What Is a Home Renovation Loan?

Mar 21, 2022 | Mortgage Guides

Financing Your Dream Home: What Is a Home Renovation Loan?

Home repairs and renovations can be expensive. That’s why many homeowners apply for home renovation loans to help them cover the costs. A home renovation loan gives homeowners access to funds to complete their projects, but the details vary with each specific type of loan.

‍Some home renovation loans may involve putting your home up as collateral, refinancing your current mortgage, submitting your application to a government agency, or even putting a small renovation on your credit card. With so many options, it’s essential to understand each type of loan and how it fits your budget and fulfills your personal requirements. 

‍Read on to find out how to plan for a home renovation so you can figure out which one is the best for you and your financial needs! ‍

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Before Applying For A Home Renovation Loan

Many homeowners take out loans for home improvement to make hefty expenses easier to manage. Before applying for any type of loan, we recommend taking a moment to assess your situation so you can make an intelligent financial decision that best meets your particular situation and needs. To help you out, we’ve outlined a few things that you should consider before putting any money on the table:  

Calculate Loan Amount

The first step before deciding on a home renovation loan is to calculate the amount of money you’ll need to complete your home improvement project. We recommend starting by listing your desired renovations and consulting with contractors to get an idea of how much everything will cost. ‍

Consider your savings as you build a concrete number for your budget and total expenditure. Doing this will allow you to decide how much of your renovations can be paid with your savings, sparing you a bit of stress in the long run.‍

Conduct A Feasibility Study

Most home renovation loans will require a proper cost breakdown. Feasibility studies not only assess your project’s likelihood of completion but also help establish potential costs. However, this doesn’t mean that a feasibility study is considered only for the sake of compliance and documentation. It has advantages that can help you prepare for your loan and repayment. 

‍Conducting a feasibility study helps you stick to your budget while also developing a more realistic number that more accurately represents the repairs and renovations you want to make. Homeowners may not be able to assess cracked foundations or faulty plumbing by themselves and, therefore, will need a licensed contractor to provide the costs and feasibility study information. 

‍Feasibility studies are also an essential piece of documentation when applying for loans. In many cases, these studies help lenders assess the financial risk of funding specific renovations. We recommend investing in a feasibility study if you have a significant renovation planned for your home, but this depends on your specific situation. ‍

Loan Eligibility Criteria

Diligence is key when deciding on a loan for home renovation. Before committing to a funding option, we recommend engaging with your lender, and Wesley Mortgage can walk you through your options. The main goal of this engagement is to familiarize yourself with your options to see which one suits you.

‍Different loan programs will have differing eligibility criteria. The most important considerations are the loan amount sought, income, credit, and credit score, as well as property value prior to the renovations. ‍

Secured Loans

Secured loans require the borrower to put up collateral that is greater or equal to the loan amount. In some cases, this collateral may be equity in your home. This means that defaulting on payments can result in foreclosure.

‍The collateral in this loan option makes lending far less risky for your lender, consequently making this alternative popular with borrowers. Secured loan options may also have lower interest rates, higher borrowing limits, and longer repayment terms. ‍

Fixed Interest Rates

The interest rates on your home renovation loan may impact the overall cost of the renovation or improve over time. Fixed-rate loans have an unchanging interest rate throughout the entire loan term, while variable rates fluctuate. ‍

Plan For Loan Repayment 

Depending on the type of loan you choose, your monthly mortgage payment will vary. The interest rates associated with shorter loan terms or repayment tenures are lower, and the opposite is true for longer-term loans. 

‍Whatever repayment tenure or interest rate you end up with, be sure to plan around your monthly mortgage payment. A failure to pay on time, otherwise known as defaulting on your loan, grants the lender the legal right to take possession of the collateral and may impact your credit score for a long time.

What Is a Home Renovation Loan | Wesley Mortgage

Home Renovation Loan Options

Understanding home renovation loans and how they differ is instrumental in finding the right financing option for you and your home. Repairs and improvements may impact the value of your home if you wish to refinance your mortgage loan or put the home on the market for sale in the future.

‍Pre-qualifying for improvement home loans can help you find the option with the best rate and features. To help you out, we’ve outlined some of the most important things to keep in mind while exploring your options:

  • Annual percentage rates (APR): Your APR determines the total amount you’ll spend in interest over your repayment tenure. A borrower’s credit score influences and is inversely proportional to your APR.
  • Loan amount and loan term: As noted above, always consider the loan term and your projected monthly payment. As a general rule of thumb, loans with longer repayment terms may have lower monthly mortgage payments. However, an extended repayment tenure also means that you’ll be paying more interest over time versus short-term loans. We recommend weighing out the total cost of the loan when making a decision about the loan amount and loan term. 

Home Equity Line Of Credit (HELOC)

A Home Equity Line of Credit, or HELOC, is a secured loan that lets you borrow against the equity you have in your home (your home’s current market value minus the amount you owe on your mortgage). A HELOC is generally a second mortgage that allows the borrower to draw from a home equity line of credit.  A HELOC may be a first mortgage if you own your home free and clear.  HELOCs may be variable interest rates or fixed interest rate loans.

‍HELOCs have a draw period during which you can access the line of credit funds up to the maximum approved credit line.  You will pay interest on the amount outstanding every month. Once the draw period comes to a close, the borrower is expected to begin to make payments that will fully amortize the outstanding balance, which includes pay interest and principal reduction amounts. This option is popular with borrowers who are selling their homes soon and need funds for repairs because the unpaid principal balance of the HELOC is subtracted from the sale proceeds. 

HELOCs may also be the right choice for people whose home renovations will be completed in stages. Some home renovations are hard to plan for perfectly, and the nature of HELOCs allows borrowers to draw only the amount they need and allow flexibility not available with a typical mortgage loan. 

Disclaimer: At present, Wesley Mortgage does not offer Home Equity Lines of Credit (HELOCs). We are providing this information to keep you informed of your loan options.

Home Equity Loans 

Home equity loans are closed-end mortgage loans that consider your home’s equity in determining how much you can borrow for a home improvement loan  Home equity loans are an excellent choice for people aware of the costs associated with their renovations. 

‍Depending on the equity in your home, you can typically borrow up to 85% of your home’s current market value minus any outstanding mortgages. Payments on home equity loans are easier to plan around because monthly payments consist of both principal and interest over a set amount of time. However, borrowers are still required to pay off the entire home equity loan amount, even if it is used in small amounts, such as ongoing home renovations.  Home equity loans can be fixed-rate or variable-rate loans.

‍Because the amount you can borrow depends on your home equity, we recommend first making steady payments toward your mortgage to increase your home’s equity and the maximum amount you can take out for a home equity loan. 

Disclaimer: At present, Wesley Mortgage does not offer Home Equity Loans. We are providing this information to keep you informed of your loan options.

Government Loans

Government loans are another viable option for financing home renovations. Qualifying for these loans varies depending on the type of government loan you choose. Still, these may be the right choice for you if your credit score is less than stellar or if your intended home renovation loan fulfills specific criteria determined by the Federal Housing Administration (FHA). ‍

FHA Title 1 Loan

The FHA Title 1 Loan is especially helpful for borrowers who don’t have enough equity in their homes to apply for personal loans. The Federal Housing Administration does not provide the loan itself but instead guarantees the loan for the mortgage lender. On the lenders’ end, this mitigates the risk of lending to people who are not able to qualify for conventional loans.

‍However, not every home renovation project is covered by a Title 1 loan. For example, borrowers may not use this loan for luxury additions to their homes, such as saunas, steam rooms, or hot tubs. On the other hand, if your home renovations are designed to accommodate a family member with a disability (ramps, elevators) or are planned to make your home more energy-efficient, you may qualify for this home renovation loan. 

‍Qualifying for FHA Title 1 loans isn’t quite as rigorous as qualifying for a conventional mortgage. Lenders will typically check your credit score and income level to assess your ability to make timely payments for the loan term. Payment terms for this kind of loan can vary from 6 months to 20 years. ‍

FHA 203(k)

Lenders don’t make a habit of approving loans for houses that need significant repairs. Still, the FHA 203(k) rehabilitation loan covers both the cost of the home itself plus any necessary renovations. Borrowers can also rehabilitate a home they currently own. What makes this loan a viable option for borrowers is that the construction-related expenses are tracked and verified by the lender, which in turn increases the likelihood of the rehabilitation project being completed properly and in the expected timeframe.

‍For borrowers with a low credit score, FHA 203(k) loans are allowed even with a FICO score as low as 500 (lenders may require a higher score), which is much lower than most conventional mortgage requirements. Other conditions for 203(k) loans are that a borrower’s debt-to-income ratio should be less than 43%, meaning that the borrower’s total debts (including the 203(k) loan) compared to monthly income cannot exceed more than 43%. 

‍One big downside of taking on this kind of loan is that lots of paperwork is involved, sometimes more so than conventional mortgages. Borrowers typically may not make renovations on their own and must instead find contractors approved by their lender. 

‍However, the specific details of requirements and features vary depending on the type of renovations planned. Before proceeding, make sure to check with your lender to get a better idea of what they need from you. ‍

USDA Rural Development Home Repair Loans

This particular loan assists low-income families residing in USDA-designated rural areas with home renovations and repairs. Many borrowers who take this loan may not have the credit score required to apply for other loans.

‍USDA loans can be used for any renovation that removes a health or safety hazard or otherwise modernizes an old home. These modernizations include roof repairs, screen installation, plumbing, heating, electrical work, and kitchen remodeling. On top of that, these loans have no maximum loan limit and can be paid for up to 30 years. ‍

Fannie Mae’s HomeStyle Mortgage

Sometimes, home renovations are less about repairs and patching up fixer-upper homes and more about injecting luxury into your home. With the Fannie Mae HomeStyle mortgage, you will have funds for a wide range of renovation projects, from repairs and energy updates to landscaping and luxury upgrades. Borrowers have the option of renovating and rehabilitating a new or existing home by including financing into a conventional purchase or refinanced home loan.  

‍One of the reasons that this particular mortgage is so unique is the amount of money you can borrow. Rather than borrowing based on their home’s current value, borrowers may draw against the “after-repaired value” (ARV) of their homes.‍

Because the HomeStyle mortgage covers almost any type of renovation, borrowers need to submit a construction plan with their mortgage application.   The loan proceeds are placed into a custodial account from which the lender manages draws based on inspections. ‍

Cash-Out Refinancing

A cash-out refinance replaces your current mortgage with a new home loan that will refinance your current mortgage and allow cash out to you based on the equity and loan-to-value requirements. For example, if your current first mortgage covers your original loan amount of $250,000 and you have a balance of $100,000 left to pay, you may be able to get a cash-out refinance subject to loan-to-value restrictions for the equity in your home. 

‍Because of the nature of refinancing, only borrowers with some equity in their homes will qualify for cash-out refinancing. Lenders often cap cash-out at 80-90% of your home’s total current market value, depending on the loan program. ‍

Conclusion

Spending money to maintain and improve your home is inevitable. Not all homeowners may be able to afford the costs of renovation out-of-pocket, and that’s why they consider taking out loans. 

‍Depending on your credit score and income, there may be options for you. However, choosing the best option for your specific needs and financial situation means that you have to plan as thoroughly as possible. This means pinning your renovations down to a concrete number and canvassing all the options available before making a decision. 

‍We know that loan applications can be overwhelming, and there is no shame in asking for assistance. Contact Wesley Mortgage today to find out the best course of action for you! 

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