When it comes to financing a renovation, there are many options to choose from. However, the type of renovation project will have a significant impact on your financing options.
The most economical way to pay for a renovation is, of course, with the money you already have. While this may be feasible for smaller projects, it likely isn’t a realistic option for homeowners doing larger renovation projects, such as a kitchen renovation or addition.
Home renovation loans
A Federal Housing Administration (FHA) 203(k) or Fannie Mae HomeStyle loan is a smart way to finance a renovation because the amount homeowners can borrow is based on the future value of their property after the improvements are made.
FHA 203(k) Loan
FHA 203(k) loans are backed by the federal government and can be used for home additions or kitchen, bathroom, and common room renovations. These loans combine the renovation costs with your home mortgage to give you one loan with one payment.
This loan allows homeowners to finance up to 97.75% of the improved home value. To check the current loan limits by county, visit http://entp.hud.gov.
Qualifications for the FHA 203(k) loan allow for lower credit scores and higher debt-to-income ratios than conventional loans. In addition to a low down payment of 3.5%, you must have a credit score of at least 620 FICO. However, homeowners must pay mortgage insurance.
Fannie Mae HomeStyle
The Fannie Mae HomeStyle renovation loan allows you to combine your mortgage with the renovation loan, so borrowers can take advantage of a low down payment, cancellable mortgage insurance, and potentially lower rates than other financing options. Similar to an FHA 203(k) loan, homeowners can finance up to 97% of the improved home value.
The HomeStyle loan does not have any minimum amount of improvements or any restrictions on the type of repairs that can be included in the loan. The only requirement is that any improvement must be permanently affixed to the property and add value.
The HomeStyle Renovation loan requires five percent home equity. Mortgage insurance is required when the loan-to-value is 80% or higher.
This is a good option for homeowners without a lot of equity.
Fix Up program
In Minnesota, the Fix Up Loan Program provides hassle-free home improvement loans for single-family homes, duplexes, triplexes, and fourplexes. You must own and occupy the property to be approved.
The program, made possible by a grant from the U.S. Department of Energy and the Minnesota Department of Commerce through the American Recovery and Reinvestment Act of 2009 (ARRA), offers affordable, fixed-interest rates with lower interest rates for energy conservation and accessibility improvements.
- Secured and unsecured loan options
- Higher loan-to-value ratio on secured loans than traditional loan products
- Longer repayment terms for lower monthly payments
- Hire a contractor or do the work yourself
- No prepayment penalty
Repair, remodel and make energy-saving improvements including:
- Porches and decks
- Remodel a bathroom or kitchen
- Add a bathroom or finish basement
- Accessibility improvements
- Basic garage
- Home additions, including internal and attached accessory dwelling units
To get started, find a participating lender near you.
Home improvement loan
A home improvement loan is an unsecured personal loan offered by banks, credit unions, and online lenders. Because it’s unsecured, you don’t need to use your house as collateral to qualify.
Your interest rate and qualification are based on your credit score, and once you agree to the terms, many lenders deposit money straight into your account in as little as a day.
However, keep in mind that because they’re unsecured loans, home renovation loans typically have higher rates, especially if you have fair or poor credit.
Typically, they have shorter repayment timelines, so they make sense if you’re looking to borrow a small amount. They’re best for small or mid-sized projects in your homes, such as a bathroom renovation or window replacement.
Home equity loan
A home equity loan is technically a second mortgage. Like a home improvement loan, you receive all funds upfront that you can repay over a number of years in regular monthly payments.
Home equity loans are fixed-rate, fixed-term loans. With these loans, you don’t have to worry about market fluctuations; once you lock in your fixed interest rate, you pay the same monthly payment over the life of your loan.
If you know exactly how much your project will cost, a home equity loan could be the perfect way to finance your renovation.
Home equity line of credit
A home equity line of credit (HELOC) is a secured loan in which you use your home as collateral. This gives you access to lower interest rates than an unsecured personal loan.
However, because you’ll have to put your home up as collateral, your home could be foreclosed on if you don’t make payments on time.
Unlike home equity loans, HELOCs tend to have little to no closing costs, and they usually have variable interest rates, though some lenders offer fixed rates for a certain number of years.
A HELOC is a revolving loan on your home, meaning it works like a credit card where you can access the funds when you choose.
Most home equity credit lines have two phases.
First is the draw period, often 10 years, during which you can access your available credit as you choose. Typically, HELOC contracts only require small, interest-only payments during the draw period, though you may have the option to pay extra toward the principal.
After the draw period ends, the loan enters the repayment phase. From this point, you can no longer access the funds and must make regular principal-plus-interest payments until the balance disappears. Most lenders offer a 20-year repayment period after a 10-year draw period.
HELOCs are best-suited for large or lengthy home renovations, such as additions, or if a homeowner plans to do several projects over a few years. If you have some equity built up in your home and can pay off the cost of your renovations within the next three years, a HELOC might be a good option for you.
A cash-out refinance replaces your existing mortgage with a new one and gives you a new interest rate. If the new home loan is more than you owe on your house, the difference goes to you in cash and you can spend the amount on home improvements.
Typically, homeowners can finance 80 to 85 percent of their home’s value. Payments begin right away on the whole debt, but it’s extended over 15 or 30 years.
A refinance has higher closing costs than a HELOC but lower, fixed interest rates.
This is a good option if you have good credit and need a large amount of money right away.
However, there are many risks to refinancing your mortgage. If the housing market drops, you could get into trouble making payments. You’ll also need to pay for an appraisal, origination fees, taxes, and other closing-related costs.
Also, you’re going to be extending the life of your loan, meaning it will take you longer to pay it off unless you refinance for a shorter term.
As a general rule of thumb, refinancing is only a good idea if you can secure a lower interest rate than your current mortgage.
If you’re making minor updates to your home, a credit card might be one of the best ways to finance your home improvement.
However, it’s only a good idea if you’re able to qualify for a card with a low-interest rate and have a plan to repay it quickly.
If you plan to use a credit card to finance your renovation project, find a card with a zero-interest period. Many cards come with a 0% introductory offer, usually around 12-18 months. If you’re able to pay off your balance within this time frame, you could finance your home improvements without ever paying interest.
You should also look for a card that will earn you rewards or cashback perks. This way, the more you spend on the renovation, the more money you’ll get back.
Of course, there are also risks of using a credit card to finance a home renovation.
You need to be careful of the card’s limit. Maxing out a credit card will hurt your credit score.
Credit cards also have high interest rates. The average credit card interest rate is 17.89% for new offers and 14.52% for existing accounts. If you’re unable to pay off the balance before the introductory offer expires, you may face higher interest rates than other home improvement loan options.
If you opt to use your existing card instead of a new card with introductory offers, you’ll need to pay back the entire amount before the next pay period, usually 30 days, in order to avoid paying interest.
So, which method is right for you?
LightStream surveyed over 3,000 adults and found that of those planning home improvement projects this year, 33% intend to pay with a credit card, 65% plan to use savings, and 18% will use a home equity line of credit, with some choosing a combination of several methods to fund their projects.
The best way to fund your home improvement project depends entirely on the scope of the project and your current financial situation.