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Mortgage and Loan Options to Pay for Your Home Renovations

Written by Allison Martin

Allison Martin is a personal finance enthusiast and a passionate entrepreneur. With over a decade of experience, Allison has made a name for herself as a syndicated financial writer. Her articles are published in leading publications, like Banks.com, Bankrate, The Wall Street Journal, MSN Money, and Investopedia. When she’s not busy creating content, Allison travels nationwide, sharing her knowledge and expertise in financial literacy and entrepreneurship through interactive workshops and programs. She also works as a Certified Financial Education Instructor (CFEI) dedicated to helping people from all walks of life achieve financial freedom and success.

Updated January 25, 2024​

3 min. read​

Are you planning to renovate your home soon? A renovation mortgage loan could be a viable option if you’re seeking ways to fund home improvements. Keep reading to learn more about how they work, along with the benefits, drawbacks and an alternative that may be more ideal.

Can You Add Costs of Renovation to Your Mortgage?

Yes. Certain types of mortgages allow you to roll renovation costs into the loan. 

What is a Renovation Mortgage Loan?

A renovation mortgage loan covers the purchase price of the home and renovation costs. It typically comes with a 15- or 30-year term. The interest rates are generally more competitive than you’ll find with most home improvement loan products.

How Do Renovation Mortgage Loans Work?

Here’s what to expect when taking out a renovation mortgage loan: 

  • Step 1: Research lenders that offer these loan products. 
  • Step 2: Narrow down your options and apply with the lender offering the most competitive loan terms. 
  • Step 3: If you’re pre-approved, select a professional contractor and submit their name and information to the lender for approval. 
  • Step 4: Secure a quote for your renovation project from the approved contractor. 
  • Step 5: The lender will visit the property, assess the home, and assign two values: the current “as-is” value and the “after-repair value.” The latter is the figure the lender will use to determine your loan amount.

When you close on the loan, you’ll have six months to a year to complete renovations. 

To illustrate, assume you’re purchasing a home for $275,000. You plan to make $50,000 in renovations to spruce up the property. 

On the day of the closing, you will close on a $325,000 home loan. However, only $275,000 will go to the seller. The other $50,000, along with an additional 10 percent for the project contingency, is placed in an escrow account that can be drawn from the contractor as they meet milestones.

Advantages and Disadvantages of Renovation Mortgage Loans 

Renovation mortgage loans offer perks to homebuyers looking to make major upgrades to their home. But there are also significant drawbacks to consider. 

Advantages of Renovation Mortgage Loans 

  • Your loan amount is based on the after-renovation value.
  • You could get a loan with a low down payment. 
  • You can keep your hard-earned cash in your pocket. 
  • You don’t need excellent credit to qualify for a loan. 

Disadvantages of Renovation Mortgage Loans 

  • The underwriting and approval process is longer than you’ll find with traditional mortgage products. 
  • The homeowner is responsible for additional renovation costs beyond the original project’s scope. 
  • The contractor must cover the cost of materials before they’re permitted to take the first draw from the lender. 

The Different Options of Renovation Mortgage Loans 

HomeStyle Renovation Loan

The Fannie Mae HomeStyle Renovation Loan can be used for most home renovation projects. You’ll need a middle FICO score of at least 620 to qualify, and renovation costs are usually limited to 95 percent of the home’s after-renovation value.

You’ll get a single loan product that covers the purchase price of the home and renovation costs. This eliminates the need to pay closing costs and monthly payments on two separate loans. 

Still, the application process can be extensive, and the contractor will have to jump through a few hoops before receiving compensation for any work completed per the disbursement schedule.

You can also use a Fannie MaeHomeStyle Loan refinance and upgrade a property you already own. However, refinancing means you could get a higher interest rate. 

FHA 203(K) Rehab Loan

The FHA 203(k) Rehab Loan is also available to homeowners looking to make renovations. 

However, the scope is limited to nonstructural and minor remodeling projects. The upside is you only need a 580 credit score to be eligible for this loan product. (If your credit score is between 500 and 579, some lenders will approve you with a 10 percent down payment. But the debt-to-income requirements could be more stringent). 

Loan amounts are capped at 96.5 percent of the property’s after-renovation value, and you’ll pay private mortgage insurance if you put down less than 20 percent.

Similar to the HomeStyle Renovation Loan, the FHA 203(K) Rehab Loan can be used on a home you purchase or currently own. Plus, the qualification criteria are relatively flexible, which means you could get approved if you’ve had trouble getting a renovation mortgage loan elsewhere. 

What is the Difference Between an FHA 203(K) Rehab Loan and a HomeStyle Renovation Loan?

Both products can be used to purchase a home and cover renovation costs. However, the FHA 203(k) Rehab Loan calls for a 3.5 percent down payment – you’ll only need 3 percent with a HomeStyle Renovation Loan. Plus, you’ll have more freedom regarding the scope of the projects that can be completed with the latter.

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