The Ultimate Guide to Renovation Loans (2024)

Available for buying or refinancing a home, Renovation Loans roll mortgage and remodeling costs into one loan. Renovation Loans are based on a home’s estimated value after renovations are complete, allowing you to borrow more than a traditional home equity loan. By improving the value of the home, the renovations can help you build equity faster than you could buying a move-in ready house, giving you more control over the value of your property.

By preserving older homes or those in disrepair, Renovation Loans help refresh and revitalize neighborhoods and provide a way for buyers to purchase in a pricier neighborhood at a more affordable rate. After all, homes needing work rarely list at full market value. Your willingness to invest time and patience while living in a construction zone can pay off in a lower overall purchase price. Whether you add a bathroom, knock out some walls, install energy-efficient appliances and water-saving fixtures and landscaping, you’ll experience the pleasure of creating a home that truly reflects your values, tastes and lifestyle.

Renovation Loans offer a number of advantages over some traditional methods of financing:

• Avoid depleting your savings or maxing out your credit cards to pay for needed repairs and wanted upgrades.
• By combining your mortgage and your remodeling loans, you simplify your monthly bill paying and may lower your interest rate.
• Claim a larger tax deduction by combining renovation and mortgage interest.*
• Build equity faster by increasing the value of your home.
• Add to your home’s value when you decide to sell.

*USA Mortgage is not a licensed to provide tax advice. For more information on tax deductions, please reach out to your licensed tax advisor.

How Does A Home Renovation Loan Work?

Requirements & Restrictions

When you qualify for a Renovation Loan, you will be subject to a variety of guidelines and limitations. Most Renovation Loans require that you live in the home as your primary residence. There are limits to the amount of money you can borrow as well as what kind of projects you use it for.

You must use licensed contractors for any structural, electrical or plumbing renovations. And you can only have one general contractor overseeing work on your home. Your mortgage lender wants to protect its assets until the loan is paid off. So, there’s no cutting corners by hiring your part-time handyman buddy or doing it yourself. You and your contractors must abide by a set payment schedule. And, you may be required to work with a consultant to manage the renovation process.

Customize your home and find the perfect mortgage loan solution. With over a dozen financing options to choose from, you’re sure to find the right loan to turn your fixer-upper into the home of your dreams.

FHA 203(k) Loans

Insured by the Federal Housing Administration, FHA 203(k) loans are backed by the government, making them a good choice for buyers who need a low down payment or have less-than-stellar credit. Available in Limited and Standard options, they can be used to purchase a one- to four-unit family home, individual or site condominium unit or a mobile or manufactured home.

Advantages:

• 3.5% minimum down payment option
• Lower credit score requirements
• No income limits
• A $5,000 minimum on renovation costs
• Gifts allowed
• Seller contributes of up to 6% of the purchase price
• 15- to 30-year term with fixed interest rate

Disadvantages:

• Requires Mortgage Insurance Premium which can be rolled into the monthly loan payments
• Must be an owner-occupied, primary residence

Allowed Improvements:

• Repair/replace roofs, gutters, and downspouts
• Repair/replace/upgrade existing HVAC systems
• Repair/replace/upgrade plumbing and electrical systems
• Repair/replace flooring
• Minor remodeling, such as kitchens and bathrooms not involving structural repairs
• Painting, interior and exterior
• Weatherization, including storm windows and doors, insulation, weather stripping, etc.
• Purchase and installation of appliances, including free-standing ranges, refrigerators, washers/dryers, dishwashers and microwave ovens
• Accessibility improvements for persons with disabilities
• Lead-based paint stabilization or abatement of lead-based paint hazards
• Repair/replace/add exterior decks, patios, porches
• Basem*nt finishing and remodeling not involving structural repairs
• Basem*nt waterproofing
• Window and door replacements and exterior wall re-siding
• Septic system and/or well repair or replacement

Limited FHA 203(k) loans cover minor, non-structural repairs and upgrades up to $35,000. There is no minimum cost for renovations.

Standard FHA 203(k) loans require a HUD-approved 203(k) consultant to work with the owner and the contractor to ensure all required renovations are made and payments are disbursed on-schedule, as directed. You will need to select the Standard loan if your home needs major rehabilitation work, structural repairs, landscaping or renovations exceeding $35,000. Renovations must be $5,000 or more. You cannot use the Standard loan to purchase or renovate any luxury item or make improvements that are not a permanent part of the property.

Fannie Mae HomeStyle Renovation Loan

This loan can be a smart choice for homeowners with good credit and a sizeable down payment. It can be used for repairs, remodeling or energy efficient upgrades as well as to finance primary, vacation and rental properties.

Advantages:

• Minimum 5% down payment or 10% for second homes
• Gift funds may be used towards the down payment and closing costs
• Offers higher loan limits
• No restrictions on type of repairs as long as they are permanently affixed and add value to the property

Disadvantages:

• Requires Private Mortgage Insurance for down payments less than 20%

Cash-out Mortgage Refinances

One of the most common choices for financing home improvements, a cash-out mortgage lets you refinance your home for more than you owe. You can then draw on the extra money to pay for your renovations. Offering a fixed interest rate, a cash-out refinance loan can lower your interest rate and/or your monthly payments.

Conventional Cash-out Refinance Loans are a great option if your credit is good and you’ve built a lot of equity in your home. Their larger loan limits can cover more costly renovations. Conventional cash-out loans limit you to an 80% loan-to-value ratio (LTV), which is the amount of the loan divided by your home’s market value.

FHA Cash-out Refinance Loans are backed by the government, making it a good option for homeowners with lower credit scores and higher debt-to-income ratios. With a maximum loan-to-value ratio of 80%, an FHA cash-out lets you borrow more money, while potentially lowering your interest rate or changing the length of your loan.

FHA Title 1 Loans are backed by the FHA and are a solid option for borrowers with poor credit or little-to-no equity in their home. Single-family home owners can borrow up to $25,000 for home improvements while owners of multi-family properties can borrow up to $12,000 for each additional living unit with a limit of five units or $60,000.

VA Cash-out Refinance Loans are also backed by the government and are available to eligible service members and veterans as well as their unmarried surviving spouses. Allowing you to refinance up to 100% of your home’s current value, a VA cash-out is a great option, even if you’ve only accrued 10-15% equity in your home. Unlike other types of cash-out loans, VA cash-outs do not require private mortgage insurance.

Home Equity Loans & Lines of Credit

Access the money you’ve invested in your home while you’re still living in it. Home equity loans and lines of credit are personal loans that use your home as collateral. Often used to finance college tuition, debt consolidation, or new business ventures as well as home improvements, home equity loans let you borrow up to 80% of your home’s market value minus the amount you owe on the mortgage. It can be a smart choice if you have a substantial amount of equity built into your home and want to borrow a large lump sum for bigger renovation projects.

Home Equity Loan Advantages:

• Fast approvals
• Lower rates and closing costs
• Fixed interest rate
• Fully amortizing, so you start repaying interest and principal from the beginning
• No restrictions on how you use the money
• May be tax deductible—ask your tax advisor

Disadvantages:

• Higher rates than cash-out loans
• Smaller loan amounts
• Payments do not go towards your existing mortgage
• Adds another monthly loan payment

Home Equity Line of Credit (HELOC) is a revolving credit line you can draw on as you need it. Typically offering variable rates, HELOCs are similar to credit cards—take out as much as you need at any time, up to your credit limit. Your monthly payments depend on current interest rates and your loan balance. You can pay it down over time or all at once as you see fit. HELOCs are a good option for smaller, less expensive or ongoing projects.

HELOCs have a draw phase, during which you can draw on your credit line as much and as often as you need to while paying off the interest each month. After a set amount of time (typically 10 years), you will enter the repayment phase. You can no longer take money out of your credit line. Instead, you will make monthly payments on the interest and the principal as the loan becomes fully amortized through the remainder of your term.

Home Equity Line of Credit Advantages:

• Borrow what you need, as you need it
• Low monthly payments during the draw phase
• Low to no closing costs
• Great for smaller or ongoing projects
• Pay interest only on the amount borrowed, not the entire credit line

Disadvantages:

• Variable interest rates
• Higher rates than a home equity loan
• Lender can change repayment terms
• Monthly payments can grow substantially when you enter the repayment period

Other Options

Not all of your renovation loan options use your home as collateral. There are a number of other loans that can help you pay for home improvements.

Personal Loans & Lines of Credit

Unsecured loans that do not require you to put up collateral, personal loans and lines of credit eliminate the risk of losing your house or car should you become unable to repay the loan. Offering speed and simplicity, personal loans can be processed and approved quickly with far less paperwork than refinance or home equity loans require.

Advantages:

• No home equity or collateral needed
• No appraisal required—a great asset if your home is in disrepair
• Access money quickly

Disadvantages:

• Higher interest rates, especially for borrowers with lower credit scores
• Loans limited to $100,000

Personal Lines of Credit are revolving lines of credit allowing you to borrow what you need, as you need it, up to the limit of your credit line. Like the HELOC, a personal line of credit functions much like a credit card, offering great flexibility in when and how much credit you draw on and how you pay it back. Unlike credit cards, credit lines have variable interest rates that can be applied to your existing balance. Be sure you understand how often and how much your lender can raise your rate before signing on to a personal line of credit.

Contractor Financing

According to a survey by Consumer Reports, 42% of general contractors offer financing options to their clients. Some may offer to help you secure a loan through a trusted third-party lender. Rates and terms can vary widely, so make sure you understand the details, just as you would with any major financial commitment. Before signing, look for online reviews from your contractor-lender’s previous customers and check with your local Better Business Bureau.

With so many renovation financing options to choose from, the question is: which one? The answer is unsatisfying: it depends.

Take a long, objective look at your unique situation. Are you buying a new home or refinancing your current one? How’s your credit? How’s your equity? How extensive—and expensive—are the renovations you want to undertake? How fast do you need the money, and how much paperwork and hassle are you willing to go through?

All of these questions, and more, play a role in determining the best loan for your situation.

Are you a homeowner with lots of equity but a higher rate on your existing mortgage? A cash-out refinance can provide the money you need to fund your renovations while lowering your interest rate. If you have little to no equity built up or you’re struggling with your mortgage, a personal loan or line of credit may be your only option.

Are you dreaming of renovating a fixer-upper with “good bones” and lots of potential? Whether buying or refinancing, a no-equity-required FHA Title 1 loan or FHA 203(k) loan can provide the money you need. Although Title 1 loans are capped at $25,000 for single-family homes, they offer additional financing for up to five units in a multi-family property. Keep in mind that a 203(k) loan requires a great deal of paperwork and processing time, making it a less desirable option if you need to move in a hurry.

Have you built a decent amount of equity? Are you happy with your current mortgage rate? A home equity loan or line of credit can provide the financing you need to renovate your home just the way you want.

Are you buying or refinancing, need money for renovations, and don’t mind following a long list of rules? The FHA 203k or Fannie Mae Homestyle loan may be right for you. And, if you’re a veteran or active-duty military, don’t hesitate to take advantage of the benefits you’ve earned by serving our country. Take a good look at the low-cost, easy-to-qualify-for refinance loans from the VA.

Do you have bad credit? Government-backed refinance loans may be your best bet. Borrowers with lower credit scores and little-to-no home equity may consider taking out a smaller loan to get a lower interest rate or putting up collateral such as your car to get an affordable rate on a larger loan.

In a big nutshell, here is a top-line look the best option for every situation:

Can you lower your interest rate? Cash-out refinance

Looking at an older or fixer-up home? FHA 203(k) rehab loan

Undertaking a big, one-time project? Home equity loan

Planning several ongoing projects? Home equity line of credit

Have low-to-no equity? Personal loan

Doing smaller, short-term projects? Credit cards

An experienced and reputable Mortgage Loan Originator can help you navigate all the options and steer you in the right direction.

Best and Worst Home Improvement Projects

Before you knock out that wall, pick out paint, or begin mentally decorating the home office you’re planning to add, think about your long-term goals for your home and your family. Are you renovating to make your home safer, more comfortable, and more energy efficient? Or do you have grand visions of scoring big profits when you sell the home next year?

While it’s entirely reasonable and desirable to reshape your home to better fit your needs, your budget and your interests, do not expect to make a killing at resale. Homeowners rarely recoup 100% of the money spent on remodeling projects. Yes, an additional bathroom, updated kitchen or in-ground swimming pool can improve your equity and resale value. But not enough to pay for itself.

In fact, the home improvements that tend to generate the best ROI are some of the least exciting, like fiberglass insulation for the attic, a new steel front door, manufactured stone veneer, minor kitchen remodels, and garage door or siding replacements.

Borrowers see the worst ROIs from such sexy projects as a bathroom addition, installing a backyard patio, major or minor bathroom remodels, and major kitchen remodels. While such renovations may not pay for themselves, they can increase your home’s equity and value. If renovations make you happier, prouder and more comfortable in your home—and you can afford the expense and the hassle—a renovation loan can be well worth the investment.

Tips and Red Flags

Home improvements and the financial commitments that come with them are a massive investment of your money, time and sanity. Shop as carefully for your Renovation Loan as you did for your house.

• Shop around and talk to more than one lender, paying close attention to rates and terms, closing costs and fees.
• Beware of balloon payments, a large lump sum that is due before you can pay off your loan. You don’t want to be surprised just when you’re looking forward to being done with loan payments.
• Look beyond the interest rate. The lowest rate does not always indicate the least-expensive or best loan for you.
• For FHA 203(k) loans, be sure you understand the contractor disbursem*nt schedule. They are designed to protect your—and your lender’s—assets and ensure you get the high-quality work you are paying for. Your FHA 203(k) consultant can help you understand the details.
• Check your rate variability. If rates go up on your variable-rate loan, it could raise your monthly payments and overall cost of your loan considerably. Ask if you have the option to convert the loan to a fixed rate down the road.
• Check your credit score before shopping or applying for a loan. It can be a good indicator of which type of renovation loan will best meet your financial needs as well as what your interest rate might be.

Think you’re ready to buy or refinance and renovate? The Mortgage Loan Originators at USA Mortgage recommend taking these first steps to ensure your Renovation Loan process is as smooth and rewarding as possible:

1. Know your budget and get pre-qualified. Talk with a Mortgage Loan Originator to determine your total purchase price eligibility—total purchase price = sales price + renovation bid + 20-35% of the bid.
2. Narrow your search. Look at homes that meet your requirements for lot size, location, and unit count. Bridge the market options and your home renovation goals with a bid from a contractor you trust.
3. Prepare for underwriting. Once your offer and bid are finalized, allow time for your mortgage to be processed and underwritten. Don’t make changes to the scope of work or your chosen contractors while your loan is under review.
4. Close the loan, and start your renovations. With your and your lender’s approval, your contractor may be eligible to receive some funds as early as loan closing to help get the project underway. You will receive a draw welcome letter once your renovation escrow account is ready for disbursing payments to your general and sub-contractors.

Congratulations! You’ve closed the loan, and renovations can now begin. During the contractor review process, a renovation expert will discuss the details with your contractor to make sure they understand the steps needed to complete your projects. The way your contractor is paid will be determined by the type of loan you get.

1. Review your closing documents. Make sure any payments due at closing have been delivered.
2. Apply for any required permits. Prior to closing, you should have signed a permit certification form. All progress draws on the loan are contingent on having the required permits in place and city inspections being completed.
3. Contact your draw administrator. Within 10-25 days of closing, the draw administrator will send you a welcome email notifying you that the escrow account for the renovation funds is setup and ready for disbursem*nt.
4. Complete project. As work is completed, you and your contractor will request draw inspections and progress payments. Once the work is complete, any change order or contingency requests can be processed along with any principle reductions.
5. Enjoy your newly renovated home!

When you finance with USA Mortgage, you get an ally and a lender for life. We’re with you for the long term. And our commitment doesn’t end when your renovations are complete. We’ll reach out periodically to let you know of any changes in the market and alert you to additional opportunities to save money. And if you ever have questions about your loan, reach out. We’re here to help any time you need it.

LEGAL:

DAS Acquisition Company, LLC is not affiliated with or endorsed by any government entity or agency, including USDA, HUD or VA. Interest rates and products are subject to change without notice and may or may not be available at the time of commitment or lock-in.