How Does a Home Renovation Loan Work?

Wondering, ‘How does a home renovation loan work?’ You’re not alone. In fact, one study shows that home remodeling searches more than doubled from 2020 to 2021. More and more people are considering renovating their homes, but not everyone has the cash on hand to do so. Enter the home renovation loan.

What is a home renovation loan?

Some home projects cost more than a quick trip to the hardware store. For things like fixing a foundation, replacing a roof, or even updating a kitchen, many home buyers and existing homeowners may need to borrow money. 

A home renovation loan is an all-in-one mortgage that funds home renovations or remodeling projects on top of the value of your home. The terms of your loan depend on the type of loan you apply for, and there are plenty of options available through private lenders and government programs. No matter which option you choose, the idea is the same: to help you access the funds you need to fix up the home you want to buy or your current home.

Who should get a home renovation loan?

You can get a home renovation loan whether you’re a buyer or a current homeowner. There’s quite a bit of flexibility when it comes to leveraging these types of loans. For instance, you can use a home renovation loan even for minor updates such as paint and flooring. In any case, a home renovation loan might be right for you if:

  • You are looking to buy a home that needs repairs or that you’d like to update, but you need to borrow money to cover the project’s costs.
  • You want to repair or update your current home, but you need to borrow money to cover the project’s costs.

Even if you think your credit score is less than ideal, there are plenty of home renovation loan options available.

What happens when you get a home renovation loan?

There are different rules depending on who funds your home renovation loan. But you will be able to borrow up to a certain percentage of your home’s future value (what it will be worth after the renovations), and many times you can benefit from having a single-close loan. In other words, it’s just like getting a traditional mortgage, where you sign one set of documents and pay only one set of closing costs.

For some types of loans, your project’s funds will be placed into an escrow account. Your lender may require inspections for your projects, and then they will use these inspections to determine how much money they will draw from the escrow account to cover the costs.

Types of home renovation loans

Fannie Mae HomeStyle Renovation Loan

The Fannie Mae HomeStyle Renovation Loan is a government-backed, all-in-one renovation loan you can use to cover project costs for your primary residence, secondary home, or investment property. Here are some quick facts about the HomeStyle renovation loan:

  • You can borrow up to 97% of your home’s future value
  • If you borrow more than 80%, you’ll be required to have Private Mortgage Insurance (PMI)
  • There are no restrictions or minimum dollar amounts regarding the type of repairs or renovations you can do
  • Your repairs/renovations must, however, be permanently affixed to the property, add value, and be completed by a contractor

This is a great loan option if you’re planning to make updates or repairs, regardless of how minor. You don’t have to spend a minimum dollar amount on your project. The interest rates for HomeStyle loans are usually lower than taking out a home equity line of credit, getting a personal loan, or using a credit card. This loan can help you buy and remodel your dream home or update your current home while spreading out the costs to make things more affordable.

FHA Limited 203(k) Rehabilitation Mortgage

The FHA Limited 203(k) Rehabilitation Mortgage is another government loan option provided by the Federal Housing Administration (FHA). This allows you to borrow up to $35,000 on top of your mortgage to fund non-structural repairs or renovations. Here are some quick facts:

  • Buyers and current homeowners can take advantage of this loan (purchase or refinance)
  • The home must be at least one year old
  • Funds are placed into an escrow account, and they are released as projects are completed
  • Project costs must be at least $5,000

This loan option may be for you if you’re looking to make repairs or renovations but continue to live in your home while projects are underway. Use the Limited 203(k) loan when you need to repair the roof, update your kitchen, replace HVAC systems, or any other project that doesn’t make your home inhabitable.

FHA Standard 203(k) Rehabilitation Mortgage

The Standard 203(k) Rehabilitation Mortgage is an FHA loan similar to the Limited 203(k) mortgage. However, there are a few notable differences that make this the right loan if you’re planning more extensive home renovations. Here are some differences:

  • The Standard 203(k) does not come with a $35,000 cap
  • You can borrow as much as you need, up to your county’s FHA lending limit
  • Your home can be inhabitable during renovations, and you can even demolish the home down to its foundation
  • You will be assigned a consultant who monitors your renovation and allows payments to be made as projects are completed

The Standard 203(k) is right for you if you need to make significant repairs or changes to your property. These include things like relocating load-bearing walls, repairing structural/foundation damage, and adding new construction (i.e., more bedrooms, sunroom, etc.).

Want to see your home renovation loan options?

If you are in the market for a home, and that home needs repairs or updates, be sure to investigate your loan options. A home renovation loan might be just what you need to get your project started. We can help you determine which type of loan is best for you and guide you through the application process. Use our free 203k qualifier app to get started today.

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