How a Home Equity Loan Can Help You Pay for Energy-Efficient Upgrades - CNET

Installing a home solar system or energy-efficient windows can lower your carbon footprint and help you save on your power bill. However, these eco-friendly upgrades can be expensive. The average cost of residential solar panels is $3.30 per watt, which adds up to $16,500 for a 5-kilowatt system.

A popular and easy way to pay for these upgrades is to borrow funds against the equity in your home. Let’s look at the advantages and drawbacks of using a home equity loan and how to decide whether this is the best option for you. 

A home equity loan is a type of financing where you’ll get a lump sum of cash upfront, using your home as collateral. Once you have at least 15% to 20% home equity, you’re eligible to borrow money at a fixed rate based on the ownership stake in your home. 

Just like other types of installment loans, you’ll make monthly payments to repay the amount you borrow over a set amount of time. The advantage is that home equity loans have lower interest rates than other types of financing, such as credit cards or personal loans. The average interest rate on a home equity loan as of early April was 8.49%, per CNET’s sister site Bankrate. 

Home equity loans always come with risks, including losing your home if you miss payments. That’s why homeowners should be cautious when borrowing against their ownership stake. If you’re planning on funding a project that will increase the value of your home with a home equity loan, make sure you have a clear repayment plan in place. 

As awareness of environmental issues grows and more homebuyers seek out sustainable living spaces, eco-friendly homes are becoming more popular. According to a 2023 National Association of Realtors report on sustainability in real estate, 63% of survey respondents recognized the value of promoting energy efficiency in home listings. 

If you’d like to spruce up your home with energy-efficient upgrades, here are some that can boost the value of your home.

While solar panels are a big-ticket expense upfront, the federal solar tax credit and various incentives that might be available where you live, such as municipal credits or state programs, can help offset costs, said David Druey, Florida regional president at Centennial Bank.

“Despite the longer time frame required to recoup the investment, solar panels offer immediate environmental benefits and can eventually lead to substantial savings on energy bills,” Druey said. 

Even if you live outside a hurricane-prone area, investing in high-quality storm windows and doors can prevent them from getting damaged by severe weather. Sustainable and resilient features can yield significant benefits: For instance, installing mirroring can help regulate the temperature in inside spaces. 

“These upgrades not only enhance energy efficiency but also contribute to cost savings through improved insulation and durability,” Druey said. 

While some eco-friendly upgrades can help you save money and boost your home’s value, others can improve your day-to-day living situation. Though specific to your preferences, these might include investing in more energy-efficient appliances or building garden structures and fencing with bamboo.

If you plan to live in your home over the long term, lifestyle criteria might be more important than boosting your home value, according to Mike Kraten, director of Accounting Program Initiatives at the University of Houston, where he specializes in sustainability and ESG issues. 

Read more: Can You Use a Home Equity Loan or HELOC to Buy Solar Panels?

There are upsides and downsides to a home equity loan. Let’s start with the main advantages:

Steady payment schedule: Since you’re responsible for repaying the same amount each month, it’s easier to budget with a home equity loan than it is with revolving loans, where the amount you pay can fluctuate each month.

Potential tax savings: If you’re using the funds from a home equity loan for home improvement projects or renovations, it typically qualifies for a home mortgage interest tax deduction, said Kraten. However, he noted that because of recent changes in tax laws, many taxpayers take the standard tax deduction and are less likely to itemize deductions like mortgage interest. 

Lower interest rates: Because you’re using the home as collateral on the loan, the interest rate is usually lower than it is with a credit card or personal loan. With solar panels, in particular, many installers offer financing themselves or through a partner financial institution. Be sure to compare the interest rates and fees on those solar-specific loans, as they may offer comparable terms without putting your home at risk.

Now, let’s go over some of the potential downsides of a home equity loan to upgrade your home: 

Your home is collateral: Since you are putting up your property as collateral, a home equity loan is a long-term financial responsibility that has serious repercussions if you’re unable to make payments. If you suffer a job loss or a financial emergency and default on your loan, you could risk losing your home.

Pay off a second mortgage: Because a home equity loan is essentially a second mortgage, you’ll need to commit to paying off a loan with interest, regardless of whether the project you’re funding materializes as expected, according to Kraten. “The loan terms may be inflexible, and you need to commit to a fixed set of repayments,” Kraten said. 

Go through an approval process: Just like with your first mortgage, you’ll need to undergo the application and approval process. You’ll also be on the hook for fees, and it can take anywhere from two weeks to two months to get approved for the financing. 

You typically need at least 20% equity in your home to qualify for a home equity loan. 

Though the specific amount of financing you qualify for depends on your equity, credit score, debt-to-income ratio, income and payment history, you can do a simple calculation to get a ballpark figure. 

Mortgage lenders typically allow up to an 80% loan-to-value ratio, though some lenders allow up to an 85% LTV. So, even if a lender offers a $600,000 loan, you might not be eligible to borrow that full amount. 

To figure out if you’re eligible to borrow, calculate your LTV by dividing your current mortgage balance by the appraised value of your home. If your loan balance is $250,000 and your home is worth $600,000, your LTV is 42%, and you have 58% equity in your home. That means you qualify for a home equity loan, and the next step is to determine how much you can borrow. 

In this case, multiply the value of your home ($600,000) by 0.80 (lender max) to get $480,000. Then subtract your existing mortgage balance ($250,000). The most you can borrow should be $230,000. 

Read more: Requirements for a Home Equity Loan or HELOC

To decide whether a home equity loan is the right fit for you, here are some questions to ask yourself: 

What projects and upgrades are you trying to accomplish? Because you’re getting a lump sum to fund your eco-friendly upgrades, it’s a good idea to decide on the project and its estimated cost. Otherwise, you might run into the danger of borrowing too little or too much. 

Will I be able to repay the debt in a timely manner? A home equity loan means more debt to pay off on a monthly basis. As home equity loan terms tend to be anywhere from five to 30 years, you’d be responsible for repayment for quite a long time. If you’re not confident you can stay on top of your monthly payments, consider taking out a smaller loan or commit to a less expensive eco-friendly upgrade. 

Also, don’t count on savings from lower income taxes or lower electricity costs to offset repayments, since there is significant risk if those savings don’t materialize, said Kraten. 

Will the benefits justify the costs? You’ll want your investment to pay off, in the short term or in the long run. For eco-friendly upgrades like solar panels, the primary benefits may be easily quantified because they’re financial in nature, according to Kraten. You’ll save on energy costs over time. 

For lifestyle upgrades, however, the primary benefits may not be quantifiable, said Kraten. In those cases, it’s more about your preferences and perceived value of an upgrade. 

Does another type of financing make sense? Other borrowing options exist depending on the project’s scope and timeline, said Druey. If you’re considering a long-term renovation with payments for upgrades spread out over time, you might consider a home equity line of credit (HELOC), which works similarly to a credit card in that you can borrow from it as needed.

You can also cover the costs for your eco-friendly upgrades with a cash-out refinance on your home. Just make sure the interest rate savings make sense.