How to Finance a Home Addition

Written by Banks Editorial Team
5 min. read
Written by Banks Editorial Team
5 min. read

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Home additions are a great way to increase your livable square footage while boosting the value of your property. However, these additions can be costly for many homeowners. Whether you’re preparing your home for sale or just want to give it a fresh look, one of the most common questions you may ask yourself is how you will finance the project.

Unless you’ve been saving for the project, you’ll probably need home improvement financing. Fortunately, there are several ways to finance a home addition. Keep reading to learn about the various financing options and what to consider when choosing how to finance your home addition.

Home Renovation Loans

 
Learn how the RenoFi ReFi cash-out refinance home renovation loan allows you access up to 80% of your home’s projected value after renovation.

Types of Home Additions

Home additions come in different sizes, shapes, and budgets, which play a critical role when choosing the best financing option for your project. Here are three popular types of home additions.

Full Addition

A full home addition generally increases the square footage of a property. This can include anything from extra rooms to building a new kitchen or garage addition. However, depending on the project, these home additions take the longest time to finish and typically cost more.

Micro Addition

As the name suggests, a micro addition is a small home improvement project that doesn’t require building a new room. Instead, it can include bump-outs on existing rooms or bathroom remodel. As a result, micro additions are typically cheaper than full additions and take a shorter period of time to complete.

Second Story Addition

If you need to increase your square footage, don’t want to build outwards, or don’t want to use your yard size, a second story could be a perfect choice. Building a second story is quite expensive than other home additions, but it has the best return on investment if you ever decide to sell your home.

Reasons Why Home Addition is a Great Idea

There are several reasons many homeowners are considering home additions. While every homeowner has a unique reason for adding on to their home, here are the most common reasons why a home addition is a good idea.

  • Extra Living Space: The number one reason homeowners are getting home additions is the need for extra living space. Whether your family is growing or just needs more space, adding extra rooms, bathrooms, or expanding the kitchen can offer the comfort you need.
  • More Functionality: Adding a space where you can make it your home office, gym, or a place to keep your musical instruments gives you more functionality without giving up a room.
  • Better Alternative to Moving: If you have a growing family, home addition is a better option than moving to a bigger house. Plus, you can still get the chance to live in the neighborhood you’re used to.
  • Extra Income: If you’re considering an extra room as your home addition project, you can earn extra income monthly by renting out the space or becoming an Airbnb host.
  • Increase Your Home’s Value: A home addition is a great way to increase the current value of your home. Not all additions, though, are guaranteed to boost the value of a property. Depending on the addition you want, you may get an ROI when you decide to sell down the road. 

Financing Your Home Addition

Here are seven common home addition financing options and when each works best to help you figure out the best option for you. Each has pros and cons worth considering, and others are the best fit for homeowners in specific situations.

Home Equity Loan or Line of Credit (HELOC)

If you’ve owned a home for a while, you’ve probably accumulated home equity, which you can borrow a loan against it. Lenders allow you to borrow up to 80% of your home’s equity value. With a home equity loan, you’ll receive a lump sum amount of capital, payable within a set period, plus a fixed interest rate.

Alternatively, you can use your home equity to secure a home equity line of credit (HELOC), which lets you tap into the funds on a needed basis. HELOC works much like a credit card, where you only pay interest on the amount you borrow. However, HELOCs typically have a variable interest rate, meaning monthly payments may fluctuate as rates change.

Generally, a home equity loan or HELOC is ideal for homeowners with sufficient equity.

Home Renovation Loans

 
Learn how the RenoFi ReFi cash-out refinance home renovation loan allows you access up to 80% of your home’s projected value after renovation.

Cash-Out Refinance

You can refinance your existing mortgage if you don’t want a second mortgage. When you refinance, you’re simply paying off your current mortgage and obtaining a new one with enough cash to refinance your home addition. 

Cash-out refinancing is a great option for homeowners looking for better repayment terms and potentially capitalize on lower interest rates than their original mortgage.

Construction Loan

Construction loans were originally designed to cover the costs of building a home, but homeowners can also use them to finance home additions. They are typically determined based on the home’s future value after construction.

This type of loan has several drawbacks, which may not be the best choice for financing a home addition. For one, you may end up paying more over time because you’ll be forced to refinance your home at a higher interest rate.

FHA 203k or Fannie Mae HomeStyle Loan

FHA 203k or Fannie Mae HomeStyle Loan are government loans ideal for homeowners looking to simultaneously refinance their first mortgage while freeing up some cash for a home addition. These loans allow you to borrow against the after-renovation value, increasing your borrowing power.

Personal Loan or Savings

If you have enough savings, you can use them to cover the costs of your home addition project. Alternatively, you can opt for personal loans to finance your home renovation quickly. Most personal loan lenders approve funds within a week because it has less underwriting process, unlike home equity loans. 

Home Improvement Loan

A home improvement loan is an unsecured personal loan that gives you access to funds to finance home renovations, upgrades, remodels, or repairs. This type of funding usually comes in a lump sum, repayable in monthly installments over a set period of time.

Since the loan is unsecured, collateral is not needed to back up the funding. For this reason, your interest rate is based on your credit score.

RenoFi Loans

You can also finance your home addition with RenoFi Loans. The good news is that RenoFi considers the home’s future value after renovation to calculate the amount of loan you can borrow. RenoFi offers three types of renovation loans: 

  • Home equity loan: You can borrow anywhere from $25,000 to $500,000 using your home’s equity. Repayment terms can go up to 20 years.
  • HELOC: A home equity line of credit offered by RenoFi is calculated using your home’s after-renovation value, capped at 80%. The revolving line of credit has a 10-year draw period, and amounts range from $25,000 to $500,000.
  • RenoFi Refi: This is a cash-out refinance that lets you refinance your existing mortgage loan to access the funds you need for a home renovation. You can borrow up to 80% of your home’s projected value after renovation.

Calculate how much RenoFi renovation loan you can borrow without obligation.

Things to Consider When Choosing How to Finance Your Home Addition

Before deciding on the best financing option for your home addition, here are some things to consider.

  • Cost of the Home Addition: What’s the overall estimated cost of your home addition? Depending on the project, a certain financing option is more ideal than another.
  • Equity in Your Home: If you’ve built enough equity in your home, a home equity loan or HELOC might be a good option to consider.
  • Your Credit Score and Credit History: Lenders will always look at your credit score and history to determine your creditworthiness. Where your credit score stands currently may impact the financing option you may qualify for.
  • Your Other Loans and Debts: If you have other loans and debts, it’s a good idea to weigh if you can manage the monthly payments if you add another loan. Keep in mind that missing payments could negatively impact your credit score.
  • The Monthly Payments: As with any other loan, you’ll repay the borrowed amount typically monthly. You should be able to handle the payments comfortably.
  • Loan Terms and Length: How long it will take to repay your loan is called the loan term. The length it takes is something to consider. Choosing a longer loan term could result in more payments over time.
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