A Beginner’s Guide to Home Renovation Loans

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• “Home renovation loan” is a catch-all term referring to a loan that pays for upgrades or repairs to a home.
• Personal loans are a popular type of home renovation loan, but you can also use a mortgage to cover renovations.
• These loans can help you buy a fixer upper or rehab your current home. But it’s important to understand the pros and cons.

If you’ve ever thought about buying a cheap home in need of some TLC and fixing it up to make it yours, a home renovation loan can help you do that. Or you might turn to one of these loans if there are changes you’d like to make to your current home that you can’t pay for out of pocket.

There are a few different types of loans that can be used for home improvements, and they each come with their own pros and cons. Here’s what borrowers need to know about home renovation loans.

What is a home renovation loan?

“Home renovation loan” is a catch-all term that can refer to a few different types of loans used to cover the costs of renovating or rehabbing a fixer-upper home. It’s also sometimes referred to as a home improvement loan.

The types of updates or changes that can be paid for using a home improvement loan varies. The changes can be big, like adding a new room to the house, or relatively small, like making aesthetic updates to a kitchen. 

Some common reasons for getting a home renovation loan include:

• Installing or updating heating and cooling systems
• Energy efficiency improvements
• New roofing
• Kitchen or bathroom remodel
• Finishing a basement

Renovation financing options

1. Personal loans

When people talk about getting a home improvement loan, they’re typically referring to a personal loan. Personal loans are super flexible because they can be used for just about anything.

The best personal loans for home improvement projects offer a wide loan amount range and low fees. But be sure to shop around, because these loans tend to have higher rates than the other types of loans on this list.

2. Renovation mortgage loans

If you’re buying a fixer-upper, you should consider home renovation loans that include the money you need to fix up the home with the mortgage used to purchase the home. This gives you a single, convenient monthly payment — typically with a lower rate than what you’d pay with other home improvement loan options.

The Federal Housing Administration offers a type of FHA loan for renovations that roll both the home’s purchase price and your renovation costs into one mortgage.

VA loans can also be used to finance repairs or updates to a home. 

Many lenders also offer conventional mortgage options for home renovations, either through Fannie Mae’s HomeStyle Renovation loan or Freddie Mac’s CHOICERenovation program.

All of these loans can also be used to roll your renovation costs into a refinance of your current mortgage.

3. Cash-out refinance

If you’re looking to update your current home and you have a lot of equity in it, you could use a cash-out refinance to cover your renovation costs. With a cash-out refinance, you’ll both replace your current mortgage and take some of the equity out of your home, turning it into cash you can use for whatever you want.

Keep in mind that when you refinance, you’ll be taking on a new interest rate. If mortgage rates are higher now than when you originally got your mortgage, you could end up paying a lot more in interest by getting a new loan.

You can use a mortgage calculator to see how a new mortgage rate could impact your monthly payment.

4. Home equity loan

Home equity loans provide a way for homeowners to tap into their home equity without replacing their current mortgages. But because these are second mortgages, they come with higher rates than first mortgage refinance loans. 

5. Home equity line of credit

Home equity lines of credit, or HELOCs, are another type of second mortgage. They work more like credit cards than traditional installment loans, giving you a line of credit that borrows from your home’s equity as you need it. These also have higher rates than first mortgages, and HELOC rates are generally variable, meaning they can fluctuate.

How to finance home improvements

1. Determine what needs to be done

The first step to financing home improvements is figuring out what needs to be done. If you’re buying a fixer-upper that’s in particularly poor shape, this is likely a task that will require bringing in a professional to see if there are any safety or structural issues that need to be addressed, in addition to any aesthetic changes you’d like to make.

2. Understand which type of home renovation loan is right for you

Before you start shopping for home renovation loan lenders, you’ll need to decide exactly what type of loan you’re looking for.

If you’re purchasing a home, a renovation mortgage loan like the FHA 203(k) loan program is a good choice because it rolls your renovation costs into your mortgage. Of all your renovation loan options, these types of loans are going to come with the lowest rates. These may also be a good choice if you’re looking to upgrade your current home, since you can use these loans to refinance as well.

If you’re upgrading your current home and don’t want to refinance your mortgage, you might want to consider a personal loan, home equity loan, or HELOC. Personal loan rates are typically higher, but they don’t require you to take equity out of your home. 

3. Figure out your budget

No matter what type of loan you get, there’s a limit to how much you can borrow. You also want to avoid borrowing more than you need. Work with a contractor to determine how much it will cost to complete all of the repairs or upgrades. Or, if it’s a smaller project that you’re DIY-ing, research online for average costs and price out how much you’ll need to pay for materials. 

4. Make sure you’re meeting your loan program’s guidelines

If you’re using a renovation mortgage, be sure you’re sticking to the loan’s requirements. Work may need to be completed by a licensed contractor, and you’ll likely need to provide certification once the project is finished.

Are home renovation loans worth it?

Home renovation loans can help homeowners finance repairs or improvements they otherwise wouldn’t be able to afford, or they can enable homebuyers to buy an affordable home and fix it up.

But borrowing money always comes with some risks, and home renovation loans can be particularly risky when used to purchase a fixer upper. Many borrowers assume that fixing up a home and improving its value will be simple, but it isn’t always so clear-cut.

Douglas Boneparth, a CFP at Bone Fide Wealth, says that the potential to earn equity through a home renovation loan is doable — but not without thoughtful preparation. He advises first-time homebuyers to be very wary of the promise of “fast equity” and make sure they understand all the costs involved before moving forward with a fixer-upper.

“The likelihood that a new homebuyer will successfully maximize equity on their first try using a home renovation loan is rather low,” says Boneparth, explaining that getting good at building wealth through real estate takes experience.

Of course, results will vary based on improvements made during renovations, the timing of the sale, and the market you’re in. While reno loans offer the potential for fast equity, it doesn’t come without risk.

Renovation loan eligibility

To get a loan for a house renovation, you’ll need to meet certain credit requirements.

If you’re getting a renovation mortgage, this will include qualifying for a mortgage, which typically requires a credit score of at least 620.

FHA loan borrowers may qualify with scores as low as 580, though different FHA loan lenders may have higher requirements. 

To qualify for a personal loan or home equity loan, you may need a credit score in the mid-to-high 600s, depending on the lender. HELOCs often require a score of 680 or higher. 

Remodeling loan rates

The rate you’ll pay for your home improvement loan depends on the type of loan you get. Cash-out refinances or renovation loans rolled into mortgages are typically the best renovation loan programs because they come with the lowest rates. Personal loans have some of the highest rates, but they also come with more flexibility. Home equity loans and HELOCs are generally somewhere in the middle.

No matter what type of loan you get, get quotes from multiple home renovation loan lenders so you can compare offers and make sure you’re getting the best deal available.

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