Renovating your home can be an exciting project, allowing you to update outdated elements or create the perfect space for your family. However, major renovations often require more money than most people have on hand. That’s where renovation loans come in.
A renovation loan is a type of financing that allows you to borrow money specifically to make improvements to your home. Unlike a traditional mortgage or refinance, renovation loans let you roll the cost of upgrades directly into your new loan amount. This means you don’t have to pay for renovations out of pocket upfront.
In this detailed guide, we’ll explain exactly how renovation loans work, their pros and cons, and help you decide if this type of financing is right for your next home project.
What Is A Renovation Loan?
A renovation loan lets you finance the purchase or refinance of a home plus renovations or repairs in a single loan. With a renovation loan, you can borrow more than what the home is currently worth to cover the planned improvement costs.
These loans make it possible to buy a fixer-upper property that needs extensive work, make the renovations you have in mind, and have just one mortgage payment to cover it all.
Renovation loans come in a few main forms:
-
FHA 203(k) loan: This government-backed loan can be used to finance more extensive renovations, including structural changes. It’s available even if you have lower credit scores or smaller down payments.
-
Fannie Mae HomeStyle loan: Offered by conventional lenders, this loan has fewer requirements than FHA but can only finance surface-level renovations, not major structural changes.
-
Proprietary renovation loans Some lenders offer their own renovation loan programs with varying requirements These aren’t backed by the government
No matter the type the process is generally the same
-
Get pre-approved for a renovation loan amount based on the home’s purchase price plus estimated renovation costs.
-
Make an offer and buy the home
-
Work with a contractor to make the planned improvements.
-
Make payments on your single loan that covers the home purchase and upgrades.
Pros Of Renovation Loans
Convenience. With a renovation loan, you don’t have to shop around for separate financing, take out a personal loan or pay for renovations using savings. Everything is bundled into one loan.
Potentially lower interest rates. Depending on your financial situation, it may be cheaper to get one renovation loan than a mortgage plus other financing for upgrades.
Increased home value. Renovations boost your home’s value, letting you build equity faster. With a renovation loan, you can make upgrades that might not be affordable otherwise.
More flexible lending standards. Programs like the FHA 203(k) allow smaller down payments and lower credit scores than standard mortgages.
Ability to finance major overhauls. A renovation loan lets you take on more ambitious projects like kitchen gut renovations and room additions.
Cons Of Renovation Loans
More complicated process. With a renovation loan, you have to work with contractors, get inspections, manage funds and finalize all renovations within the loan’s timeline.
Potential delays. If work isn’t completed on schedule, the draw process for receiving renovation funds could be delayed, leaving projects unfinished.
Upfront planning required. You must plan all renovations and their costs upfront to get approved for the right loan amount. Change orders could require loan modifications.
Ineligible projects. Renovation loans can’t be used for repairs that aren’t permanently affixed to the home, like furniture and appliances.
Higher upfront costs. Renovation loans often require higher down payments and closing costs than purchase mortgages without renovations.
Risk of overimproving. Upgrading a home far beyond the value of other properties in the neighborhood may make it harder to sell later.
What Renovations Can A Renovation Loan Cover?
What you can use renovation loan money for depends on the specific program. In general, eligible renovations include:
- Kitchen and bathroom remodels
- Flooring replacement
- Painting and wall repairs
- Roof replacement
- Window installation
- Electrical and plumbing upgrades
- HVAC improvements
- Room additions and garage conversions
- Fire safety improvements like smoke detectors
- Accessibility upgrades like ramps and lifts
- Exterior upgrades like siding, fencing and landscaping
- Necessary repairs like foundation work and mold remediation
You’ll need to work with a contractor to determine exact project costs. Cosmetic renovations like new cabinets and flooring are typically allowed, while luxury upgrades like swimming pools may be limited.
How Much Can You Borrow With A Renovation Loan?
Renovation loan limits vary:
-
FHA 203(k): You can borrow up to 96.5% of the home’s appraised value after renovations, including both purchase and renovation costs.
-
HomeStyle: You can finance up to 75% of the home’s expected value after renovations.
-
Proprietary loans: Limits depend on the lender, often ranging from 75% to 90% of the value after renovations.
For example, if you purchase a home for $200,000 that will be worth $300,000 after $100,000 in renovations, a HomeStyle loan could cover up to $225,000 (75% of $300,000).
Down payment requirements also range from 3% to 25% depending on the program. FHA 203(k) loans allow the lowest down payments for borrowers with lower credit scores.
How Much Home Can You Afford With A Renovation Loan?
As with any mortgage, the home price and loan amount you can afford depends on factors like:
- Your income, debts and credit score
- Required down payment percentage
- Estimated renovation costs
- The home’s expected after-renovation value
A lender will pre-approve you for a loan amount based on these factors. You’ll need to find a home you can purchase and renovate within that budget.
Get pre-approved by multiple lenders to see the maximum home price and loan amount you may qualify for. Then you can set your home search price point accordingly.
How Do Renovation Loans Work? 7 Key Steps
If you’re interested in a renovation loan, here are the seven major steps to get one:
1. Get Pre-Approved
Talk to renovation loan lenders and get pre-approved for a loan amount based on the type of home you want to buy plus estimated renovation costs.
Pre-approval lets sellers know you’re a serious buyer and locks in an interest rate. Shop around with multiple lenders as rates and fees can vary.
2. Find A Home To Purchase
Once pre-approved, you can start searching for homes in your price range that have renovation potential. Look for outdated properties with layouts you like in areas you want to live.
3. Make An Offer
Make an offer on the home you want to purchase. Submit your pre-approval letter and renovation loan details so the sellers understand your financing.
4. Get An Appraisal
After an offer is accepted, the lender will order a home appraisal to determine the current value. An appraiser will also assess the planned renovations.
5. Close On The Loan
At closing, you’ll finalize loan documents and take ownership of the property. Closing costs may be rolled into the loan. Renovation funds are held in escrow until work is completed.
6. Complete Renovations
Work with contractors to complete all planned renovations within the loan’s designated timeframe, usually around 6-12 months. Releases of escrowed renovation funds occur in phases after inspections.
7. Make Payments
Once the home passes final inspection, the lender issues the remaining renovation funds. You’ll then begin making mortgage payments on the combined loan for the home purchase price plus improvements.
Tips For Getting Approved For A Renovation Loan
Because renovation loans are more complex, here are some tips to successfully get approved:
-
Have a good credit score. While FHA allows scores as low as 500, you’ll get better loan terms with a score of at least 620 or higher. Pay down debts and correct errors to boost your score beforehand.
-
Document sufficient income. Lenders will want to see stable income that’s enough to cover both mortgage payments and living expenses. Gather pay stubs, tax returns, and banking records.
-
Save up for your down payment. Renovation loans often require higher down payments than standard mortgages. Save at least 10% if you can.
-
Detail all planned renovations. Lenders need a complete list of upgrades and their estimated costs from contractors to approve you for the right loan amount.
-
Shop around with lenders. Compare multiple lenders to find the best renovation loan rates and terms for your situation. Pr
How Does A Home Renovation Loan Work?
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.Section 2
Types of Renovation Loans
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.
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
- Basement finishing and remodeling not involving structural repairs
- Basement 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.
This is THE Best Home Renovation Loan Program – HomeStyle Loan Explained
FAQ
Are renovation loans hard to get?
Do renovation loans have higher interest rates?
What is a rehab loan and how does it work?
What is the maximum renovation loan amount?
What is a home renovation loan?
A home renovation loan is a single mortgage that lets you both finance a home and renovate it. It can be used either when buying a home or refinancing one you already own.
How do renovation loans function?
Renovation loans are unique because they allow you to borrow more than the home’s current value. The maximum loan amount is typically your home’s estimated future value after renovations are complete. To qualify for a renovation loan, you’ll need detailed construction plans and cost estimates.
Can you use a renovation loan to buy a home?
Renovation loans can be used when buying a home. By financing the home and the renovations together, you can consolidate your renovation costs into one low-rate mortgage rather than taking out separate loans to buy the property and pay for repairs. Renovation loans can also be used for refinancing a home you already own. How does a renovation loan work?
Is a home improvement loan the same as a renovation loan?
The terms “renovation loan” and “home improvement loan” are sometimes used interchangeably, but they’re not technically the same. Home improvement loans are generally used for more minor upgrades than renovations typically cover, and therefore offer lower loan amounts. Examples of common home improvement loans include: