How To Pay For Your Home Renovations | Find the best loan for you
If more time under your roof opens your eyes to the improvements you’d like to make, you may be wondering whether to take out a home improvement loan. You’re not alone.
“We’ve seen a huge increase in this conversation for a few months since the pandemic began,” says Brian Walsh, senior director of financial planning at fintech firm SoFi. Owners “have the time and attention focused on something they may not have for years.”
Indeed, spending on home improvements and repairs could hit $430 billion by the second half of 2022 before slowing, according to Harvard University’s Joint Center for Housing Studies.
The right financing can put a renovation within reach. Here are some options to help you pay for your home renovations and key questions to consider.
Should you get a home improvement loan?
“The million dollar question is: is this the right time?” says John Ulzheimer, a credit expert who has worked at FICO and the Equifax credit bureau.
Act now? Is this renovation essential or pleasant to have? Some home renovations are necessary because they involve structural or mechanical repairs, such as repairing a foundation or installing a new HVAC system. Other projects are purely cosmetic.
Regardless, property value should be a key factor in your decision to finance a home improvement, Ulzheimer says.
“We always look at resale value,” he says. “If you’re turning a $500,000 house into a $900,000 house because of the renovations, a big upside is the increase in value of the house, which is normally way above what you would do for a renovation. “
Act later? The pandemic-related construction demand has created labor and supply shortages, which means longer wait times to start a renovation project and receive building materials. Ulzheimer himself has been affected by the delays, saying he ordered a fridge in September 2021 but won’t receive it until May 2022.
The mismatch between supply and demand has also driven up the price of materials. You might end up spending more on remodeling your home than you would have expected, says Ulzheimer.
“You have to ask yourself, ‘Can I live with what I’m living now? Or am I so desperate for a new kitchen, garage, or master bathroom that I can’t wait for?'” says -he.
Home Renovation Financing Options
You can pay for your home improvement with cash or finance it with:
“Generally, it’s about balancing the flexibility of the funds when you actually get the money,” says Walsh, with “the interest and other fees you’ll pay by borrowing the money.”
Refinancing by collection
A cash refinance replaces your mortgage with a new loan for more than you owe, and you receive the difference in cash at closing.
You could improve your mortgage interest rate, access thousands of dollars, and spread out your payments with a new loan term. Cash refinance requirements depend on the lender, but you’ll generally need a credit score of at least 620 and significant home equity.
A big downside is that because a cash refinance is a secured loan, “you could be putting your home at risk if you default,” Ulzheimer says.
Others are that you restart the clock on interest charges, and the loan will require upfront closing costs.
HELOC or home equity loans
Both of these loans allow you to borrow against the equity in your home, giving you access to cash for renovations. A HELOC is a revolving line of credit similar to a credit card, and you only pay interest on what you borrow.
“You’re borrowing money against the value of your home that isn’t encumbered by another loan,” Ulzheimer says, adding that the process is simpler than cash refinancing. “Lenders typically do a drive-thru valuation and don’t need an exact value like they would with a cashed-in refi or first mortgage.”
Also called a second mortgage, a home equity loan usually has a fixed interest rate and gives you a lump sum with repayment terms of five to 30 years. You will know exactly what your monthly payments will be and when you will repay your loan.
You’ll pay a home equity loan immediately, including interest, unlike a HELOC, Ulzheimer says.
Generally, lenders require 20% of the equity in your home to qualify for a home equity loan or line of credit. According to the Experian credit bureau, you generally need a FICO score of at least 680 to qualify for a home equity loan or HELOC.
If you want to renovate but are reluctant to risk your home as collateral, you may want to consider an unsecured personal loan. The average interest rate on a 24-month personal loan in November 2021 was 9.09%, according to the Federal Reserve.
But interest rates can range from 5% to 20% and depend on your credit score, Walsh says.
“If someone has a good credit rating and high income relative to monthly debt payments, they might be a good candidate to explore a personal loan as they would be approved at the best interest rate,” says- he.
Still, personal loans aren’t typically used for home renovations, Walsh says. “The only times we suggest it is if they have to do renovations and there are no other options,” he says.
Fannie Mae HomeStyle Renovation Mortgage
This is a conventional mortgage that allows borrowers to finance renovations with a home purchase or refinance. Borrowers should find a lender that offers HomeStyle Renovation loans because Fannie Mae backs the loans but does not directly lend money to consumers.
Fannie Mae promotes “potentially lower rates than other forms of financing, such as home equity lines of credit or credit cards,” as well as low down payments and cancellable mortgage insurance with certain restrictions.
You can use the loan on just about any type of property, including manufactured homes. Improvements do not have to add value to your property, but proposed renovations should be assessed during the appraisal process.
Refinance loans are limited to 75% of the appraised value of the property “at completion”; Purchase loans are limited to 75% of the lesser of the purchase price plus renovation costs or the appraised value of the property upon completion.
Note that for some transactions and for first-time buyers, at least one borrower must take a homeownership training course.
FHA 203(k) Mortgage
Buyers can finance their renovations or their purchase and renovations in one loan. Two types of 203(k) loans, limited and standard, cover different types of projects.
A limited loan lets you borrow up to $35,000 to pay for repairs or improvements to the property, including those identified by a home inspector or FHA appraiser. These could include remodeling the kitchen, painting the interior, or buying a new carpet.
A standard 203(k) loan can help finance larger structural repairs, such as adding or replacing a roof. Loans must be at least $5,000 and no specific limit is set, but the value of the property must be within the FHA mortgage limit for the area.
You may need to work with a consultant from the Department of Housing and Urban Development. Borrowers must also work with FHA-approved lenders and have a credit score of at least 500.
Choosing the Right Home Improvement Loan
This multi-step process from Walsh can help you decide whether to finance or pay cash for your home renovations.
1. Assess the scope of the project. Think about costs, including whether you can live in the house for the duration of the project. What is the renovation schedule?
What is the importance of the project? “It’s important to be really honest and figure out if this is something you really need to do, like fixing a leaky roof, or if you want to do a project like building a patio,” Walsh says.
2. Understand how the renovation will affect the value of your property. “Especially if you’re planning to sell your home in the not-too-distant future, a project might make sense if it results in a drastic increase in property value,” Walsh says.
3. Examine your financing options for the renovation. “Think about how you will repay the loan and how the loan will impact the rest of your finances,” says Walsh.
Working with a financial planner can help you determine if a home improvement loan is a good choice. “Legally, they have to tell you what’s in your best interest and not what’s in the company’s best interest when you’re considering options,” Walsh says.
If timing and numbers make sense, renovation projects can make home even more enjoyable. “Sometimes you have to be told that you should just wait a few years and save some money instead of going into debt for something that will make you happy in the short term,” Walsh says.