The Complete Guide to Home Renovation Loans
Financing major home improvements with a renovation loan allows you to enhance your living space without draining your savings. But with various types of loans and lenders, it can be hard to know where to start. This comprehensive guide breaks down what you need to know about utilizing home renovation loans.
What is a Home Renovation Loan?
A home renovation loan is a type of financing specifically intended for remodeling or upgrading your residential property. The loan proceeds can be used to pay for expenses related to projects like:
- Kitchen, bathroom, and basement remodels
- Room additions and expansions
- HVAC and plumbing system upgrades
- Flooring, roofing, and window replacements
- Exterior improvements like siding, fencing, and landscaping
- Energy efficiency upgrades like insulation and solar panels
The funds are distributed directly to you in a lump sum so you can start on the projects immediately without tapping your personal savings significantly.
Types of Home Renovation Loans
There are several loan instruments available to finance renovations, each with their own pros, cons, and eligibility requirements:
Home Equity Loan
- Borrow against existing home equity at fixed rate
- Loan up to 80% of home’s value minus mortgage balance
- Lower interest rate than credit cards or personal loans
- Uses home as collateral if unable to repay
HELOC (Home Equity Line of Credit)
- Credit line based on available equity
- Variable interest rate so payments fluctuate
- Withdraw funds as needed rather than lump sum
- Often interest-only payments during draw period
Cash-Out Refinance
- Refinance existing mortgage at higher amount
- Closing costs make only suitable for major updates
- Must owe sufficient mortgage balance to make worthwhile
FHA 203(k) Loan
- Finance purchase and renovation of fixer-upper homes
- Receive full loan amount upfront
- Lower down payment requirement than conventional loans
- More complex application and oversight requirements
Personal Loans
- Borrow a fixed amount for any use
- Unsecured so no collateral required
- Quick online approvals even for lower credit scores
- Higher interest rates than secured loans
How Much Can be Borrowed?
Loan amounts are primarily based on your available home equity if going the secured route, or your income and credit score for personal loans.
Home Equity Loan and HELOC
The maximum amount you can borrow is typically 80% of your home’s appraised market value, minus what you still owe on your mortgage.
For example, if your home is worth $400,000 and your current mortgage balance is $200,000, then the equity available is $400,000 – $200,000 = $200,000. Of this, 80% would mean qualified to borrow up to $160,000 through a home equity loan or HELOC.
FHA 203(k) Loan
For the 203(k) program, the maximum loan depends on the as-improved value of the property:
- 1-4 unit properties: Up to $50,000
- Condos/PUDs: Up to $35,000
You can finance up to 96.5% of the future expected value of the home after renovations.
Personal Loans
Personal loan amounts range from $1,000 to $100,000 based on income, credit score, debt-to-income ratio, and other factors. Lenders determine the amount you qualify for.
Choosing the Right Renovation Loan
Consider the following factors when deciding which type of loan works best for your situation:
Loan Amount Needed
If taking on a larger scale renovation requiring over $50,000, a home equity loan/HELOC or cash-out refinance may be required to secure that amount. Personal loans and 203(k) have lower limits.
Credit Score and Income
All lenders will check creditworthiness, but 203(k) and personal loans are more flexible for borrowers with limited credit history or past issues. Home equity products require stronger profiles.
Interest Rates
Generally lowest for fixed home equity loans, higher for HELOCs and personal loans. Compare quotes from multiple lenders.
Timeline for Completion
Personal loans distribute funds upfront to be used within 6-12 months. HELOCs provide ongoing access to approved funds over months.
Collateral Required
Home equity loans use the home as security so there is risk of foreclosure. Personal loans are unsecured.
Applying for a Renovation Loan
After choosing a loan type, the application process includes these key steps:
Estimate Project Costs
Compile contractor quotes to estimate total renovation costs and loan amount required. Most lenders require these upfront.
Check Rates and Loan Criteria
Compare interest rates, term lengths, fees, and eligibility criteria from multiple competing lenders. Apply with lenders most likely to approve based on your profile.
Submit Application and Documents
Provide financial information like income, debts, assets, credit reports, and tax returns. Submit construction contracts, cost estimates, and details on scope of work.
Home Appraisal
The lender will order a home appraisal to verify market value if securing the loan against home equity.
Loan Underwriting and Approval
It takes 1-2 weeks for the lender to verify your information and underwrite and approve the loan.
Closing and Funding
Once approved, closing takes place where you sign final loan documents and receive the lump sum of funds, minus closing costs and fees.
Now you can hire contractors and kickoff your renovations!
Using the Funds Wisely
It’s easy to go over budget with home renovations, so borrow conservatively and plan ahead:
- Get 3+ contractor bids for every project and compare carefully
- Add a 10-20% buffer to cost estimates for unexpected expenses
- Closely track project costs against the budget
- Keep receipts and records for every expenditure
- Avoid changes that increase scope without lender approval
Also set aside funds for final touches like furniture, fixtures, landscaping, and decor.
Tips for Streamlining the Process
- Shop lenders and apply during off-peak times to speed approvals
- Get all financial paperwork ready before applying
- Hire only licensed and insured contractors
- Read all contracts carefully to avoid misunderstandings
- Make payments on time to avoid derailing active loans
- Consider working with a renovation loan officer to simplify
With proper planning and borrowing conservatively, you can ensure your renovation loan provides affordable financing that improves your quality of life.
Conclusion
Renovation loans allow you to finance home improvements and upgrades through secured lending against your equity or alternative online loan options. Compare loan types like HELOCs, cash-out refinances, and personal loans to choose the best source of funding for your specific situation. Submit detailed project scopes, cost estimates, and contracts during the application process. Careful planning and tracking against a realistic budget helps ensure you complete renovations efficiently with the loan proceeds. Executed wisely, a renovation loan lets you enhance your living space beyond what may be possible by saving over time.
FAQs
What credit score is needed for a renovation loan?
Required credit scores vary by lender but generally you’ll need a score of at least 620-650 for personal loans and 640-700 for home equity loans. Better scores qualify for lower interest rates.
Where can I find renovation loan lenders?
Start with your existing bank, mortgage lender, or credit union to see if they offer renovation loan products. Also compare interest rates from online lenders. Look for options like Lightstream, SoFi, LendingClub, and others.
How long do I have to repay a renovation loan?
Repayment terms often range from 3-7 years for personal loans, and 10-15 years for secured home equity loans. Longer terms have lower monthly payments but higher total interest.
What happens if I go over budget with the loan?
If project costs exceed the loan amount, you will need to cover excess costs out of pocket. Get firm quotes upfront and budget generously to avoid this. Consider a HELOC with reusable funds if costs are unpredictable.
Should I get multiple contractor bids?
Yes, get at least 3 different bids for every major project and compare in detail. This allows you to select the best contractor at the most competitive price.
ALSO SEE:
First-time Borrower’s Guide: How to Get a Home Loan
How to Avoid the 10 Most Common Personal Loan Mistakes
Rocket Loans: A Fast But Potentially Costly Option for Personal Loans
Financial Choices: Gold Loan vs. Personal Loan – What Suits You Better?
Secure Your Approval: How to Avoid Loan Rejection with a Good Credit Score