Today’s housing inventory is limited, and buyers may feel that their only options are fixer-uppers in need of renovations. For this reason, present homeowners might prefer staying put and upgrading their current homes instead. Whether you want to remodel your newly purchased home or add an addition to your current house, renovation loans can give you the funding you need to launch the project. Your home is your most important investment—which is why I’ve put together a helpful guide on renovation lending, so you can get the most out of your upgrades.
There are two different types of home renovation loans that you could pursue:
1.) Purchase loans for a new property:
- Fannie Mae’s HomeStyle Loan: A popular loan for home improvements is Fannie Mae’s HomeStyle Renovation loan, which allows borrowers to either buy a home that needs repairs or refinance their existing home loan to pay for improvements. One advantage of the HomeStyle loan is that it’s just one loan closing. The payments and draw schedules go into an escrow account that’s used to pay the contractor directly. Meaning you will not have access to those funds like you do with a home equity loan or a cash-out refinance. A certified contractor must prepare and submit a cost estimate and details of the work to be done.
- FHA 203(k) Loans: The Federal Housing Administration offers a home renovation loan called a 203(k). Compared to the HomeStyle loan, the 203(k) has its own advantages including a lower credit score requirement and a lower minimum down payment of 3.5 percent. The FHA 203 (k) loans require an approved FHA 203(k) contractor who is familiar with the working of the draw schedule and inspections. With a standard FHA 203(k) loan, the consultant acts as your project manager, assessing the cost, the plans and overseeing the work.
2.) Refinance loans to use current equity:
- HELOCs: A third way to finance your home renovation is through a home equity line of credit, or HELOC, which is basically a second mortgage. A HELOC has a revolving balance and might be best for someone who has several large payments due over time, like with a big home improvement project. Essentially your home acts as collateral. So, if you don’t make your payments on time, the lender will end up owning your house.
- Cash-out Mortgage Refinance: A cash-out refi allows homeowners to refinance their mortgage at a higher amount than the first one. Essentially the homeowner gets the difference in cash. Like HELOCs, cash-out mortgages require using your home as collateral. But if you have a considerable amount of equity in your home, you might be able to find lower interest rates. Lower interest rates, combined with the added home value derived from renovations, could benefit you greatly over the long run. These types of loans allow the homeowner to be more involved with the payment schedule and allows for individual contractors for separate parts of the project.
Your Home Value After Renovations
You should only take out a loan to renovate your home if you feel confident that the project will either reduce your long-term costs or increase the value of your property. If done correctly, home renovations will increase your property value by a greater amount than what you spent. Hire a contractor to give you recommendations so you can get a return on your most valued investment. Be sure to renovate the rooms that will give you the biggest bang for your buck, like bathrooms and kitchens.
Hire a Knowledgeable Contractor
Hiring a contractor who is familiar with home renovation lending is very important since your lender will need to approve him or her before you can complete the loan closing and start the projects. Your contractor will also work closely with the bank during the appraisal process, so he or she will need to communicate clearly with all parties on the progress, quotes, and details of your renovation.
When choosing a contractor, I recommend meeting with a few individuals personally. At that time, obtain quotes to determine the scope of work and the most cost-effective price. It’s important to detail a clear plan with your contractor before getting started on renovating, so the pricing and projects are well laid out in advance.