Mortgages and Loans to Pay for Home Renovations

What Is a Home Renovation Loan?

A home renovation loan provides funding you can use to make improvements to your home ranging from minor upgrades to full-scale remodels. Some loans limit the types of projects you can complete, while others let you use the financing for whatever you like.

Renovation loans can be a good investment when using the funds to complete essential repairs that will make your home safer, such as replacing a leaking roof, or projects that will increase the value of your home, such as upgrading your kitchen or bathrooms.

Mortgages and Loans to Pay for Home Renovations

Government-sponsored enterprises, such as Fannie Mae and Freddie Mac, offer loans specifically for home renovations, while home equity loans offer another option for homeowners who have built some equity in their homes.

Here are common loan options that could help you fund your home renovations.

Because lenders must be approved to offer FHA, VA and USDA, Fannie Mae and Freddie Mac renovation loans, the availability of specific loan programs varies. Check with your local bank, credit union, mortgage company or online lender to find out what types of home renovation loans they offer.

Fannie Mae HomeStyle Loan

Borrowers can use a Fannie Mae HomeStyle loan to finance the purchase of a fixer-upper and its renovation costs in a single loan or refinance an existing mortgage to make improvements to a property they already own. Primary residences, second homes and investment properties are eligible, and you can use the money for any improvement, including for accessory units, as long as it is permanently attached to the property.

Before your loan application can be approved, you must select a contractor and submit renovation plans to the lender. The lender will order an "as-completed" appraisal to determine the estimated post-renovation value of the property and make a loan decision.

If your application is approved, the lender will put the money that's earmarked for renovations into an escrow account and disburse funds to the contractor as work is completed. Leftover funds will be applied to the principal loan balance when renovations are complete.

Freddie Mac CHOICERenovation Loan

You can purchase your home and get the cash you need to make improvements in one loan with the Freddie Mac CHOICERenovation loan. This loan can be used to renovate existing properties, including one- to four-unit primary residences, manufactured homes, second homes, one-unit investment properties, condos and units in a planned unit development.

Renovation funding is limited to 75% of the property's estimated post-renovation value or the sum of the home's purchase price plus estimated renovation costs, whichever is less, for purchase mortgages and 75% of the post-renovation value for refinances. For manufactured homes, renovation expenses are limited to the lesser of $50,000 or 50% of the estimated post-renovation value.

Home improvement funds are held in an escrow account. When renovations are complete, unused funds may be returned to the borrower, used to pay down the principal balance or applied to additional eligible renovations, depending on the loan and property type.

FHA 203(k)

The FHA 203(k) loan is a government-backed mortgage, secured by the Federal Housing Administration (FHA), that allows borrowers to finance the purchase of their home plus improvements, or refinance a current mortgage to renovate a property. Two types of FHA 203(k) loans are available: standard and limited.

Limited FHA 203(k) loans can be used to fund smaller-scale, non-structural projects up to $35,000, and standard FHA 203(k) loans can be used for structural improvements and major renovations with a minimum price tag of $5,000.

You can only use an FHA 203(k) loan for a primary residence, and improvements must meet the program's eligibility requirements. Getting a standard 203(k) loan to finance your home purchase and renovations will increase the time it takes to complete the application process. Borrowers must work with a consultant to create and submit a home improvement plan and cost estimate to the lender, adding to the closing timeline.

HUD maintains a database of lenders that have closed a 203(k) loan in the past 12 months, which you can check out here.

Learn more: FHA vs. Conventional Loans: What's the Difference?

VA Alteration and Repair Loan

Eligible service members, veterans, National Guard and reserve members can use a Department of Veterans Affairs (VA) alteration and repair loan to finance the purchase of their home and renovations in one loan or get a cash-out refinance to fund improvements to a home they already own.

Most improvements, repairs and renovations are eligible under this program as long as they would normally be found on a similar property in the area and the property meets the VA's minimum requirements after repairs are complete.

If you're buying a home, you can finance up to 100% of the acquisition cost or post-renovation value, whichever is less. You can also finance up to 100% of the as-completed value for cash-out refinances.

Learn more: Pros and Cons of a VA Loan

USDA Renovation Loan

USDA renovation loans, backed by the U.S. Department of Agriculture (USDA), allow low- and moderate-income borrowers in rural areas to finance the purchase of a home and renovation costs in a single loan closing. USDA loans may only be used to purchase a primary residence, but you can finance up to 100% of the price of the home and improvement costs.

Loans can be used to complete a wide range of structural and non-structural improvements, including repairing existing amenities, but cannot be used to add amenities, such as pools or fireplaces. Loan amounts for non-structural repairs are limited to $35,000. If you're making structural repairs, you can borrow larger amounts, but you must work with a qualified inspector.

The USDA maintains a list of active lenders that may help you find one in your area.

Home Equity Loan

A home equity loan lets you borrow against the equity you've accumulated in your house, but it doesn't allow you to combine financing for the purchase of a home and renovations into a single loan. When you get this kind of loan, you make two payments each month—one for your original mortgage and one for your home equity loan.

Known as a second mortgage, home equity loans generally have a fixed interest rate, and you repay what you borrow in equal installments over the life of the loan. You can typically use the funds however you want, and home equity loans generally have lower interest rates than unsecured debt. But you could lose your home if you can't make your payments.

You typically need to have at least 20% equity in your home to qualify for a home equity loan, and terms typically range from five to 30 years.

Learn more: How to Use Home Equity for Remodeling

HELOC

A home equity line of credit (HELOC) is a revolving line of credit, like a credit card, that allows you to borrow against the equity in your home. HELOCs are divided into two phases: the draw period and the repayment period.

During the draw period, you can borrow repeatedly, up to the credit limit, giving you the flexibility to cover unanticipated costs or fund multiple projects over time. During the repayment period, you can no longer borrow money and must repay the amount you withdrew.

HELOCs typically have variable interest rates that may result in higher-than-expected monthly payments, but you only pay interest on what you borrow, not the total credit available. They also have closing costs and may have other fees.

Cash-Out Refinance

Another way to tap the equity in a home you've already financed is by refinancing your existing mortgage and replacing it with a larger one. The new loan pays off the original, and you keep the difference in cash to pay for home improvements.

Unlike a home equity loan or HELOC, with a cash-out refinance, you only have one home loan and make a single monthly payment. However, it reduces your equity stake in the property, and you have the same foreclosure risk as you would with a home equity loan or HELOC.

Because you're replacing your original loan with a new one, the terms will change, potentially leaving you with a higher interest rate, and restarting the clock on your loan term. You typically need to have more than 20% equity to qualify for a cash-out refinance.

Should You Get a Home Renovation Loan?

Whether you should get a home renovation loan depends on your specific financial situation, goals and the scope of the improvements. It may be worth it if:

• Your goal is to increase the property's value. Making home improvements, renovations or upgrades can increase your home's value without waiting for the local real estate market to appreciate.
• You are making essential repairs. It's generally best to make essential repairs like replacing a leaking and worn-out roof sooner rather than later to avoid even larger expenses down the road.
• You want to spread out the cost over time. With a home renovation loan, you don't have to deplete your cash reserves to pay for repairs or improvements.
• You have low-interest options available. If you can qualify for a low interest rate, it will help keep your monthly payments manageable and minimize the amount of interest you pay over the life of the loan.

What Are the Pros and Cons of a Home Renovation Loan?

While a home renovation loan can provide funds to make improvements or repairs, it's important to weigh both the benefits and risks.

How to Choose a Home Renovation Loan

Multiple types of home renovation loans can provide the financing you need to make repairs or improvements. Here are some things to consider to help you select the one that's right for your situation.

• Evaluate the loan purpose. Some loans limit the types of changes you can make to your home. Loan options also vary based on whether you're combining purchase and renovation costs versus making improvements to a property you already own.
• Estimate renovation costs. Loans generally have minimum and maximum borrowing requirements that vary by loan type. One type of loan may not work for you if you have a lot of costly repairs to make.
• Calculate your equity. If you want to make improvements to a property you already own, you'll need to meet the lender's equity requirements. If you're financing purchase and renovation costs with a single loan, the amount you borrow can't exceed the program's loan-to-value (LTV) requirements.
• Evaluate your ability to qualify. Your credit scores, down payment amount, debt-to-income (DTI) ratio and equity in your home may affect your ability to qualify. Consider all of these factors to determine how likely it is that you will be able to get a loan.
• Compare interest rates and fees. Getting loan offers from multiple lenders can help you identify the most affordable option.
• Determine your repayment timeline. Some loans have more flexible repayment terms than others. Review your available options and choose one that fits your budget and keeps your payments within your budget.

Do Home Renovation Loans Have High Interest Rates?

Typically, loans secured by property, such as your home, have lower interest rates than unsecured loans. The rate you'll pay varies based on the loan type, your credit scores, down payment amount (if you're purchasing a home) and debt-to-income ratio (DTI). Borrowers with higher credit scores generally qualify for lower rates than borrowers with lower scores.

The Bottom Line

A home renovation mortgage can provide the funding you need to buy a house and renovate it in a single loan, making it ideal if your dream home is a fixer upper. You can also use a home renovation loan to get cash for improvements you want to make on a home you've already financed.

If you're considering a mortgage or home renovation loan, check your FICO^® Score^☉ and credit report for free from Experian. If your credit isn't where you'd like it to be to qualify for a loan, take time to improve your credit before applying.