Whether you have an existing home that needs a new kitchen, or you have an eye on a new home with a low asking price but a lot of necessary home renovations before it is really livable, a home renovation loan can allow you to make the necessary home improvements without the cash upfront. These home improvement loans are available for those looking to make renovations that will increase the value of the property and you don’t need perfect credit to qualify for many of the available options. But when is a home renovation loan the right choice? Which loan option provides you with the best home improvement opportunities? How do you qualify for a home renovation loan?
What is a home renovation loan?
A home renovation loan is a loan that incorporates additional funds for the purpose of home remodeling or home repairs. In many cases, a home renovation loan is a mortgage that covers the home price as well as the additional funds. However, this can also include a mortgage refinance with a cash payout for remodeling, a home equity line of credit, a government-backed loan, or an unsecured personal loan.
Why should you consider a home renovation mortgage?
When deciding on a home renovation loan, you must begin by considering the benefits and the risks. Will your home renovations increase your property value or reduce your long-term costs? For example, roof repairs, new siding, and updated windows can help improve your home’s overall appearance but also provide weatherproofing and make your home more energy-efficient. However, you must determine if the cost of the home renovations and of the loan will fit your budget and that the renovations to your home will not make your home overly expensive compared to similar homes in your housing market, leaving you with damaged marketability should you decide to sell.
How do home renovation loans work?
When it comes to this type of loan, there are multiple options available. Each of these options has specific qualifications, as well as pros and cons. Before applying for a renovation loan, it is important to understand the differences and determine which loan option will work best for you.
1. Fannie Mae HomeStyle® Loan
The Fannie Mae HomeStyle loan enables buyers to finance the purchase of a home as well as the renovations planned and have the full loan amount combined into one mortgage. For those that already own the home, this loan option allows for refinancing that combines the original mortgage with the renovation costs. The money for renovations goes into a separate escrow account that directly pays the renovation contractors, so the borrower does not have direct access to the funds.
How to qualify
Qualifying for a Fannie Mae HomeStyle loan is similar to qualifying for any Fannie Mae home loan. While there are no income limits, there are caps on how much you can borrow that match the loan limits for conforming loans that follow the Fannie Mac guidelines. A borrower will need a minimum credit score of 620 and a debt-to-income ratio of less than 50%. You must have a down payment of at least 5% (though some first-time buyers can qualify at 3%). This percentage is determined by the home loan price plus the amount of renovation. For example, if your home is $150,000 and you are borrowing an additional $100,000 for renovations, your down payment would be 5% of $250,000.
- One monthly mortgage payment that covers both the home principal and renovation costs, with only one set of closing costs.
- May offer lower interest rates than conventional improvement loans.
- Available for many different property types.
- Renovations are limited to 75% of the post-renovation value of the home.
- Acquiring funds can take longer than a conventional mortgage loan.
- Can have higher fees and closing costs than other loan options.
2. Freddie Mac CHOICERenovation Loan
Similar to the Fannie Mae HomeStyle loan, the Freddie Mac CHOICERenovation loan allows you to finance both the purchase price of the home and the renovation costs, giving you one mortgage payment. This loan is also available to refinance an existing property with an additional amount for renovations. Renovations must be completed within a year of loan closing and are available for a variety of different property types. For those with smaller home renovations, Freddie Mac also offers the CHOICEReno eXPress loan option that applies for renovations under 15% of the home value.
How to qualify
While the Freddie Mac CHOICERenovation loan does not have any specific credit score of debt-to-income ratio requirements, borrowers must meet the same requirements necessary for any other Freddie Mac conventional loan, including a credit score of at least 620 and a DTI of 36% or less.
- Able to combine the purchase price and renovation into one mortgage payment.
- Available for single-family homes, primary residences, second homes, and investment properties.
- Low down payment options
- Mortgage amount based on after-renovation property value
- Permits the use of sweat equity
- Renovations must be completed within the first year.
- Bank-owned properties can require additional approvals that can extend the approval processing time
- Renovation costs are capped
- May require higher closing costs and fees
- Can have a higher mortgage rate
3. FHA 203(k)
The FHA 203(k) loan is another loan option that allows you to purchase a home and include the renovations in one mortgage. This loan option includes two different types: Limited and Standard. Limited 203(k) loans are capped at $35,000 for renovations while the Standard option is for more major renovations. With more lenient qualifications, this loan option often appeals to borrowers with less than perfect credit.
How to qualify
To qualify for an FHA 203(k) loan, borrowers must have a minimum credit score of 500 and a maximum debt-to-income ratio below 45%. Down payments can be as low as 3.5% for lenders with a credit score over 580 and 10% for those below 580. The home you are purchasing and renovating must be your primary residence and meet FHA property eligibility requirements. Your loan cannot exceed FHA loan limits for your area.
- Lower qualification requirements making this loan appealing to those with less than perfect credit.
- One mortgage payment for both home loan and renovation.
- Low down payment.
- Loan requires a mortgage insurance premium (MIP)
- Can only be used to purchase a primary residence.
- No renovations can be performed by yourself.
- Involves more paperwork than many of the other loan options.
4. Home Equity Loan / HELOC
A home equity loan is a lump-sum loan at a fixed rate that provides up-front cash for home renovations at a fixed rate. A home equity line of credit (HELOC) is similar however, instead of up-front cash, this loan option provides a credit limit with a revolving balance and a draw period of five to 10 years.
How to qualify
To qualify for a home equity or HELOC, borrowers generally need at least 20% equity in their home, a credit score of over 600, and a stable, verifiable income history of over two years.
- Home equity loans offer a fixed interest rate and payment amounts that do not fluctuate.
- HELOC allows you to draw money as you need and only pay interest when you draw a payment.
- Loans can be used for a variety of different renovations, including DIY renovations.
HELOCs have variable interest rates, meaning your rates and payments can increase over time.
5. USDA Rural Development Home Repair Loans
Offered through the USDA’s Rural Development program, borrowers can apply for a USDA Rural Development Home Repair Loan to homeowners in rural locations looking to improve their current property.
How to qualify
In order to qualify for these loans, the loan must be for a primary residence, have an income that exceeds 50% of the median income in the county, and live in an eligible rural area.
- No down payment is required
- Low-interest rates, credit score requirements, and origination fees.
- Geographical requirements for properties
- Income limits
- Must be a primary residence
Covering renovation costs with your home loan
Whether you are looking to purchase a new home that needs some renovations, or you love your current home but would really love a more modern kitchen or bathroom, home renovation loans can help you achieve your dream home.
At Hero Home Programs, we understand how important home ownership is and how having the perfect home makes all the difference. If you are considering a new home purchase with renovations or simply looking to improve your current home, our team can help you navigate the renovation loan process. To learn more, contact us today.