What Are My Options For Financing a Home Remodel?
When trying to decide on a financing plan for your home remodel, it’s easy to feel overwhelmed by the different options. However, it’s important to understand all of the different remodeling loans available to you so you can choose the one that best fits your remodeling needs.
At Lamont Bros. Design & Construction, we’ve helped hundreds of Portland area homeowners transform their homes. For many of our clients, part of this process has been to work with lenders to secure financing for their remodel. Having worked with several homeowners to navigate this process, we’ve seen how choosing the right financing plan can make or break a remodel.
In this article, you can read about the three most popular options for home remodel financing loans. We’ll discuss how each one works, their strengths and weaknesses, and when you might consider using each one. With this information, you’ll be able to consider which of these financing options will best fit your personal circumstances. Specifically, we’ll discuss:
Home Equity Financing
Owning a home doesn’t just give you a roof over your head, it can also serve as an investment that grows in value. Over time, as you pay down your mortgage and your home’s value increases, you build more and more equity. If you choose, you can borrow against that equity for a range of expenses, like paying off high-interest debt, covering the costs of an emergency, or using it to reinvest in your home and further increase its value.
Two popular ways to access your equity are as a home equity loan or home equity line of credit (HELOC). While similar, there are a few differences:
Home equity loan
A home equity loan typically comes as a lump sum of cash, often with a fixed interest rate and predictable monthly payments, similar to your first mortgage. These will normally come with closing costs that range from about 2%-5% of the value of the loan. The term or length of the loan can range from 5 to 30 years.
Interest rates will usually be much lower than other types of personal loan options, so experts recommend these over credit cards for example, in order to pay for home improvements.
Home equity line of credit
Whereas a home equity loan allows you to borrow a lump sum all at once, a home equity line of credit works more like a credit card where you can borrow what you need as you need it, up to a certain limit. Unlike home equity loans, HELOCs will have few, if any, closing costs and normally have variable interest rates.
The line of credit usually comes with 2 payment phases:
The draw period is the initial phase of a HELOC during which you can access the available funds from your line of credit. It is a predetermined period, usually ranging from 5 to 10 years, depending on the terms of your specific HELOC agreement.
During the draw period, you may borrow funds from the line of credit as needed, up to the approved limit. The available funds can be accessed using various methods, such as writing checks or using a specific credit card associated with the HELOC.
Following the draw period is the repayment period. During this phase, you’ll be required to make principal plus interest payments until your balance is paid off, and you won’t be able to borrow any further against your line of credit.
How much of my home equity can I borrow?
Your maximum loan amount will depend on the value of your home, what percentage of that value the lender will allow you to borrow against, and how much you still owe on your mortgage.
For example, let’s say your bank will let you borrow up to 80% of the value of your home. It’s currently worth $900,000, and you still owe $150,000 on your first mortgage. That means you may qualify to borrow an additional $600,000 in the form of a home equity loan or HELOC ($900,000 x 0.80 = $720,000 – $150,000 = $570,000).
Pros:
- Interest may be deductible in specific cases
- The loan is separate from your mortgage, so you can keep a low mortgage rate
Cons:
- Higher interest rates
- Relies on having equity — no equity means no equity loan
Good option if: You need access to additional funds and already have a low interest rate on your first mortgage (i.e., you don’t want to replace your current mortgage by refinancing).
Cash-out Refinance
Another one of your options for financing a remodel is a cash-out refinance. Like a home equity loan, this also provides a lump sum payment and usually comes with fixed interest rates. But a cash out refinance isn’t a second mortgage. This is a new home loan that replaces your existing mortgage, and is valued at more than you owe on your house. That difference is the “cash out” portion, which goes to you.
In order to qualify, you must have equity built up in your house, and the cash-out amounts are limited to 80% to 90% of that equity. Here’s how it works…
Your home is currently valued at $900,000, and your mortgage balance is $200,000. That means you have $700,000 of equity in your home. Instead of refinancing as much as 90% of that balance, you decide to opt for 50% instead. As a result, your new refinanced loan is for $550,000, which includes the existing $200,000 balance plus 50% of the equity, amounting to $350,000. At the closing, you receive a lump sum of $350,000 to fund your home renovations.
Pros:
- Access to lump sum payment.
- Interest may be deductible in some cases
- It’s not a second mortgage
- May be easier to qualify for than a home equity loan
Cons:
- You’ll typically pay up to 2% to 5% of the mortgage in closing costs.
- May require mortgage insurance premiums
Good option if: you need access to additional funds and can secure a lower interest rate than you’re currently paying.
Renovation or construction loan
A third loan option to help with your home remodel financing is a renovation or construction loan. These generally allow you to access more funds than you could otherwise because they let you borrow against the value of your home after the renovations are complete. But there are some strings attached. Let’s look at a few of the most common types of these loans:
Fannie May Homestyle renovation loans
These are conventional loans backed by the federal government, so they’ll come with a fair amount of oversight. First, you’ll need to meet to some credit requirements, including a credit score of at least 620 and a maximum debt-to-income ratio of 45%. If it is a new home purchase, you’ll also need a minimum down payment — typically 3% for a single-family home.
Some other conditions apply as well. You’ll need to work with a contractor beforehand on your renovation plans and submit them to the lender for approval. The lender will then review those plans and determine the post-remodel value of your home (and how much you can borrow).
Once the project gets underway, the lender will periodically inspect the project work to make sure it aligns with the initial plans and will result in the “as-completed” value they projected. If it doesn’t, that could affect funds it releases to you and your contractor. Once the work is completed, the lender must issue a final approval.
This type of home improvement financing does have a major advantage: Generally, you can borrow more than 80% of the home’s post-remodel value. So, if your house is currently worth $900,000, but after renovations, it’s expected to be valued at $1,100,000, you can borrow up to $880,000 (80% of $1.1 million). This can be a substantial advantage, as it allows you to access additional funds that you may not have been able to secure otherwise.
Pros:
- Can refinance and remodel your home with a single loan
- Access to more funds than your home is currently worth
- Can use to renovate primary or second/investment homes
Cons:
- More paperwork and regulation than other loans
- Project must finish within 12 months of closing
- You need to design the renovation with a contractor for the lender to approve
203(k) renovation loan
This type of differs from other home remodel financing options because it lets you use a single loan for both a home purchase and the renovation costs it may need. This can be useful if you’re buying a fixer-upper for example. These are also government-backed, guaranteed by the Federal Housing Authority (FHA). That means there are fewer risks for the lenders when offering these loans, which can translate into lower rates for you.
This differs from the Homestyle loan in that you can only borrow up to 110% of your home’s future value post-renovations. With what’s called a “Standard” 203(k), you can use the loan for major renovations, but it requires a 203(k) consultant — usually a licensed contractor or architect — to oversee the work from start to finish. He or she will act as a liaison between you, your contractor, and the lender. The consultant is meant to keep the project on track and signs off on the release of funds from the lender to the contractor.
You as the borrower need to find and pay for the consultant, which can run up to $1,000. You can check the US Department of Housing and Urban Development for a list of approved 203(k) consultants.
In addition, with this type of loan, you’ll be required to pay upfront and annual mortgage insurance premiums for the life of the loan.
Pros:
- Interest rates may be lower than other home remodel financing options.
- Can access up to 110% of post-remodel value of your home.
- Don’t need high credit scores to quality. 580 can qualify for a 3.5% down payment.
Cons:
- Loan limits may be lower than conventional mortgages.
- Must find and pay for 203(k) consultant.
- Must pay mortgage insurance premiums.
Good option if: Renovations loans can be good if you need to borrow more than your home is currently worth and want to refinance and remodel your home with a single loan.
Local Bank Renovation Loan
This type of loan also lets you borrow against the post-renovation value of your home, but it typically comes with fewer regulations. You can use them to remodel an existing home, a second or vacation home, and even an accessory dwelling unit (ADU). Options range from minor updates to major renovations.
Similar to the government-backed financing options noted previously, you’ll still need to submit work plans to the lender before beginning your remodel. However, the lender will have their own team that inspects work progress and approves the disbursement of funds to pay for ongoing construction. You’re not required to hire a separate consultant as in the case of a 203(k) loan.
The main benefit of this type of home improvement financing is that your local bank can generally approve your application and ongoing work more quickly, with fewer hoops to jump through, so your project can be completed in less time. You may already have a relationship with a loan officer at your bank as well, which could also help ease the loan process.
Pros:
- Fewer regulations
- Can borrow against value of home post-remodel
- Not required to pay for outside consultant to approve construction work
- Quicker approvals throughout the process
Cons:
- Mortgage rates may be higher than government-backed loans
- More preparation is involved vs. a home equity loan
- Not all banks offer special renovation loans
Good option if:You already have a good relationship with a local bank, you need to borrow more than your home is currently worth, and want to avoid regulations that come with government-backed loans.
Unsecured Personal Loans
In some cases, one of your remodel financing options may be to take out an unsecured personal loan. Unlike traditional mortgages or renovation loans, an unsecured loan has no collateral. Because of this, they typically have higher interest rates, lower credit limits, and require borrowers to have good credit.
EnerBank Small Renovation Loan
Good for projects up to $100,000, EnerBank’s personal loans are often used as gap financing. If you plan to make money or secure long-term funding in the future but want to remodel now, this loan option can serve as a bridge loan to get you started.
The loan term can be up to 5 years, with 0% for the first 12 months and increase thereafter.
Before going this route, you should meet with a design consultant to discuss it. If you decide to move forward, your design consultant will provide you with a loan code. Click the button below to apply for an EnerBank personal loan.
Pros
- No collateral required, do not need to put your assets on the line.
- Funds can be accessed quickly, often with minimal paperwork.
- No need to pay closing costs or other fees associated with the other loan types.
Cons
- Higher interest rates than secured loans, due to the higher risk for the lender.
- Lower borrowing limits compared to secured loans.
- Repayment terms may be shorter than secured loans.
Want to Know More about Remodeling Costs?
Now that you’ve educated yourself on the different financing options available for your remodel, take the next step. To better understand remodel pricing and how much you can expect to pay for your next remodel, check our our Pricing Page. Here, you can find more information on average remodeling costs for a design-build firm like Lamont Bros.
Want to discuss your remodeling dreams with a professional designer? Click the link below to schedule a free consultation with a member of our design team. We’ll help you navigate the challenges of remodeling so that your current home can be your dream home.