Suppose you want to make home improvements and don’t have enough cash to fund the renovation work. The option available for you is to look for renovation loans. In most instances, when you need financing, there are several options available for you. For example, if you want money for college tuition, there are student loans available. If you want money for a car, there are car loans available. However, bankers and loan companies present you with several loan options if you want to take out a loan for home improvement projects.
Though we will discuss what home renovation loans are in detail in another article, we will discuss how a home renovation loan works based on how it differs from the most commonly offered loan options, the home equity loan. Comparing home equity loans and renovation loans will help you understand which best home improvement loan type you can choose.
What are Home Renovation Loans?
A home renovation loan is one of several types of home improvement loans available for homeowners specifically for providing the most cash for home renovation. The amount of money you can borrow for your home renovation loan is calculated as the difference between the home’s estimated value and current value. The maximum cash out is 80% of this difference. You need to ask specifically for this feature of the loan because certain home improvement loans could just be a renamed version of an unsecured personal loan.
How do Home Renovation Loans Work? Home Renovation Loans vs. Home Equity Loans Comparison
To be clear about how home renovation loans work, let us compare them with home equity loans to get an idea about its best selling point: how much you could borrow.
The key term in this comparison is the equity line of credit. The home equity line is important because it defines how much money you can borrow from a home equity loan. We will get back to that in detail later.
Suppose you have a one-story home that you want to improve. Suppose you are two years into ownership of the house you bought for $400,000 (which, for the purpose of discussion, is your home’s current value), with an outstanding mortgage of $300,000. The appraised value of your house after renovation is $750,000.
How Much You Can Borrow Using a Home Equity Loan:
For a traditional home equity loan, you can borrow up to 80% of your home’s current value. However, since your current mortgage is $300,000, the most money you can borrow is 80% of $400,000 minus $300,000, or $20,000.
How Much You Can Borrow Using Home Renovation Loans:
In the case of specific home renovation loans, you can borrow up to 80% of your home’s estimated value after your renovation project. If the value of your home after renovation is $750,000, 80% of that value is $600,000. Subtract the current mortgage of $300,000, then the maximum amount you can borrow is $300,000!
Asking for these terms is key because renovation that increase home value is worthy of being financed accordingly.
What Are The Other Home Renovation Loan Options Available?
Here is a quick look at other available home renovation loan options. Please note that you need to check if you qualify for these home improvement loans. Please take special consideration on factors such as monthly payments, credit score, closing costs, and interest rates.
Single-Close Construction to Permanent Loan (CTP)
In this construction loan, the money is paid to the contractor rather than to the homeowner. The disbursement is based on a schedule that involves on-site inspection by the bank. This type of renovation loan converts to a new permanent first mortgage and replaces the existing mortgage. It is like a cash-out refinance but based on the after-renovation value.
This type of loan has the advantage of low-interest rates and flexible repayment options. You can also borrow up to $1,000,000. However, because you are refinancing, you are restarting your mortgage loan, which slows down the rate at which you build value or equity in your house.
FHA Loans (FHA 203K)
FHA loans are insured by the FHA and are suited for people with a lower credit score and a higher debt-to-income ratio. With FHA loans, you can borrow up to 96.5% of the estimated value of your home after renovation. However, you may have to pay Private Morgage Insurance (or PMI) if you borrow beyond 80%. As a comparison, private banks usually limit renovation loans to 80%.
The disadvantage of this home improvement loan is that FHA loan limits are lower. Moreover, on average, FHA 203K mortgage rates are higher than most renovation loans. Because you are refinancing, it slows down the rate at which you build equity in your house.
Fannie Mae Homestyle Loan
This type of construction loan is similar to the FHA 203K but is insured by Fannie Mae, a government-sponsored agency. The Fannie Mae Homestyle Loan has most of the advantages of the FHA loan but has a higher loan limit. Like the FHA 203k, you can have the fixed monthly payments spread to 30 years. It has most of the same disadvantages as an FHA loan, especially the resulting higher rate because you are refinancing.
Personal Loans or Credit Cards
Using personal loans or credit cards is a dangerous option for home renovations because these are unsecured personal loans. Being an unsecured personal loan means you will have higher interest rates, shorter terms, and a much higher monthly payment. Credit cards are simply not designed to work as a property improvement loan. Unsecured personal loans may work if you require a lump sum to purchase materials that were overlooked during build or specific emergencies. Cash-out refinancing is also another option available for you. However, you need to approach this type of home improvement financing depending on the interest rate or if you can find credit unions that offer reasonable terms like fixed interest rates with no surprises.
Takeaways: Study How Home Improvement Loans Work Before Deciding On One
For many people who want to realize their dream home, renovation projects are one way to realize that dream after initially purchasing a home. Depending on your financial situation, you have many options to take our loans for home repairs. However, home repair loans need to be approached with caution. A home renovation loan can be a second mortgage burdening you in the long run. Fortunately, A1 Home Repair offers one of the most affordable and best-value home remodeling in Scottsdale, Gilbert, and the Phoenix East Valley Area. Numerous clients praise us for the best value of service we provide them. Please don’t take our word for it. Call us at (480) 343-0886 to ask for a free quote or contact us by visiting this page.
