By BankingMyWay.com Staff
If you don’t have the cash to finance a home renovation, cashing in on your home equity is a solid option.

With home equity loans, you borrow against the equity in your home, which is accumulated through principal payments, appreciation and down payment. Because your home is used as collateral on these loans, you can usually get a much better interest rate than through unsecured credit, like with credit cards.

There are two options when it comes to equity loans -- installment home equity loans (HELs) and home equity lines of credit (HELOCs). Both are second mortgages, but they offer different ways to access and repay the money. With an installment home equity loan, you receive a lump sum and then make monthly payments to pay off the balance, just like you would with a mortgage. HELs are available with fixed or variable interest rates, and terms can be as short as 12 months or a long as 30 years.

A HELOC is a type of revolving credit like a credit card. With a HELOC, you are approved up to a limit and can draw funds as needed. Interest rates are typically tied to the prime rate and fluctuate regularly with market conditions. Consequently, your payment can vary significantly from month to month. HELOCs often allow you to make minimum payments of interest only. Typically, you will have to repay the full amount of the HELOC within a fixed period (10 to 20 years), however.

Using an equity loan to finance renovations is appropriate because the money is reinvested in the value of the property. The improvements on your home will likely increase the value of the home and compensate, at least in part, for the equity used.

For example, say your home is worth $200,000 and you have $100,000 in equity. You borrow $25,000 from your home’s equity to remodel your kitchen. The renovations increase your home’s value by $20,000 to $220,000. In essence, it will have only cost you $5,000 to remodel your kitchen. In some cases, an investment in home renovations can actually increase the value of the home by more than the cost of the renovations. In this situation, you would actually make money. Additionally, interest payments on HELs and HELOCs are usually tax deductible.

Depending on how you do your renovations, a HEL or a HELOC may be a better option. For a single major renovation such as adding an addition, an installment home equity loan is generally more practical. The fixed-rate option for a HEL allows you to budget for payments that will not change over time. The structured repayment plan helps you pay off your debt sooner than the relatively flexible repayment options of the HELOC. However, expect to pay some closing costs with a HEL, which are generally less than primary mortgage closing costs.

If you plan on doing a series of ongoing renovations over time, a HELOC may be a better option. Because you can draw funds as needed, you run less of a risk of spending a lump sum loan on expenses other than the renovation. There are no closing costs for a HELOC, but you may have to pay an annual fee. HELOC interest rates usually start lower than HEL interest rates, but often move higher over time. Compare rates on home equity loans in your area at BankingMyWay.com.

—For more ways to save, spend, invest and borrow, visit MainStreet.com.