What is a home renovation loan?
A home renovation loan is a type of mortgage that includes funds for purchasing or refinancing a home along with financing for renovations and repairs. This loan allows borrowers to combine the costs of buying a home and funding its improvements into a single loan, streamlining the process and potentially saving money on closing costs and interest rates.
For example, let’s say you’re house hunting and just can’t quite find the perfect home that hits all your needs and wants. You love the area, but the home itself isn’t exactly what you’re looking for. With a home renovation loan, you can buy the home and remodel it into your dream home—all with one loan.
Or, let’s say you’re a current homeowner who wants to upgrade your amenities. You could refinance with a renovation loan to turn your existing home into the perfect abode. That means you can move into your dream home—without moving!
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Home renovation loan pros
- Single loan convenience: Purchase a home and secure funds for renovations, from basic repairs to room additions and more, all in one 30-year fixed-rate mortgage.
- Potential cost savings: A home renovation loan can help you potentially save on closing costs and interest rates compared to taking out separate loans.
- No out-of-pocket expenses: There is no need to spend additional out-of-pocket cash on up-front renovations; it can be covered in the loan.
- Increased home value: Home renovations can help increase the value of your home, potentially leading to higher equity and a greater return on investment.
- Expand your search: Expand your home search to include competitively priced older homes and fixer-uppers you can renovate.
- Personalization: It’s all about you. A home renovation loan allows you to customize your home to your specific needs and preferences, allowing you to create your dream home.
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Home renovation loan cons
- Requires preplanning: A home renovation loan requires you to provide detailed renovation plans and cost estimates, which necessitates more preplanning compared to a traditional mortgage.
- Potentially higher interest rates: These loans may have higher interest rates compared to traditional mortgages.
- Strict guidelines: Renovations must be completed by licensed contractors, which can limit flexibility, although you can choose the contractors.
- Increased debt: Combining the purchase price and renovation costs can lead to a larger loan amount, increasing your debt load.
- Potential for cost overruns: Renovation projects can easily go over budget. It’s a good idea to factor in a buffer for unexpected costs when calculating affordability.
- Additional fees: There may be origination fees, appraisal fees, and other closing costs associated with the loan.
Where can I get a renovation loan?
Home renovation loans are typically available through banks, credit unions, and mortgage lenders like any other kind of mortgage.
The government also provides loans for certain types of borrowers (more on that below), along with community development financial institutions and peer-to-peer lending platforms. Some home improvement stores have financing partnerships with certain institutions that may be used for renovations
How to qualify for a home renovation loan
A homeowner should meet the following qualifications to get a home renovation loan with the most favorable terms.
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1
Credit score
A positive credit record makes everything easier, including getting a home improvement loan. With a good credit score, the borrower stands a better chance of getting approved, securing lower interest rates, and obtaining favorable terms like higher loan amounts and generous repayment periods.
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2
Stable income
If you can prove you have reliable sources of ongoing revenue, lenders feel more secure that you’ll be able to stick to your repayment schedule. You may also stand a better chance of getting approved and nailing down favorable terms.
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3
Collateral
Home equity is often used as collateral for a renovation loan. Lenders believe borrowers with substantial home equity pose fewer risks. If the owner defaults, lenders can use proceeds from the property’s sale to recover the outstanding loan balance.
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4
Detailed renovation plans
The more information you can provide lenders about your renovation plans, the more transparent you’ll appear to be. Transparency removes a lot of doubt about what you’ll do and how much you’ll spend, especially if you share backup plans in case certain renovations don’t work out.
Getting a renovation loan: The application process
Once you’ve decided to apply for a home improvement loan, what can you expect to happen? Here are the steps most rehabilitation and renovation loans include.
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After the initial inquiry, you, the homeowner, collect all the information you need to give to the lender. This includes contact information, current credit score and debt status, and optimally detailed plans.
The owner then applies for prequalification, submitting to a credit check and presenting their current financial assets and liabilities. If successful, the lender will make an offer for prequalification with an estimate of the loan amount and the interest rate they’ll charge.
Prequalifying has a lot of advantages. It helps the borrower learn what factors make them eligible for a loan and makes for easier financial planning.
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A prospective borrower must handle a lot of documentation. Paperwork may include:
- Personal ID documents
- Income verification
- Credit information
- Debts and assets
- Property deeds
- Mortgage statements
- Detailed home renovation plans
Sufficient documentation makes quicker approval more likely. It may even have a positive effect on loan terms and interest rates.
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The home inspection is a critical part of verifying the property’s condition and the scope of the improvement work. Professional inspectors should have ample experience with the type of loan being issued, whether it’s government-backed or privately disbursed.
Here’s how it works:
- The inspector thoroughly examines every element of the property’s interior and exterior. They identify cases of structural damage, potential code violations, and systems that need to be upgraded. This comprehensive evaluation ensures that both the current state of the property and the proposed renovation plans are accurately documented.
- Once the inspection is complete, the inspector submits a detailed report covering the proposed renovations and any necessary improvements. This report is crucial because it directly informs the appraisal process. During the appraisal, the property’s value is assessed not just on its current state but also on the value it is expected to have after the proposed improvements are made. This future value plays a significant role in determining the loan amount.
- The lender then reviews the inspector’s report and the appraisal to determine the appropriate loan amount. They consider the increased value after the renovations are completed, ensuring the loan covers both the purchase price and the renovation costs. The lender may also impose specific conditions on the loan that must be addressed, based on the inspector’s findings. These conditions could include mandatory repairs or upgrades to ensure the property’s safety and compliance with building codes.
- By incorporating the detailed inspection report and appraisal, lenders can make informed decisions, providing you with the necessary funds to transform your property into your dream home.
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After all reviews are conducted and underwriting is secured, the lender may approve the loan. Again, they may impose conditions that must be met before or shortly after the loan is given.
The final loan agreement reveals the loan amount, repayment terms, and interest rates attached to the loan. It might also require the borrower to pay closing costs, origination fees, appraisal and inspection reports, and other incidental charges.
What types of home improvement loans are available?
Quite a few types of home improvement loans exist, including government and private entity institutions. Here are six of the most common types to consider.
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1
FHA 203(k) loan
An FHA 203(k) is backed by the Federal Housing Administration (FHA). It lets homeowners combine their purchase or refinancing of a home with rehabilitation costs, all covered under a single mortgage agreement.
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2
HomeStyle® Renovation loan
This loan is offered by Fannie Mae. A conventional renovation loan that, like an FHA 203(k) loan, allows owners to combine purchase costs and renovations in a single mortgage.
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3
CHOICERenovation® loan
This loan is offered by Freddie Mac. A conventional renovation loan that, like an FHA 203(k) loan, allows owners to combine purchase costs and renovations in a single mortgage.
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4
VA Renovation loan
This type of loan is guaranteed by the Department of Veterans Affairs (VA) and is available to Active-Duty Service Members and Veterans of the U.S. Military. VA renovation loans incorporate home purchases and renovation costs into one agreement like the two other government loans above.
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5
USDA Rural Development
This loan is offered by USDA Rural Development. A Department of Agriculture loan that, like an FHA 203(k) loan, allows owners to combine purchase costs and renovations in a single mortgage in rural parts of the United States.
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6
Home equity loan
This fixed-rate loan permits owners to borrow against their home equity to finance renovations. Payouts are usually lump sums.
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7
Home equity line of credit (HELOC)
HELOCs also work off a homeowner’s equity but offer equity lines of credit rather than full cash sums. In most cases, HELOCs have variable interest rates.
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8
Cash-out refinance
With a cash-out refinance, the homeowner takes out a new mortgage for an amount higher than their current open balance on the remainder of their repayment term. Payouts are issued in cash and can be used for any purpose, including home renovations.
Are renovation loans tax-deductible?
Renovation loans can be as tax-deductible as any other mortgage. Since these loans are typically conforming loans offered through various agencies, the interest paid on a renovation loan often qualifies for the same tax deductions as a traditional mortgage. However, it’s important to note that the specifics of tax deductions can vary based on individual circumstances and the ever-evolving tax laws.
To ensure you’re maximizing your potential tax benefits, it’s highly recommended you consult with a qualified accountant or tax professional. They can provide personalized advice and help you navigate the complexities of tax deductions related to your renovation loan. By doing so, you can make informed decisions that align with your financial goals and ensure you’re taking full advantage of any applicable deductions.
Final thoughts
Securing a home renovation loan can be a strategic and effective way to finance your home improvement projects. Whether addressing essential repairs, boosting energy efficiency, or increasing property value, this may be an effective loan for you.
Homeowners can make better decisions about loans for renovations by learning about the different options, qualifications, and application steps.
While there are advantages and potential drawbacks, being well-informed will help you navigate the process of getting a renovation loan. This ensures that your home improvements are financially feasible and beneficial in the long run.
