What is a Renovation Loan?

Renovating your home can be expensive. However, there are ways to repair or refurbish your home affordably, and that's with a renovation loan. Sadly, not many people are aware of renovating their homes with loans; even if they are, many are unaware of the nitty-gritty of the process.

Renovation financing is based on one key factor - the home's value after renovation.  It is like a credit given to a homeowner for the perceived value of his residential property after renovation.

This guide will help you understand the entire gamut of renovation loans so that navigating the landscape becomes more accessible and friendly. 

What is a Renovation Loan? How Do They Work?

As the name suggests, a renovation loan is where you get the funds to repair or renovate your home. It means you do not have to use your savings to refurbish your home. The loan amount is generally calculated based on the project's estimated cost and the property's value after repair. 

Like other loan types, renovation financing of your home through a loan means that you need to pay interest and repay the amount after the agreed term period is completed. You should be able to differentiate between a home improvement loan, a personal loan, and an actual renovation loan, with lower interest rates than the former.

Types Of Home Renovation Loans Available

• Personal Loans

Homeowners have the option of taking personal loans to remodel a house. However, these are unsecured loans and are characterized by higher rates of interest, almost 25%, compared to secured loans. If you have a decent credit score, you can easily get a personal loan for home improvement. You would need to submit collateral to get this loan. The origination fee is applicable, and in many cases, it is charged upfront. The fees range between 3% and 5% of the total loan value.

The term for repayment in this type is usually short as compared to other types of home improvement loans. This means that you need to repay the amount faster, which means higher monthly payments. To top it off, you may be penalized if you repay the loan earlier than the term period.

It is generally not a good idea to take personal loans for home renovation. That is mainly because of the higher interest rates and shorter-term periods.

• Home Equity Loans

Your house builds equity as time progresses. You can take a renovation home loan against this equity. The funds come in a lump sum. The rates of interest are lower than personal loans. Your home will be the collateral for this kind of loan.

The interest rates in home equity loans are usually between 3% and 15%, depending on the loan term and your creditworthiness. Usually, you must pay closing costs ranging between 2% and 5% of the amount, including expenses like appraisal fees, insurance fees, origination fees, title searches, etc. You may also be charged an annual maintenance fee of about $50 or more.

Home equity loans are the most common home renovation loans. Since these are secured loans, the lender is at minimal risk, which is why the interest rates are low compared to personal loans.

• Home Equity Lines of Credit (HELOCs) 

These are similar in nature to home equity loans. The only difference is that you can withdraw funds only when required and have a variable interest rate. Thus, in this renovation home loan, you do not receive a lump sum amount. The collateral is your home. 

The interest rates in HELOCs are variable and mostly hover around a benchmark rate. The interest rates can initially be lower than the interest rates of home equity loans. However, with time, it can increase. HELOCs have closing costs ranging between 2% and 5% of the credit limit. The closing costs include appraisal fees, title searches, insurance costs, origination fees, etc. You will also be required to pay an annual fee of 50$ or more, but this may not apply to all HELOCs. 

This home reno loan is usually funded against the home equity. For homeowners who have lived in the home for ten-plus years, this may not be an issue. However, for recent homeowners, gaining this loan may be a challenge.

• Cash-Out Refinance

In this renovation loan type, your present mortgage is replaced with a newer mortgage of a more considerable value. The balance between the original mortgage and the new amount can be taken out and used to renovate your property. If your home equity is high, the rate of interest can be lower than the rate of your present mortgage. 

The interest rate in this renovation financing scheme is primarily dependent on the prevailing market rates and creditworthiness. There are closing costs that include origination fees, appraisal fees, insurance fees, etc., and usually lie between 2% and 5% of the total value. Private mortgage insurance (PMI)applies if your equity in the home is less than 20%. 

• FHA Rehab Loans

These are loans for home renovation insured by the Federal Housing Agency (FHA). Borrowers use a single mortgage to refinance or finance the renovation of their home. FHA offers two types of home renovation loans: the Standard 203 (k) loan and the Limited 203 (k) loan. 

The standard 203 (k) loan is the best choice for structural refurbishments or large-scale renovations, while the limited 203 (k) loan is ideal for non-structural work.

There is a third type of renovation loan from the FHA—the particular 203 (h) loan. It's specifically meant for people who have lost or damaged their homes during natural disasters. The funds help people buy or rebuild a new home in a declared disaster area. People can use the 203 (h) loan with or without the 203 (k) loan. 

FHA Rehab loans require certain qualifying factors depending on the type of repair or renovation. There is also a limit on the loan amount, which is determined based on the value and the location of your home.  Borrowers must pay an Upfront Mortgage Insurance Premium (UFMIP), 1.75% of the loan's value. The UFMIP needs to be paid when closing the loan. The UFMIP is a means to safeguard lenders from default. A monthly insurance premium (MIP) has to be paid by borrowers. 

A 3.5% down payment is required, and closing costs, which are between 2% and 6% of the loan value, are also included. The biggest advantage of an FHA 203 Rehab Loan is that it is backed by the government. There is no requirement for home equity, and the interest rates are quite low, too.

Requirements for Renovation Loans

Loans for home renovation have certain eligibility conditions.  Some of these have been mentioned here - 

• Credit Score Requirements

In most cases, to get a home reno loan, you need a credit score of 620 or more. However, in certain cases, the lender requires a higher credit score. The correct course of action is to check with your lender to understand their specific requirements for credit scores.

• Income and Employment Requirements

Most lenders will assess your income and employment history before they qualify you for a home reno loan. You will need to have a stable income and also have a sound employment history. This is required so that the lender is sure that you will be able to repay the loan. 

• Property Eligibility

Lenders also have specific property eligibility criteria. For instance, the property should be your primary place of residence and meet the pre-requisite safety and livability standards.

• Other Eligibility Factors

Many other factors must be considered to determine your eligibility for a renovation loan. For example, the debt-to-income (DBI) ratio is considered. Similarly, the borrower's financial history is considered. The renovation project type is also an eligibility criterion for a loan to remodel a home.

 

Deciding if a Home Renovation Loan is Right for You

Renovating home loans is a choice for homeowners who wish to repair and refurbish their homes. The right kind of renovation can help increase your home's value. You can work with a credible mortgage advisor like Total Mortgage. 

The following are the pros and cons of a renovation loan.

Advantages of Renovation Loans

• Availability of Funds: loans for home renovation offer borrowers ready-to-use and ready-to-access funds to refinance their home improvement projects. Thus, homeowners can undertake minor or major renovation projects of their homes.

• Multi-purpose use: The funds from the renovating financing loan can be used to repair and refurbish different areas of your property. It can be used for renovating the kitchen or the bathroom, or extend your home, etc. 

• Competitive Rates of Interest: Most renovation home loans have low interest rates, especially secured home renovation loans, which are lower than unsecured loans. This converts into lower monthly payment schedules for borrowers.

• Fixed Interest Rates: In the case of Home Equity Loans, the rates are fixed with pre-fixed repayment terms. For borrowers, the monthly payments remain fixed and consistent. This helps you achieve your financial goals.

• Tax Benefits: In some instances, loans for home renovation can give you tax benefits. In such cases, the interest is tax-deductible. This depends on the local tax regulations.

• Home Value Increases: Renovating and repairing your home leads to increasing the value of your home. Home improvement loans help in the process, and with enhanced functionality, look, and energy efficiency, your home can get a better sale price when you put it up for sale.

• Smooth Application Process: in most cases, obtaining renovation home loans is streamlined. Therefore, it is easy to get the funds for renovating your home. The process is faster, too, helping you save time and effort.

Disadvantages of Renovation Loans

• Extra Debt: A loan to remodel a home means another loan and adds to your debt obligations. Make sure that it does not become a financial burden. Research well to get a low-interest loan. 

• Collateral: Most lenders will ask for collateral, and you must give your home as one. This could place an additional burden on you.

• Eligibility Conditions: Most lenders will have lots of eligibility criteria, such as your income and employment history, your debt-to-income ratio, your credit score, and more. If you meet the eligibility criteria, there are fewer chances of getting the desired renovation home loan.

Apply for a Renovation Loan with Total Mortgage!

Finding the right loan for home renovation can be tiresome. It would help if you found a lender ready to work with you, aligned with your home goals, and offering competitive interest rates that fit your budget. 

If you are looking for a seamless process that saves time and energy, you can apply for renovation financing with Total Mortgage. Follow these steps for a quick and effective application process for a renovation loan.

Step # 1: The Pre-Approval Process

Getting a pre-approval is highly advisable before applying for a home renovation loan. With pre-approval, you are in a better position to understand how much you are eligible to borrow and get an idea about the interest rates and the terms of payment.

Step # 2: Documentation

Lenders require you to submit various documents for a renovation loan, including proof of income and employment, a credit score, etc.

Step # 3: Complete the Application Process

Now is the time to fill out the loan application form and ensure all necessary documents are in place. It is crucial to complete the form and documents property because the lender will assess each aspect of the application and even ask for more documents if need be.

Contact us for more information.