Renovation Financing: Home Equity Loan Vs. 401(k)


What’s green, crisp, but doesn’t grow on trees? The answer is money. In its basic physical incarnation, it looks, feels and spends the same—no matter where you get it. But when you’re dealing with money on a larger scale—like a multi-thousand dollar loan for home renovations—where it comes from can ultimately make a big difference in your bottom line.

Home Equity Loan

Many borrowers looking to finance renovations turn to the traditional home equity loan. With a repayment term of at least a decade, this product allows you to borrow against the equity you’ve built in your home, after years of principal payments and property appreciation. The amount you can access depends on the market value of your home minus the balance you owe on your mortgage. Most lenders cap disbursements at 75 to 80 percent of the available equity, after they factor in the first loan. Your credit score and income affect your ability to obtain financing. You’ll also have to pay closing costs, which vary by lender. Interest rates on home equity loans are typically higher than those on primary mortgages, as well. Fortunately, this interest is usually tax deductible if you’re using the loan proceeds for home improvements. If you find yourself unable to make your home equity loan payments, though, you risk losing your home.

SEE ALSO: 5 Disadvantages Of Home Equity Loans


Another home renovation financing option is a 401(k) loan. However, most financial professionals advise against it, unless you’re facing an emergency situation with no other feasible options. You put the funds in your 401(k) to assist you in retirement; they should not be withdrawn lightly. Borrowing from a 401(k) is usually easy. A credit check is not required, because the remainder of your account serves as collateral. Companies generally cap the amount you can access at 50 percent of your vested account balance, or $50,000, whichever is larger. Unlike a home equity loan, there are no closing costs or fees to obtain a 401(k) loan, and interest rates are often quite low. Depending on your employer, you may even be able to call an automated system and have a check within days. However, the strict repayment requirements are major drawbacks of 401(k) loans. You generally havefive years to settle the balance of the loan, and your employer will take your monthly payments directly out of your after-tax pay. In addition, should you leave or lose your job, you have only 60 to 90 days to repay it. If you’re unable to settle the debt in that time, the loan will be subject to taxes, plus a 10 percent early-withdrawal penalty if you’re under the age of 55.

Weighing The Options

Whether a home equity loan or borrowing from your 401(k) is the best option for you, will depend on many factors: How important are the renovations to the value of your home and the safety of your family? How high is your credit score? Can your income support another loan payment? How close are you to retirement age? How secure is your current job? Consider the answers to these questions very carefully, and consult a financial advisor for additional clarity.

SEE ALSO: Looking For A New Bank? Three Scenarios That Aren’t Worth It

Date of original publication:
Updated on: November 10, 2015

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