A HELOC Pays for a Renovation in Draws, Then Gets Harder to Repay

A home equity line of credit lets you borrow against your home in draws during a draw period and then repay, so it suits a renovation paid in stages but carries a variable rate, a payment jump and the risk of losing the home if you fall behind. This is general information and not legal, tax or financial advice, and Good Haus is a free matching service and not a contractor or a lender.

What is a HELOC?

The Consumer Financial Protection Bureau says a home equity line of credit is an open-end line of credit that allows you to borrow repeatedly against your home equity, which is the value of your home minus the amount you owe on your mortgage. It says to only consider a HELOC if you are confident you can keep up with the payments, because if you fall behind or cannot repay on schedule you could lose your home. For a renovation, that means the loan is secured by the house you are improving, so size it to what you can repay if the project costs more than planned. Under the United States (federal) Regulation Z, 12 CFR 1026.23(a), a consumer whose principal dwelling will secure the credit has the right to rescind the transaction until midnight of the third business day following consummation, delivery of the required rescission notice or delivery of all material disclosures, whichever occurs last. Ask the lender in writing when the right to cancel starts and where to send a written cancellation before you sign.

How does the draw period work for a renovation?

The bureau says that with a HELOC you can generally spend up to your credit limit anytime during the borrowing period, also called the draw period, which could last 10 years, for example. It says lenders can charge certain fees, that some plans require you to borrow a minimum amount each time or keep a minimum amount outstanding and that other plans require an initial amount when the line is set up. Because draws can follow each contractor payment, ask the lender how draws are requested, how fast funds arrive and what each draw costs.

What changes when repayment starts?

The bureau says that after the draw period ends you stop being able to borrow and enter the repayment period, and that your lender may set a schedule to repay the full balance, often over ten or 20 years. It says monthly payments are often significantly higher once you enter repayment, and that in some cases you may have to pay back the whole amount borrowed as soon as the repayment period begins. It says HELOCs usually have a variable interest rate, so payments may change from month to month, and that some let you convert part of the balance to a fixed rate that is usually higher than the variable rate but more predictable. Ask the lender for a payment example at the end of the draw period using your expected balance, so the jump is not a surprise.

Can the lender freeze the line before the work is done?

The bureau says that if the value of your home decreases significantly your lender might decide not to allow additional credit, and might also freeze your ability to take out additional funds if your financial circumstances change and the lender does not believe you will be able to make your payments. If the line is your only funding, keep a cash reserve and do not start work that cannot be paused if a freeze comes mid-project.

Which loans are similar to a HELOC?

The bureau says a home equity loan lets you borrow against the equity in your home, typically with all the money up front repaid in regular monthly payments, and that a cash-out refinance replaces your existing mortgage with a bigger mortgage and gives you the difference in cash, often with closing costs. It says that depending on the terms a cash-out refinance may be more or less expensive than a HELOC, that a personal line of credit does not use your home as collateral and may have lower limits and higher rates, and that a HUD-approved housing counseling agency can help you evaluate the alternatives. Compare the total cost and the risk of each option with the same renovation budget before you choose.

What should you ask a lender before opening a line?

1. Ask what fees apply at opening and with each draw, and whether there is a minimum draw or an initial draw.
2. Ask how long the draw period lasts and what the payment will be when repayment begins.
3. Ask whether the rate is variable and whether part of the balance can be fixed.
4. Ask under what conditions the lender can freeze or reduce the line.
5. Ask for the terms of any alternative the lender offers, so you can compare them.

Is the interest tax deductible?

The Internal Revenue Service says in Publication 936 that interest on home equity loans and lines of credit is deductible only if the borrowed funds are used to buy, build or substantially improve the taxpayer’s home that secures the loan, and that the loan must be secured by the taxpayer’s main home or second home and meet other requirements. Whether that applies to you depends on your tax situation, so ask a tax professional before counting on a deduction.

Match the Loan to the Project Before You Request Quotes

Settle the funding plan and a cash reserve before you request kitchen remodeling quotes, so the bids you accept fit what the loan allows.