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How Do Home Renovation Loans Work?

Apr 18, 2022 | Blog, Mortgage

If you want to make renovations to your home or even buy a home that needs major renovations, you might need financing for it. Rather than taking out a separate loan at a high interest rate, you could consider home renovation loans.

They are easier to qualify for than most people think, and they offer attractive terms. Here’s what you should know.

What is a Home Renovation Loan?

A home renovation loan is a loan to purchase/refinance a home and fix it up. The funds to buy the home or pay off the existing mortgage are disbursed, whereas the remaining funds to fix up the home are placed in an escrow account and disbursed according to the agreement between the lender and contractors.

Types of Home Renovation Loans

There are two common home renovation loans borrowers use most commonly – the FHA 203K rehab loan and the Fannie Mae HomeStyle loan.

FHA 203K Loan

The FHA 203K loan is an easy-to-qualify for rehab loan that provides funds to buy/refinance a home and fix it up. The home must be your primary residence and the renovations must be reasonable and/or necessary – they can’t be luxurious.

You can put down as little as 3.5% on the home to use this loan. You can use the renovation funds to make structural changes, cosmetic changes, or a combination of both. You need only a 620 credit score and a 43% – 50% debt-to-income ratio.

You’ll pay mortgage insurance for the life of the loan, but the amount decreases as you pay your loan balance down.

Fannie Mae Homestyle Loan

The Fannie Mae HomeStyle loan is another renovation loan you can try. You’ll need better credit since it’s a conventional loan backed by Fannie Mae and the renovations must not cost more than 75% of the home’s expected value after the renovations.

You don’t have to live in the property as your primary residence, but you do need great credit and a low debt-to-income ratio to qualify for this loan. If you put down over 20% of the home’s price, you won’t pay any mortgage insurance, but if you do, you can cancel the insurance once you owe less than 80% of the home’s value.

Pros and Cons of Home Renovation Loans

Pros:

  • You have one loan to manage for your purchase/refi and renovations
  • Interest rates are typically low or at least competitive
  • You can do just about any renovations (except luxurious renovations with the FHA loan)

Cons:

  • You must run the planned renovations past the lender and get them approved
  • You must complete the renovations within 6 months
  • You can’t do any of the work yourself unless you can prove you’re qualified to do so

Final Thoughts

Home renovation loans can be a great way to finance the work a home needs that you’re buying or that you already own. With one loan to manage, you pay closing costs only once and have all your money in one place to renovate the home.

If you’re interested in learning more about your options for a home renovation project, call us today!