7 loan options to pay for a home renovation

If you’re looking for the right way to pay for your home renovation, there’s a chance that you’ve been recommended a number of different options.

And the sheer number of different ways to finance home improvements can, in itself, cause confusion.

Maybe you’ve seen that your bank is offering home improvement loans? Been told to go and look into a construction loan? Or even that a home renovation loan could let you borrow based on your home’s future value?

And while there are different options for financing your renovation, they’re certainly not all equal, and some will leave you needing to refinance, unable to borrow the amount you need, or paying higher interest rates than necessary.

So, just what are the best ways to pay for improvements and additions to your home?

In this guide, we’ll run down the different options you have and help you to figure out which is your best choice.

Specifically, you’ll learn:

When Should You Finance A Renovation?

Imagine this scenario.

You’ve got a young family, have just bought a new house, and have a renovation wishlist of projects that you’re desperate to undertake to turn the property into a forever home that perfectly suits your needs.

But there’s just one problem.

To carry out all of the work, it’s going to cost you around $100,000.

You’ve only just bought the house, so haven’t built up sufficient equity that you can tap into, and don’t have that sort of cash to pay for the renovation. In fact, even the most basic renovations are out of reach for many years for homeowners in this position.

So what do most people do?

87% of them use cash - borrowing from retirement accounts, draining emergency savings, borrowing from friends and family.

Others begrudgingly reduce the scope of their project and tackle their renovation wishlist piecemeal over many years while living in a never-ending construction zone.

But, it doesn’t have to be this way, and if this sounds like the position that you’ve found yourself in, financing could help you to complete your wishlist now and allow you to raise your children in a home that better meets your family’s needs.

What Should You Consider When Financing Home Renovations?

When it comes to financing a renovation, there are a few things that you should consider when exploring the options that are available to you.

You should be thinking about:

• How much tappable equity do you have in your home?
• How much do you need to borrow / how much will your project cost to complete?
• What will the value of your home be after the renovation?
• How much can you afford your monthly payments to be?
• What period do you want to repay any borrowed money over?
• Do you want to refinance your existing mortgage?

These are all questions that you should be asking, given that the different types of financing that are suitable for your project will depend upon your answers to these and your priorities.

7 Ways To Pay For Improvements

So just what are your options to pay for home improvements?

Below, we’ll dive deep into seven of the most common ways that homeowners finance home renovation projects and share the pros and cons of each.

A Home Renovation Loan

Home renovation loans let you borrow against the after renovation value of your property, significantly increasing your borrowing power when compared to the alternatives.

And this means that, for most homeowners, they’re the best way to finance the cost of a home remodel.

But there is more than one type of renovation loan for you to get your head around, and they’re most likely not all right for your project.

A RenoFi Loan

RenoFi Loans, quite simply, are the perfect way for most homeowners to borrow the money they need to tackle their whole renovation wishlist in one go. 

This new type of renovation finance combines the best bits of a construction loan with the simplicity of a home equity loan, letting you borrow based on your home’s after renovation value without the need to refinance your first mortgage.  

In fact, this type of loan can increase your borrowing power by more than 9x.

Just take a look at this illustration to help you understand how a RenoFi Loan can help you to borrow the money you need to finance your entire wishlist:

Pros:

• Does NOT require you to refinance your first mortgage, meaning you can keep your low rates and avoid restarting the clock on your mortgage.
• For 10 to 20-year terms, rates are typically the same as a traditional home equity loan or lines of credit.
• Because the loan doesn’t require you to refinance your mortgage, thus you’ll likely pay much less in closing costs.
• You can borrow $20k to $500k
• The only renovation loan that doesn’t require you to refinance and it’s the only one that doesn’t require funds to be disbursed to the contractor through a messy inspection & draw schedule process.

Cons:

• Because home equity loans typically max out at 20-year terms, the monthly payments for these loans are often a bit higher than repayments on loans with a term of over 30 years.

RenoFi Loans were created specifically to solve a problem that homeowners were facing, and offer a purpose-built product to help finance renovations as cost-effectively as possible.

A Construction Loan

Many homeowners are pointed in the direction of construction loans as a way to pay for home improvements, but the honest truth is that most people shouldn’t use them, as there are better alternatives.

These loans were originally designed as a way to pay for the ground-up construction of a new home, but some homeowners use them to pay for major renovations. And while construction loans let you borrow based on your home’s future value, they come with a stringent set of requirements that cause extra work and delays.

In fact, many contractors hate construction loans and some even refuse to work with them.

Pros:

• The lowest possible monthly payments, because, like a traditional mortgage, you can spread repayments over a term of 30 years.
• Low rates which are typically in line with the market rate for first mortgages, although some lenders can charge a premium.
• You can borrow $1 million+
• Options to convert to a traditional 30 year fixed or specialty loan offerings like Adjustable Rate Mortgages (ARMs).
• Single close means you only sign one set of documents and pay one set of closing costs.

Cons:

• Many contractors simply refuse to take on projects that are using construction loans due to the headaches involved with the inspections and disbursement schedule.
• Because you need to refinance, you might be doing so at a higher rate.
• Given that you are refinancing, you have to pay typical closing costs PLUS the extra costs associated with the construction loan, making it one of the most expensive loans on the market from a fee perspective.
• Because you are refinancing, you are starting the clock over on your mortgage which slows down the rate at which you build equity in your home.

A Fannie Mae HomeStyle or FHA 203k Loan

Traditionally, the most common solution for homebuyers looking to finance both the purchase and renovation of a new fixer-upper home in one have been FHA 203k and Fannie Mae Homestyle loans though they can also be used for existing homeowners. Read our guide on the differences between FHA 203k and Fannie Mae Homestyle loans here.

And like other home renovation loans, these both allow you to borrow based on your home’s after renovation value.

But many mortgage bankers now avoid suggesting FHA 203ks and Homestyle loans to their clients, and realtors are steering both their buyers and sellers away from these options completely.

To learn more about why this is, read our guide on Why FHA 203ks & Homestyle Loans Suck for Purchasing & then Renovating.

Pros:

• You only need one loan that covers both the purchase and renovations of your new home.
• These require a low minimum down payment (as low as 3.5% with 203k loans and 3% with Homestyle loans).
• You can get approved for these loans if you have a less-than-perfect credit score (as low as 500 for 203k loans or 620 for HomeStyle loans).

Cons:

• Many contractors simply refuse to take on projects that are using these loans due to the headaches involved with the inspections and disbursement schedule.

• Homebuyers who are using FHA 203k or Fannie Mae HomeStyle loans are at a huge disadvantage when putting in an offer on a home, especially in a competitive market, because they require extra steps when compared to paying cash or using a traditional mortgage.

  When you’re up against someone who can move quickly to finalize the deal while you’d drag out the sale bogged down by the FHA 203k or Homestyle process, odds are that seller won’t be choosing you.

  Do you really want to miss out on your dream home because of your financing choice?

• Using these loans can result in significant delays, and some lenders are even closing these in as much as 3-6 months, compared to 45 days on a traditional loan.

• This type of loan typically comes at a higher interest rate than the alternatives and has a requirement to pay a monthly mortgage insurance payment in addition to financing, with an FHA 203K loan also adding an upfront mortgage insurance premium.

  A smarter move is often to purchase the home with the lowest rate mortgage you can find and then use a RenoFi Loan to fund the renovations when you’re ready!

Home Equity Loan or Line of Credit (HELOC)

For homeowners who have tappable equity available, a traditional home equity loan (also known as a second mortgage) or line of credit (HELOC) can be used to pay for home improvement work.

A home equity loan allows you to borrow a fixed amount of money by tapping into your home’s equity, whereas a HELOC gives you access to a revolving line of credit.

And, according to the US Census Bureau’s Housing Survey, approximately 50% of home equity loans are used for the purpose of home renovations. 

But the problem here is that it takes a long time to build up sufficient equity, and it can often take more than ten years to be able to draw on this to finance the projects you want to do.

This makes this type of financing unsuitable for people who have only recently bought their home or whose renovation work will cost more than the loan amount available.

Pros:

• A lower, fixed interest rate than personal loans and credit cards.
• The interest paid on a home improvement loan or HELOC is tax-deductible.
• Funds are available as an upfront lump-sum payment with an equity loan and can be drawn down as and when needed from a home equity line of credit, and not all of the money needs to be spent on home improvements.

Cons:

• Equity must be available to take out a home equity loan or HELOC, and not having sufficient equity can significantly reduce your borrowing power. Homeowners get no credit for the home value increase that will result from the renovation.
• Terms typically max out at 20 years unlike a first mortgage which can go to 30 year. Shorter term results in a higher monthly payment.
• The interest rate payable on a home equity line of credit will typically be variable, meaning that your monthly repayments can change.

Cash-Out Refinance

A cash-out refinance can allow you to combine refinancing your first mortgage AND let you secure the cash you need to tackle your major renovation project by tapping into the equity that you’ve built up.

But as with home equity loans and lines of credit, you will need sufficient equity for this to be a viable option.

And even in cases where you have built up equity, lenders typically cap what you can borrow with a cash-out refi at 80% of your current home value, significantly reducing your borrowing power compared to other options.

Our general opinion is that most homeowners shouldn’t use a cash-out refinance for renovations.

Pros:

• This option allows you to consolidate the finance needed for remodeling and your current mortgage into a single loan, meaning a single monthly mortgage payment.
• A cash-out refi, like your first mortgage, will let you make repayments over a term of up to 30 years. For someone who purchased their home in their early 2000s and locked in at a much higher interest rate, this could be a good move.

Cons:

• Homeowners get no credit for the home value increase that will result from the renovation, the loan is based on the CURRENT home value and thus you must have significant equity available in your home to take cash out.
• You will have a much lower borrowing power than other types of home improvement finance, given that most cash-out refinances only let you tap up to 80% of your home’s current value.
• They come with higher closing costs than the alternatives.
• Homeowners typically pay a higher rate when taking cash-out vs. a non cash-out refinance.

Unsecured Personal Loan

Most homeowners shouldn’t use a personal loan to pay for home improvements, but it’s important to know they’re often considered without realizing it, at least at first.

They offer limited borrowing power, high-interest rates, and short repayment periods, yet can be an effective way to quickly borrow a smaller amount of money, let’s say to carry out home repairs rather than a full remodel.

You see, many lenders market personal loans as a home improvement loan, and many homeowners simply don’t realize that they have alternatives when they have no equity available to borrow against.

The same applies to borrowing using credit cards.

Pros:

• When you only need to borrow a small amount of money (let’s say, less than $20k), a personal loan might be your best option without tapping into equity.
• Personal loans let you get access to the money immediately and typically have a quick and simple application process.

Cons:

• The interest rate on personal loans is usually much higher than on other types of financing, often somewhere between 8% and 15%.
• Many personal loans come with origination fees of between 1% and 6%, adding further costs.
• The payback period on a personal loan will usually be somewhere between five and 10 years, whereas home renovation loans allow repayments to be made over 20 to 30 years.
• You will have much less borrowing power than with other types of financing. And while it may appear that there are personal loans that will let you borrow up to $100k, the reality is that very few borrowers will actually qualify for a loan amount this high.

Cash

Some homeowners choose to use cash to finance their renovation wishlist, and while this is a great option if you are able to afford to do so, for most people, this isn’t as simple as it sounds.

You see, using cash often means borrowing from retirement accounts, draining emergency savings, or borrowing from friends and family.

In these cases, cash is usually being used because there isn’t much equity built up to tap into, and because the homeowner isn’t aware that options exist to borrow against their home’s after renovation value.

Think carefully before paying for home improvement projects with cash, especially when this could be coming out of long-term or emergency savings.

Pros:

• There are no interest or fees or charges to pay. The cost of your renovation is the total cost of the project.
• The funds are available immediately and payments can be made to contractors on your own agreed schedule.
• There is no requirement for an appraisal to be carried out.

Cons:

• Using cash often means borrowing from retirement accounts or taking out of your emergency savings, therefore depleting your cash reserves or money that’s been set aside for the future.
• Most homeowners do not have sufficient savings put aside to cover their whole renovation wishlist. However, it does often make sense to cover smaller repairs with cash. And when interest rates are lower than the interest your money would get from keeping it in the stock market, then financing and paying over time can be a smarter move.

What Type Of Loan Is Best For Home Improvements?

The bottom line is that, while there are a number of different options available, a RenoFi Loan is by far the most attractive way to finance remodeling projects for most homeowners.

And RenoFi CEO & Co-Founder, Justin Goldman comments on the problems faced by homeowners, stating that:

“Today, the two most popular financial products used to finance home renovations - a cash-out refinance or a home equity loan - aren’t even really designed for renovations at all.

“While they can be a good option for long-term homeowners (having lived in their home for 10+ years), they aren’t the right type of loan for recent homebuyers who haven’t yet built up equity.

“Because when equity is your only leverage, it can take years to build up enough equity to achieve your entire renovation wishlist.”

A RenoFi Loan lets you borrow against your home’s future value while enjoying the simplicity of a home equity loan, making it easier for you to complete your renovation wishlist straight away.

We are here to help you get your someday home, today. And we help you do it in the most financially responsible way possible.