Home Remodeling Loans: The Complete Guide

Living in your dream home equals living the dream. Or well, for many people it is! But sometimes your dream home can become a little dilapidated. Or, you have found the perfect home in the perfect spot, but the house needs a little bit of TLC for it to live up to its full glory. Whatever your needs are, and irrespective of whether you are a citizen, permanent resident or Visa holder, there are many options out there that will help finance your home remodeling project and help you live the dream. Below are some of the options you might want to consider for your home renovation project.

What is a Home Remodeling Loan?

A home remodeling loan is a loan or credit used to renovate your home. This type of loan can be in the form of a home equity loan or personal loan or line of credit. Some loans are even government backed and aimed at ensuring old homes are restored to new beauties.

Who Needs a Home Improvement Loan and Why?

Most people can’t afford to take on a home renovation project with just the cash they have in the bank. To do a proper home renovation project, you will probably need to take out a loan.

If you are a visa holder, chances are that you moved (either temporary or permanently) and are looking for a new home. You can use a home remodeling loan to make sure that your new house is what you always dreamed about. Or, if your money is tight and you can only afford an older home, you can use the remodeling loan to clean it up a bit.

Let’s take a look at home remodeling finance options available to you and then we’ll help you to compare and weight the options against each other.

Home Renovation Loan Options

Cash-out Mortgage Refinances

Cash-out mortgage refinance is a form of debt refinancing where you take out a new (additional) mortgage over and above your existing one. This new mortgage is larger than your outstanding balance on the current mortgage. You then use this new mortgage to pay off the existing one and the difference between the two you have available as equity to provide funds for your remodeling project.

This might be a good option to consider if interest rates have dropped since taking out your initial mortgage. If so, there is a good chance the new interest rate on the new mortgage will be lower than your existing one. You might be able to get lower monthly repayments on the new mortgage as well.

Keep in mind, however, that the new mortgage can possibly come with a longer repayment term. This results in a greater total repayment amount. So, make sure to calculate the cost of the mortgage upfront before opting to do cash-mortgage refinance.

Consider the 5 pros and cons of a Cash-Out Mortgage Refinancing option:

Pros

• This option has larger loan sizes available
• Fixed interest rates apply (so you can calculate the cost of your loan upfront)

Cons

• Refinancing a mortgage can sometimes carry a higher interest rate than primary mortgages
• The cost of closing your initial mortgage can come with a few hundred (or few thousand) dollar fee
• The application process isn’t simple and requires a lot of documents and time

FHA Cash-out Refinances

An FHA cash-out refinance is a form of cash-out refinance which is backed by the Federal Housing Administration (FHA). This reduces risk to lenders and allows people with lower credit scores (or high amounts of outstanding debt) to qualify or to get more money.

Consider the 5 pros and cons of an FHA Cash-Out Refinancing option:

Pros

• Higher LTV limit available, so it allows you to borrow more money
• You can qualify even if your credit score isn’t looking great
• Fixed interest rates apply

Cons

• This option requires monthly mortgage insurance ($67 per month for every $100,000 borrowed)
• An upfront fee of 1.75% applies

Veterans Administration Cash-out Refinances

A Veterans Administration (VA) cash-out refinance is a cash-out refinance which is guaranteed by the VA. This is similar to FHA cash-out refinance except that it is only available to veterans or eligible service persons.

You can use a VA cash-out to refinance an existing VA-backed loan or a non-VA loan. This cash-out loan as the highest LTV, as it allows you to finance up to 100% of your home’s current value.

VA loans don’t require mortgage insurance, so this is a great option if you want to replace your FHA mortgage loan (with its mortgage insurance premiums ) or another private loan with mortgage insurance premiums, with this one. You’ll be saving a lot on home-ownership costs.

Consider the 5 pros and cons of a Veterans Administration Cash-Out Refinancing option:

Pros

• Fixed interest rates apply
• Very high LTV ratio
• No mortgage insurance premiums applicable

Cons

• Often comes with a higher interest rate than other mortgage refinances
• You need income verification and a new property appraisal to apply
• Only certain people are eligible

Loans and Lines of Credit for Home Improvement

Home Equity Loans

Home equity loans allow you to borrow money against the value of your home. If you borrow against your home’s value, it gives you access to a larger loan amount and might also be easier to get, since the loan is secured.

Home equity loans are generally only available if the value of your home is more than your existing mortgage. This means there is equity available on your home that can be used to secure a loan.

Consider the 6 pros and cons of a Home Equity Loan option:

Pros

• Larger loan amounts available
• Possible lower interest rates due to being a secured loan
• Available for people with bad credit
• It is easier to qualify for these loans
• Tax benefits as interest paid on this loan is tax deductible

Cons

• Using your home as collateral puts your asset at risk in case of default

Home Equity Lines of Credit (HELOC)

This is a form of revolving credit where your home is used as collateral. As it is revolving, you can pay back and draw from the loan as many times as you like during the drawing period. Remember that variable interest rates (which is tied to the prime rate) often apply to revolving forms of credit, so your monthly repayment may vary.

You will also most probably have a higher monthly repayment if you draw more funds, especially if you have a fixed draw period and repayment term.

There are two periods which apply to HELOCs:

1. The drawing period – during this period you can access the funds in the loan
2. Repayment period – you will no longer have access to the funds and will now be repaying the loan.

Some HELOCs only require payment of the interest due during the drawing period. Repayment of the principal loan amount only starts once the repayment period starts. This can cause monthly repayments to skyrocket and should be anticipated.

Consider the 8 pros and cons of a Home Equity Lines of Credit:

Pros

• Lower interest rates because it is a secured form of credit
• Payment flexibility as this is a revolving fund
• Your interest payments on home equity financing might be tax deductible (unlike credit cards and personal loans)
• Monthly payments are low during the draw period
• Low cost of closing

Cons

• Monthly repayments may change as interest rates fluctuate
• The cost of the loan fluctuates as interest rates change
• Monthly payments sometimes increase drastically when the repayment phase begins

Personal Loans and Lines of Credit

Personal loans and lines of credit aren’t tied to your home equity. This means that the interest on these loans is not tax deductible as with home equity. Homeowners shouldn’t opt for these options for various reasons unless they have little or no equity.

There are two forms of personal credit – secured and unsecured. If your credit is secured it means that one of your assets is used as collateral for the loan. Secured loans carry a lower interest rate than unsecured one

Personal Loans

Applying for personal loans are much faster and less complicated than applying for mortgages or other home equity loans. If your personal loan is unsecured (so you don’t have to put up collateral) then you also don’t risk losing your home or other assets if you were to default.

Consider the 7 pros and cons of Personal Loans:

Pros

• You don’t need a home appraisal done for the application (this is a great perk if your house isn’t in a great condition)
• Simple, fast and easy application process
• Home equity is not required

Cons

• Lower loan amounts are available
• Interest rates are often high
• If you have a low credit score you might not qualify or you might pay a very high interest rate
• If the interest rate is low, there might be a high origination fee

Personal Lines of Credit

Personal lines of credit are usually in the form of revolving credit. This is similar to the equity lines of credit explained above. Revolving credit allows you to use what you need when you need it up to the stated limit. This offers more flexibility than personal loans, especially with the repayments during the draw period.

Remember, this form of credit has a variable interest rate which might cause the cost or repayments to take you by surprise.

Consider the 6 pros and cons of Personal Lines of Credit:

Pros

• Payment flexibility
• Monthly payments are low during the draw period
• Low cost of closing

Cons

• Monthly repayments may change as interest rates fluctuate
• The cost of the loan fluctuates as interest rates change
• Monthly payments sometimes increase drastically when the repayment phase begins

Credit Cards

Credit cards might seem like an easy, flexible way to finance your home renovation. The reality is, it is definitely one of the most costly options. Since 2017 the average APR on a credit card was between 16.7% and 22.99%.

If you are planning to undertake a relatively small home renovation project, it could make sense to use a credit card that has an introductory % APR. For the introductory period (which is typically 12 months) the card has a zero APR. If you use the funds to remodel your home and make sure you pay back the outstanding balance before the intro period runs out, this could be a good option.

Consider the 7 pros and cons of a Credit Card option:

Pros

• Quick and easy application process
• Almost instant access to extra cash
• If you use a card with an introductory zero APR and pay off before the period runs out, you can have an interest free loan!
• Low minimum monthly repayments

Cons

• High-interest rates and APR
• Smaller amounts of money available than other credit options
• The low required monthly repayments often encourage overspending

Government-backed Loan Programs

There are various loans that are backed or guaranteed by federal government. These loans are generally more readily available to people with lower credit scores.

FHA Home Improvement Loans – the 203k

An FHA 203k loan is a loan designed for buyers who want to buy an old or damaged home and repair it. This loan is backed by the federal government. The loan’s purpose is to cover the cost of buying the house and renovating it. This loan is also available if you want to refinance your home and renovate it.

Many times the  203k loan includes a contingency reserve (up to 20%) that allows you to complete the remodeling of your home if the renovations end up costing more than originally anticipated. It also has provision for up to 6-month mortgage payments, which enables you to live somewhere else while your home is being renovated.

203k Refinance

Most people are unaware that the 203k loan can actually be used to refinance or renovate your home (over and above just buying one).

The great thing about the 203k is that the loan amount is not limited to the current value of your home. The loan amount can be determined by the value of your home after improvements have been made – and even up to 97.5% of that value.

You can use the difference between the existing balance in your existing loan and the 203k loan amount to renovate your home after you have paid the closing cost of your existing loan and the 203k fees.

Renovation Financing: 203k Home Purchase

The 203k offers you one loan for both your home purchase and your home remodeling. Generally, mortgages don’t allow for this total loan amount, which means you have to find a private home improvement and home purchase loan that usually comes with high interest rates, short repayment periods and a balloon payment.

Perks and downsides of the FHA 203k

Due to the relaxed financial aspects of this loan, the guidelines regarding the property to which it can be applied is quite strict. You are only allowed to use this loan for a house that is regarded as your “primary residence” and you are not allowed to use the loan for any renovation that is classified as “luxury”. You can take a look at the allowed improvements here .

Finally, you are only allowed to use licensed contractors to do your home repairs with the 203k. So this loan will not be an option for someone who wants to renovate their home as a DIY project. The purpose of this loan is for hardcore repair work.

Consider the 7 pros and cons of a 203k Refinance option:

Pros

• Available for people with low credit scores
• No home equity required
• A very affordable option

Cons

• The application process is paper heavy (for you and your contractors)
• Due to the paperwork, the process is quite time-consuming
• The FHA might require additional work to be done to your home which is required to meet building codes and health and safety requirements
• Only available for primary residences

FHA Title 1 Loans

These are loans from FHA-approved lenders which the FHA guarantees. FHA Title 1 loans are made to existing homeowners who want to make improvements to their homes.

This loan offers up to $25 000 for a single-family home and up to $12 000 per living unit for multi-family properties (mut this is capped to 5 living units and a total of $60 000). If the loan is more than $7 500, it has to be secured by a deed of trust or mortgage.

The available improvements allowed under this loan is quite broad and can even include buying appliances.

Consider the 5 pros and cons of FHA Title 1 Loans:

Pros

• No home equity required
• Available to people with low credit scores
• A wider range of home improvements allowed

Cons

• Maximum loan amounts apply
• Loan amounts are smaller than other options

Alternative Lending Options

Contractor Financing

Many general contractors provide financing options to customers who want to renovate their homes. Some contractors also offer to act as a middleman to help you secure loans with third-party lenders.

It will be a good idea to check out online reviews from previous customers and also take a look at your local consumer affairs office and the Better Business Bureau. Getting credit from your contractor could be a riskier option.

The repayment terms, rates, and cost involved will differ from contractor to contractor so make sure to also compare this with more traditional lenders like banks or online lenders.

Peer-to-Peer Loans

Peer-to-peer lenders are platforms that connect lenders and borrowers according to risk, rates and loan amounts. If you want to use these platforms to get a loan for your home improvement, the loan will typically be in the form of a personal loan. These loans usually have terms ranging from 1 to 5 years and loan amounts from $1 000 to $40 000.

The rates applicable to the loans will depend on the platform you use. Most lending platforms cap their rates at about 36%. Naturally, if you have a low credit score, your rates will be higher so this might be a costly option.

Peer-to-peer lending has the advantage of quick and easy applications and almost instant money. As the rates are fixed, you might be able to get a better rate than at the bank and other lenders, if you have a good credit score.  Watch out though, as early payment penalties usually apply.

Home Improvement Financing Companies and Rates

There are many companies out there offering many different types of loans. Some are more traditional lenders like banks and others are online or peer to peer lenders. Below we compare a few of your options.

Cash-out, Home Equity Loan, or Personal Loan?

So we know there are many options out there if you want to finance your home renovation project . After taking in all the information above, it is now  important to find one that is right for you. Let’s take a look at how the options play off against each and to help you choose the right loan, consider to also do a basic cost-benefit analysis. After calculating the cost, ask yourself the following questions:

1. How much equity do I have?
2. How much money do I need?
3. Is there a possibility that I can get a better rate with a refinance loan, or possible better loan terms?
4. Is my credit score good or bad?
5. How fast do I need the money?
6. How much effort am I willing to go through when applying for a loan?

If your credit score is on the low side, you will have options but not as many. Your best bet might be to go for one of the government-backed options. Alternatively, you’ll have to try for a personal loan and hope for a good interest rate (or just make sure you pay it back quickly to save on the extra cost). You might need to make a few trade-offs if your credit score is low. This can include giving collateral to get a bigger loan amount for a reasonable rate. The trade-offs will be bigger the less home equity you have to back you.

If you have extra equity available on your home and your first mortgage has a high-interest rate, a cash-out refinance loan will probably be a good option. You might be able to lower your rate and save on cost while renovating your home.

If you don’t have a lot of equity and your mortgage isn’t close to being paid off, your only options might be to opt for a personal loan or personal line of credit. Or you could apply for the FHA Title 1 loan or FHA 203k loan that doesn’t require equity. Keep in mind that the FHA Title 1 loan is capped.

If you are happy with your current mortgage rate but you have some extra equity available, opting for a HELOC is probably best.

And of course, if you are a veteran that wants to make use of the years of sacrifice, consider the VA loan options and cash-out refinance.

The most important rule to always keep in mind when it comes to any loan is to shop around. Make sure you do proper research on the fees involved with each option and the possible rates out there that apply to the different types of loans. Remember to not only compare interest rates, but also the repayment terms and other fees involved. You might grab a low-interest rate loan with an enormous closing cost, which means up paying more in the end.

Factors to keep in mind when comparing your options

1. Does this loan include a balloon payment?
2. What are the draw and repayment periods (in the case of HELOCs) and what are the terms? If you are opting for HELOCs make sure by how much the monthly repayment will increase once the draw period ends.
3. Is the rate variable? If so, how will it influence your ability to meet your monthly repayments if the interest rate skyrockets?
4. Will the loan give you the amount of cash you need? It is always safer to borrow more than you think you’ll need so you have some room in case of any hidden costs of the project.

If doing the loan comparison is a tedious thought to you, you can try one of the online loan comparison platforms. These platforms match you up with the right lender or provide your details to various lenders who contact you with quotes.

Conclusion

Whether you are just cleaning up your old family home or redoing your entire new home, you will definitely be able to find the right home remodeling loan for you. It might just need a little bit of research and patience in the application process. As it is a big decision to make, make sure that you take all the important factors into account. Once you have made your decision, apply, breathe and then enjoy the project!

Alyssa Francisco

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