Home Improvement Loans: Understanding Your Options
Lauren Nowacki10-Minute Read
December 14, 2020
Do you love your home but just aren’t in love with it yet? A love for a home isn’t always unconditional. Maybe you’d be happier with a new roof, siding or garage . Or perhaps your love will grow when the kitchen is updated or the flooring is replaced. Whatever it is that’ll make you fall head over heels for your home, you’re most likely going to need some money to get it done.
Enter the home improvement loan.
In this article, we’ll introduce you to the concept of a home improvement loan and provide a few options. Read on to learn more about the benefits of these renovation loans and what they can allow you to accomplish as the owner of your home.
Home Improvement Loans, Defined
A home improvement loan, or home renovation loan, is money you borrow from a financial lending institution to make upgrades to your home. These upgrades may enhance the livability and usability of the house, remove health and safety hazards, or save energy. For sellers, these renovation loans could increase the value of the home. For home buyers, these loans may allow you to make the necessary improvements to pass inspection or move into what truly is your dream home.
With a home improvement loan, homeowners or home buyers could even complete some of this year’s most popular home improvement projects, including:
- Creating an open-concept layout
- Building in smart home technologies
- Renovating the bathroom
- Creating an outdoor living space
- Providing more accessibility for older or disabled homeowners
Best Home Improvement Loan Options
There are several different types of home improvement loans. Some are insured by the government, while others are not. Some may require you to get a new mortgage – whether through purchasing a new home or refinancing your current one – while others will be an additional monthly payment to your other debts, including your mortgage. Learn more about these loans to figure out which option is right for you based on your financial situation and home improvement needs.
FHA 203(k) Loan
One of the Federal Housing Administration’s top home improvement loan programs is the FHA 203(k) loan, which allows homeowners to finance up to $35,000 for home improvements or repairs. They simply add the loan to their mortgage through a refinance or new home purchase. Once you use the loan to purchase a home or pay off an existing mortgage, the remaining funds are used to pay for the home improvement as work is completed. Since the loan is insured by the government, there are a few restrictions you must adhere to. For example, you cannot do the work yourself, nor can you use your proceeds to fund any luxuries, like a swimming pool or tennis court. You’re also under a tight deadline of 6 months to get the project done and you must borrow at least $5,000.
Fannie Mae HomeStyle Loan
The Fannie Mae HomeStyle Loan works the same as the FHA 203(k) loan: the costs of the renovation can be bundled with your purchase or refinance loan. However, the Fannie Mae HomeStyle loan can be used to pay for luxury renovations to any property, including vacation homes and investment properties. While it is a little more flexible when it comes to how you may use it, the loan does have stricter qualifications, including a higher credit score requirement.
FHA Title 1 Loan
The FHA Title 1 loan is a home improvement loan with a fixed interest rate. This renovation loan allows you to make both small and large improvements and repairs that enhance the livability or utility of the home. Neither HUD nor the FHA actually provide the loan, but the entities insure private lenders who provide them, instead. That means the loan is government-insured and you’ll need to pay a mortgage insurance premium. In order to receive the loan, you’ll need to live in the home at least 90 days and you may need to verify that proceeds will be used for home improvements. You can borrow up to $25,000 for a single-family home with a loan term of up to 20 years. You pay the loan off through monthly payments and there are no penalties if you pay it off early.
HUD does not require a credit score or income for this type of loan, and if you borrow less than $7,500, you will not need to use your home as collateral. If you borrow more than $7,500, you’ll need to secure the loan with your mortgage or a deed of trust.
FHA Energy Efficient Mortgage
The Energy Efficient Mortgage allows you to purchase a new home or refinance your current home and roll the costs of energy-saving improvements into one mortgage. Since the energy-saving improvements will lower the costs of utility bills, thus providing more money to put toward your mortgage payment, you’ll only need to qualify for the amount used to purchase or refinance the home. You will not need to qualify for the additional financing. In order to get this loan, you must complete a home energy assessment. The maximum amount you can borrow will depend on several factors, including your location, property value, improvements you intend to make and results of the home energy assessment. Your lender will be able to determine the maximum amount you’re able to borrow.
Local Government Loans
Depending on where you live, some local governments will provide home improvement loans, particularly to low-income families and the elderly. Many times, these loans are used for home improvements that better the health and safety of the home or add energy-saving, eco-conscious amenities. Check with your government to see if they offer these types of loans and what the qualifications are to get one.
Applying For A Home Improvement Loan
Just as these renovation loans have different features, they will also have different eligibility requirements. While you should learn more about the specific qualifications for the loan you choose, expect to include the following pieces of information during application:
- Credit history and score requirements
- Proof of income
- Debt-to-income ratio
- Property type
- Down payment
- Type of renovations
- Amount of money you wish to borrow
Keep in mind, too, that depending on the type of loan you get, you may have to provide a comprehensive renovation plan and budget, get an appraisal or other assessment on the home and pay origination fees. You may also need to work with a lender-approved contractor.
Choosing The Best Home Improvement Lender
When choosing the best home improvement lender, shop around. Lenders will charge different fees and interest rates, so it’s best to get quotes from a few to get the best deals. In addition to finding the best loan terms, you’ll also want to make sure you’re working with a lender you trust. When shopping for your loan, make sure you learn more about the lender and their customer service. Review their website and social media and read reviews from past and current customers. Sometimes, it’s worth it to pay a little extra in fees to get stellar customer service. Keep in mind that, depending on the type of loan you get, you may need to work with a HUD-approved lender.
Finding Home Improvement Loan Alternatives
If you’re not sure whether a home loan is the right option for you, there are alternative ways to get financing for your home improvement project. There are pros and cons to all of the options, so make sure you understand the terms of each before committing to one.
A personal loan is one of the only alternatives on our list that don’t require you to use the equity in your home or use your home as collateral. When it comes to how much you can borrow with a personal loan, a lender will decide that based on several factors, including your income and credit history. When you take out a personal loan, you’ll have a specific amount of time to pay it back, and once you pay it back in full, your account will be closed. Just like any other loan, you will pay interest on the money you borrow. That interest rate will be determined, in part, by your credit score. Since credit plays a major role in these types of loans, be sure you know what yours is and make sure it’s good. You can check your score and monitor it for free at RocketHQ. And if you plan on using a personal loan to make renovations to your home, Rocket Loans offers a Home Improvement Personal Loan for doing just that.
Before applying for a personal loan, make sure you understand what it is and how it works. Lenders will typically charge an origination fee of about 1% – 6% of your balance, so factor that into your costs. The amount of time you’re given to pay off the loan varies, but is generally around 36 – 60 months, so be sure you’ll be able to pay it off by then. Make your payments on time as well because, just like a credit card, there could be a late payment fee if you don’t. And remember, if you default on your loan, your credit history and score will be negatively impacted.
When you do a cash-out refinance, you convert some of the equity you have in your home into cash. You’re basically borrowing more money on your loan and using that money however you want (instead of purchasing a home, like you originally did). The refinance replaces your original mortgage and becomes your new one. Here’s an example:
You originally borrowed $150,000 to purchase your home and have paid off $50,000. You still owe $100,000. Home prices have gone up since purchasing your home and it is now worth $200,000. When you refinance with that home value, you’ll pay off the $100,000 you still owe on the original mortgage and use the remaining $100,000 for renovations.
While this option typically has a lower interest rate than a personal loan, it also has some drawbacks. For one, you’ll be using the equity in your home that has taken you years of mortgage payments to build up. You’ll also need to pay closing costs and go through another application process to get the loan. And you’ll get whatever the current interest rate is, which means you could end up with a higher one than you originally had. Of course, you could also snag a lower interest rate if rates are low when you refinance.
Home Equity Line Of Credit
A home equity line of credit allows you to borrow against the equity in your home through a line of credit. Much like a credit card, you can borrow up to a certain amount of money and any balance carries over month to month. Unlike a refinance, you’ll need to make monthly minimum payments on this loan in addition to your mortgage. You’ll only be charged interest on money you use. One drawback of this option is that your interest rate on the credit line can fluctuate, which will make your monthly payment go up or down. You may also incur a small fee to have your HELOC set up. Before you decide to go this route, make sure you’re responsible with credit (don’t get this if you’ve maxed out your other credit cards) and that you understand the risks you take. Such risks include damage to your credit if you fail to repay the HELOC or a frozen credit line if your home value drops too much.
Home Equity Loan
Home equity loans are similar to a HELOC in that you borrow against the equity in your home. However, the money is provided in a lump sum instead of a line of credit. These loans typically have a lower interest rate than a personal loan. The drawback with a home equity loan is that you use your home as collateral; so, if you don’t pay your home equity loan back, you could lose your house. You’ll also have to pay closing costs for this renovation loan, which only makes the renovation more expensive. This may sound a lot like a cash-out refinance, but the two are not the same. A home equity loan will add an additional payment to your monthly debt because it’s like a second mortgage. A cash-out refinance replaces your original mortgage, basically updating your mortgage payment. With a home equity loan, you’ll have a mortgage payment and a home equity loan payment.
If there is not an immediate need, save up for your renovations and pay cash instead. It may take time, patience and sacrifice, but paying with cash will most likely be the most rewarding and inexpensive option for you. Paying with cash will allow you to renovate your home without having to pay more on interest and other finance charges. The only problem with this option is that it may take time to save up that large sum of money, so make sure you can wait that long and that any problem you need to fix won’t get worse over time. If you choose this option, determine how much money you’ll need, set that budget, pick a date to have that money saved by and create a savings plan to get you there.
Using A Home Improvement Loan To Increase Equity
Before you start renovation projects that you believe will increase the value of your home, do your homework and learn more about which projects actually add value. Believe it or not, some may not be worth the cost. One great resource is Remodeling Magazine’s 2019 Cost vs. Value Report, which provides a list of common remodeling projects, their average cost and how much of that cost you’ll recoup once the project is complete. Among the home improvement projects with the highest amount recouped are:
- Garage door replacement (97.5% recouped)
- Addition of manufactured stone veneer to the exterior (94.9% recouped)
- Minor kitchen remodel (80.5% recouped)
According to the report, a few renovations you may want to reconsider doing include:
- Master suite addition (50.4% recouped)
- Backyard patio build (55.2% recouped)
- Bathroom addition (58.1% recouped)
Another feature that homeowners often believe will up the resale value (but definitely doesn’t) is a pool. While this could be a great amenity for many, pools are usually more of a burden than an added bonus. They often require a lot of time and money to insure, run and maintain. Pools can also be a liability that a homeowner just doesn’t want to take on. And if you live in a state that experiences cold weather, potential buyers may not think it’s worth it.
Along with these projects, which are more cosmetic, consider upgrades to your home maintenance systems, too. While it is nice to have a reliable HVAC system and new water heater, buyers won’t necessarily see these as something they should pay extra for. Instead, they’ll see them as necessities.
Home Improvement Loans: Final Thoughts
However you choose to pay for your renovations, it may be wise to get estimates from professionals before you take out a loan or save up the money. This will help you set and stick to a budget and prevent you from taking out too little or too much money.
If you’re not sure what option is best for you, consult a financial advisor or reach out to a home loan expert at Rocket Mortgage® who can talk to you about your financial goals and help you decide what option is right for you.
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