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If you’re considering selling your home and want to boost its value before hitting the market, using a home equity loan for renovations could be a smart move.
A home equity loan allows you to make targeted improvements, potentially increasing your home’s resale value and covering the upfront costs of the loan. While this approach can potentially enhance resale value, it’s important to weigh the benefits against the risks, including the upfront costs of the loan and market uncertainties.
Let’s explore the key considerations for using a home equity loan to renovate before selling your house.
How Home Equity Loans Work
A home equity loan is a second mortgage that allows homeowners to borrow against the equity they’ve built up in their property, allowing them to receive a lump sum payment for things like home renovations.
Lenders considering your application will evaluate a variety of factors, including your existing home equity, debt-to-income ratio and credit history. The loan will come with an interest rate and closing costs, just as you’d expect with a traditional mortgage.
It’s important to note that lenders will not let you borrow money against a house that is already for sale. Plan ahead and secure the home equity loan before listing the property. Getting approval for the funds can take time, as can home renovations, so patience will be a virtue.
How a Home Sale Works with a Home Equity Loan
Selling a home with a home equity loan can be more complex than a traditional home sale. The proceeds from this kind of sale are used to pay off both debts. Here’s how it typically works at closing:
- Settlement Statement: At the closing of the home sale, the settlement statement outlines all the financial transactions involved, including the payoff of the existing mortgage and any outstanding balance on the home equity loan.
- Mortgage Payoff: The first step is to pay off the primary mortgage using the proceeds from the home sale.
- Home Equity Loan Payoff: After paying off the mortgage, the remaining funds are then used to settle other liens on the property, such as a home equity loan.
- Title Transfer: Once all liens are satisfied, the property title is transferred to the new owner, and any remaining funds from the sale are disbursed to the seller.
If proceeds from the home sale comes up short , the homeowner is responsible for covering the difference from the amount owed on the home equity loan. Consult your lender or a real estate attorney to avoid surprises on closing day.
Choose Renovation Investments Carefully
Before diving into renovations, carefully assess which projects are likely to add the most value to your home. Focus on popular improvements among potential buyers with a high return on investment (ROI).
Best Home Upgrades to Invest In with a Home Equity Loan
Three of the most productive, market-tested places to invest when doing a makeover are:
- The kitchen: Money spent on kitchen upgrades returns a high yield, often more than dollar-for-dollar. Concentrate on specifics like new appliances, flooring, and attractive, functional lighting.
- The bathroom: See if you can create another bathroom or half bath without disrupting the floor plan. Homebuyers and their agents often search according to the number of bedrooms and bathrooms. Adding a full or half bath could double the number of potential buyers.
- Paint and trim: A relatively inexpensive approach for a home makeover is to concentrate on freshening it up with a good paint job in neutral colors with broad aesthetic appeal. Buyers and their building inspectors feel more confident about homes that are well maintained, and a freshly painted home conveys that attitude.
» MORE: See today’s refinance rates
Estimating the ROI of Your Renovations
Leveraging a home equity loan to prepare a home to sell is an investment. And, like all smart investments, crunching the numbers is imperative. In this case, there are two core figures to calculate:
- Revenue: How much will your home value increase after renovations are complete?
- Investment: What is the cost of the home equity loan?
Estimating Revenue from Your Renovation
To estimate your revenue gained from renovations, try to determine the value of your home before and after renovations are completed. Research comparable properties, consult real estate professionals for local insights, consider market trends and understand appraisal guidelines in your area.
For example, if your renovations result in an additional bathroom, look at comparable homes with and without the added bathroom to see the relative price difference in your area.
Estimating the Costs of Your Home Equity-Funded Renovation
To estimate your costs, you’ll need to understand the cost of the home equity loan and factor in expecting closing costs once you sell your home. If your home price increases substantially, closing costs, such as realtor commissions, will increase as well.
Start by researching different lenders to compare their offerings and determine the interest rates and loan terms that best fit your financial situation. To get a complete picture, factor in origination fees, closing costs, and other associated expenses that may apply to the loan. By carefully evaluating these factors and obtaining quotes from multiple lenders, you can estimate the total cost of getting a home equity loan.
Consider your payment plan against the estimated time to complete your renovations and sell the home. Your home equity lender won’t wait for repayment, so you must be prepared to pay on your existing mortgage and your home equity loan until you’ve recouped your costs through the home sale.
What Happens if My Home Has Decreased in Value?
If your home has decreased in value since you obtained your home equity loan, it can present challenges when selling your property. You may find yourself owing more on your mortgage and home equity loan combined than the sale price of your home, resulting in a potential shortfall. This situation, known as being “underwater” or having negative equity, can limit your options and may require you to bring additional funds to the closing table to pay off your debts.
You may need to explore options such as a short sale or negotiating with your lender to settle the outstanding debt. Consult with real estate professionals and financial advisors to determine the best course of action if your home’s value has decreased.
Are There Fees for Selling a House With a Home Equity Loan?
Yes, there are fees when selling a house with a home equity loan. You’ll typically encounter closing costs like real estate agent commissions, attorney fees, title insurance, and transfer taxes. If you still have an outstanding balance on your home equity loan at the time of sale, you’ll need to settle this debt using the proceeds from the sale.
Depending on your lender and the terms of your loan agreement, there may be prepayment penalties or early termination fees associated with paying off your home equity loan before its scheduled term. Review your loan documents and consult your lender to understand any potential fees or penalties that may apply when selling your home with a home equity loan.