn’t mean a home equity loan is off the table, but it might be helpful to view your home’s value differently than you would cash in the bank. Renovations that stretch the budget thin can be risky, especially if they’re justified solely by current market value. If everyday essentials like groceries or gas are hard to cover, the home’s estimated value might not offer much practical relief in the moment.
–3. Weigh your options. A home equity loan can make a lot of sense when there’s steady income to support the payments and the interest rate is low enough to make the math work. As long as you aren’t getting caught up in how good the rate is and ignoring the actual price of the remodel, it may be a good financial move. Before you borrow, make sure you’ve done some thorough planning on the remodel (we all know those can get real pricey, real fast) and considered other things you might want to spend your time and money on. Once the contractors break ground, you won’t have much spending cash for a while.
It’s just like every type of borrowing. If you have a repayment plan and are in good financial standing, you can turn that debt into more wealth. Conversely, without good planning, you might end up digging yourself a hole that’s hard to get out of. Thanks for the question!
Taylor Kovar, CFP®
CHIEF EXECUTIVE OFFICER
