By Jeanne Lee, Bankrate
Whether you need a new roof or your kitchen is outdated, there is a mortgage that’s right for your fixer-upper. Here are your options and what you should know about each one.
Comparing popular home renovation loans:
Goverment-backed home renovation loans
Fannie Mae’s HomeStyle Loan
One of the best-known loans for home improvements, Fannie Mae's HomeStyle Renovation loan, allows borrowers to either buy a place that needs repairs or refinance their existing home loan to pay for improvements.
The HomeStyle loan is available from any Fannie Mae-approved lender, but there are qualification requirements:
- For a primary residence, you must have a credit score of at least 620. You can check your credit score for free at myBankrate to see if you meet this criterion.
- You have to make a down payment of at least 5 percent of the purchase price of the home.
- A certified contractor must prepare and submit a cost estimate and details of the work to be done.
One advantage of a HomeStyle loan is that it's just one loan; you don’t have to take out a loan for the mortgage and then another loan for home repairs. One loan reduces paperwork and closing costs.
Keep in mind that the money for the home improvements goes into a separate escrow account that's used to pay the contractor directly. You don't have access to those funds like you do with a home equity loan or a cash-out refinance.
"The nuance with the HomeStyle loan is that there's a little less freedom for the customer because the funds are held in an escrow account," says Eric Wilson, director of operations at Better Mortgage.
FHA 203(k) loans
The Federal Housing Administration offers a home renovation loan called a 203(k). There's typically a lower credit-score requirement for this loan than there is for a HomeStyle loan, and a lower minimum down payment of 3.5 percent.
There are two types of FHA 203(k) loans:
- Limited (formerly called streamline)
- Standard
A limited FHA 203(k) loan is designed for cosmetic improvements and is capped at $35,000. This rehab loan can be used to finance repairs and improvements like a kitchen remodeling or a new paint job.
A standard FHA 203(k) loan can be used for extensive remodeling, but it requires you to hire a qualified 203(k) consultant to oversee every step of the work, from the plans to the finished product.
This type of home renovation loan is available for homes that are at least a year old. The rehab project must have a cost of at least $5,000. The agency sets mortgage amount limits by state, county or area, and you can look your area up through a searchable tool on its website.
There's security in having the consultant. Most people doing a major home improvement project hire a contractor on their own, notes Stuart Blend, regional sales manager for Planet Home Lending. But with a standard 203(k) loan, the consultant is your project manager, assessing the cost, the plans and overseeing the work.
"When you take out that loan, that money rests with the lender. We're holding those funds in escrow, and we're making sure everything is done the way it's supposed to be done," Blend says.
Private home renovation loans
Home equity loan and HELOC
Another way to finance your home renovation is by taking out a home equity loan, also known as a second mortgage. This is a one-time loan, so it’s not subject to fluctuating interest rates, and monthly payments remain the same for the loan term.
A similar loan is the home equity line of credit, or HELOC. It has a revolving balance and might be best for someone who has several large payments due over time, like with a big home improvement project.
With either option, you're pledging your home as collateral, meaning if you don't make your payments, the lender will end up owning your house. Alternatively, you can take out an unsecured personal loan to avoid putting up your home as collateral.
But HomeStyle and FHA 203(k) loans have some advantages over home equity loans.
"The loan amount with either of these is based on the completed value and not the present value. A home equity loan is based on the current value," says Gregg Harris, president of LenderCity Home Loans, a division of BBMC/Bridgeview Bank Group.
Cash-out mortgage refinance
A cash-out refi allows homeowners to refinance their mortgage. This mortgage will be for a higher amount than the first one, and the homeowner gets the difference in cash.
Like home equity loans and HELOCs, cash-out mortgages require homeowners to use their home as collateral. But if you've got a considerable amount of equity in your home, you might be able to find lower interest rates. Combine lower interest rates with the added home value derived from renovations, and you could benefit more in the long run.
You'll need at least 20 percent equity in your home to qualify for cash-out refinancing. The total loan amount is limited to the available equity in your home. Credit score requirements vary per loan amount and value of your home, but generally start at 640.
How do you choose the best renovation loan?
"It really comes down to credit and eligibility," Harris says.
An FHA 203(k) might be best for a borrower with so-so credit and little money to pay down since borrowers can get a mortgage with only 3.5 percent down.
Consider how much you want to borrow and what it is you want to change. It can be hard to calculate the best home renovation mortgage for your needs, so work with a lender who has extensive knowledge of the different loans, advises Laurie Souza, national business development manager at Mortgage Network Inc. in the Boston area.
"Make sure you're working with a lender that is well versed with the details of the program," she says.
To help you pick the right renovation loan, here's a list of key considerations for each type of financing.
Fannie Mae HomeStyle loan
- Loan amounts can be as high as 75 percent of the home price plus renovation costs or the as-completed appraised value
- HomeStyle funds can be used for any renovation project
- Funds can be used to complete a real estate deal that has repair contingencies, such as replacing a roof
- Requires you to use a certified contractor
- Funds go into an escrow account, not directly to the borrower
FHA 203(k) loan
- Funds can be used for a wide range of projects, whether minor improvements (costing at least $5,000) to total reconstruction (as long as the original foundation remains)
- Can be used to convert a building to a one- to four-unit property
- Affordable interest rates for those with imperfect credit
- Property must meet government energy efficiency and structural standards
- Requires you to use a qualified 203(k) consultant
- You can't use an FHA loan on a property that you intend to flip within 90 days. Rules limit how soon you can resell it, and under what circumstances.
- Funds go into an escrow account, not directly to the borrower
Home equity loan or line of credit (HELOC)
- Interest rates are lower on home equity loans and HELOCs than unsecured personal loans
- With HELOCs, you pay interest only on the amount you draw down
- With a home equity loan, you have a predictable repayment schedule with equal monthly payments
- May have upfront fees, including application or loan processing fees, appraisal fees, document fees and broker fees
Cash-out mortgage refinance
- No restrictions on use of the money
- Lower interest rates than an unsecured personal loan
- Extends the time to payoff of your house
- Requires significant home equity
