How Home Improvement Loans Work

June 18, 2019

From minor updates to major renovations, home improvements are an excellent way to increase the value of your home. You might need to update your home to prepare for a new baby or to refresh your empty nest, or perhaps you watch too much HGTV. 

No matter the reason, there are several options for financing home improvements. In this blog, we will focus on Home Equity Loans and how they work. 

A Home Equity Loan is typically used when you want to complete a defined project in a specific amount of time. This loan type, often referred to as a second mortgage, gives you a lump sum which you pay back in fixed payments. The amount of the loan depends on the amount of equity you have in your home – more on that in a bit. 

If you’re considering a home improvement loan, here’s some information to consider. 

First, you need to define your project. You’ll need to be able to tell your lender what your project is and how much you estimate it will cost. You do not want to be wrong here. It’s best practice to meet with multiple contractors to compare estimates. 

Once you have a solid estimate, you can roughly calculate whether or not you have enough equity to qualify for a loan that will cover the cost. Lenders determine your home equity by subtracting the current balance on your mortgage from the current total value of your home. 

To the amount of a home equity loan, lenders will use a loan-to-value (or LTV) ratio. Limits on LTV vary by lender, but Texas Home Equity Loans cannot exceed 80%. How do you calculate LTV? Let’s back our way into it with this example. 

Let’s say that your home has an appraised value of $100,000 and your mortgage balance is $70,000. If the LTV ratio is 80%, that means that the maximum debt allowed is $80,000. When you subtract your mortgage balance, you have $10,000 of remaining equity to tap. 

Remember, LTV limits vary by lender. For exact calculations, speak with one of our experienced, local loan officers. 

Beyond your existing home equity, your lender will need to review other relevant financial information. Similar to your initial mortgage, they will take a look at your credit history. Because this is a second mortgage, lenders are usually more stringent with credit score requirements. The bank will also want to know that you have enough income to cover your expenses, so be prepared to show a healthy debt to income ratio. 

If your application is approved, the loan officer will issue terms and interest rates. The terms for a Home Equity Loan are typically shorter than a home loan. Ten to fifteen years is standard; however, they can be as short as five years. Home Equity Loans usually have fixed interest rates. As long as you put the funds toward home improvements, the interest you pay is tax-deductible. Ask your accountant about tax-deductibility of the interest paid. 

With a Home Equity Loan, you are using your home as collateral to secure the funds. If you cannot make the additional monthly payments, you risk foreclosure on your home. 

The friendly and knowledgeable staff here at Peoples Bank is here to help you with any of your home loan needs. Contact us to get your next home improvement project underway!