So, you bought the house and you love it! But, that bathroom needs a re-do. Or maybe your new home is overdue for some upgrades to the heating and air conditioning systems. No matter what your house needs, there are ways to finance those upgrades to give your home the lift it needs.
And it's a smart investment.
A home renovation can increase the value of your home, allowing you to make more money when you sell it. But before you dive in on that home improvement project, there are some preliminary questions you need to consider.
There are a lot of financing options to weight before you commit to financing a home renovation! Let's take it step-by-step.
A home renovation can increase the value of your home, allowing you to make more money when you sell it. But before you dive in on that home improvement project, there are some preliminary questions you need to consider.
- Do you know the role your credit plays in financing home renovations?
- Should you consider using a credit card?
- What about a government loan to cover renovation costs?
- Should you consider a HELOC or home equity loan?
There are a lot of financing options to weight before you commit to financing a home renovation! Let's take it step-by-step.
Financing Home Improvements: What to Consider
First up, there's the big question of cost. What are the costs of the renovation and how much do you need to finance? Renovation costs can vary depending on the complexity of the project and the quality of the materials you choose.
We recommend you find three home renovation specialists to get quotes. But remember, the lowest bid isn't always the best bid. This is your home we're talking about! Talk to each of the contractors to get a read on how they approach a home renovation project. What materials do they use and why.
Do you like the overall demeanor of the person who's representing the company? Did they show up when they said they would? Check reviews to learn as much as you can before making a decision.
Another consideration to make are your monthly payments, interest rates, and the lender you want to work with. More on that below.
We recommend you find three home renovation specialists to get quotes. But remember, the lowest bid isn't always the best bid. This is your home we're talking about! Talk to each of the contractors to get a read on how they approach a home renovation project. What materials do they use and why.
Do you like the overall demeanor of the person who's representing the company? Did they show up when they said they would? Check reviews to learn as much as you can before making a decision.
Another consideration to make are your monthly payments, interest rates, and the lender you want to work with. More on that below.
Financing a Home Remodel: How Much Can You Borrow?
Once you decide on a contractor, make sure you get a firm bid with labor and materials broken down. For good measure, add an additional 10% because there are always surprises with remodeling!
If you're doing the work yourself for a smaller project or home repairs, draw up a list that details the materials you'll be using, costs, quantities, and a total. You'll want to include permit fees and equipment rental fees. Then add up to 30% to that total, just to be on the safe side.
For smaller projects, you may even decide to take out a personal loan as a way to finance home improvements. More about that later.
Now it's time to talk about borrowing the money you need for the project. In spite of what you read in ads from lenders, the cost of borrowing money all depends on your credit rating, your loan-to-value ratio, and your income.
Together, these three factors will help determine the length of your loan, the interest rate, and whether you'll pay points.
If you're doing the work yourself for a smaller project or home repairs, draw up a list that details the materials you'll be using, costs, quantities, and a total. You'll want to include permit fees and equipment rental fees. Then add up to 30% to that total, just to be on the safe side.
For smaller projects, you may even decide to take out a personal loan as a way to finance home improvements. More about that later.
Now it's time to talk about borrowing the money you need for the project. In spite of what you read in ads from lenders, the cost of borrowing money all depends on your credit rating, your loan-to-value ratio, and your income.
Together, these three factors will help determine the length of your loan, the interest rate, and whether you'll pay points.
Your Credit Score: What You Need to Qualify for a Home Improvement Loan
One of the most important aspects to getting a home renovation loan is your credit. It's your greatest asset in the financial world. Why? It's your ticket for getting the best interest rate and financing.
Your credit score is calculated considering these 5 areas:
For lenders, a high credit score indicates that you handle your credit and your money responsibly. Here's the credit score range lenders use to evaluate your credit:
300-579: Poor
580-669: Fair
670-739: Good
740-799: Very good
800-850: Excellent
That means no late payments in the last 12 months and no maxed out credit cards. If you have one or two late payments or you were overdrawn on your credit cards, you could end up with a smaller loan and a higher interest rate.
Remember, the best interest rates and terms are reserved for those with the best credit score. Not sure what your credit score is? You can check it for free here.
Your credit score is calculated considering these 5 areas:
- 30%--The amount you owe on all of your accounts
- 35%--Your payment history
- 15%--The length of your credit history
- 10%--How much new credit you have such as a new credit card
- 10%--Your credit mix such as retail accounts, mortgages, credit card debt, auto loans
For lenders, a high credit score indicates that you handle your credit and your money responsibly. Here's the credit score range lenders use to evaluate your credit:
300-579: Poor
580-669: Fair
670-739: Good
740-799: Very good
800-850: Excellent
That means no late payments in the last 12 months and no maxed out credit cards. If you have one or two late payments or you were overdrawn on your credit cards, you could end up with a smaller loan and a higher interest rate.
Remember, the best interest rates and terms are reserved for those with the best credit score. Not sure what your credit score is? You can check it for free here.
Loan-to-Value Ratio: Your Home Can Help Fund Home Improvements
Besides your credit score, lenders use another financial measurement tool to make sure you can pay for home renovations. It's called the loan-to-value ratio (LTV). Essentially, this is a percentage of the appraised value of your home. Generally, the limit is 80% of the value of the home.
For a home appraised at $125,000, 80% would be $100,000. Lenders then subtract your mortgage balance to come up with the amount you can borrow. Basically, you're using your home as collateral. It's called a cash-out refinance.
If you have excellent credit, it's possible the lender might make your loan for more than 80%. There are some lenders who will finance 100% of the loan-to-value, but beware. Interest rates and fees balloon at such a high ratio.
For a home appraised at $125,000, 80% would be $100,000. Lenders then subtract your mortgage balance to come up with the amount you can borrow. Basically, you're using your home as collateral. It's called a cash-out refinance.
If you have excellent credit, it's possible the lender might make your loan for more than 80%. There are some lenders who will finance 100% of the loan-to-value, but beware. Interest rates and fees balloon at such a high ratio.
Your Income as Part of the Costs of a Renovation
So, we've got your credit score and a loan-to-value ratio to measure your ability to pay off your project. But as you can imagine, your income is also a big part of the financial equation for determining loan eligibility. If you've got a lot of high expenses and a high income, that doesn't necessarily mean you'll get a larger loan.
Lenders follow two rules to minimize their financial risk:
1.Your house payment and any other debt should fall below 36% of your gross monthly income.
2.Your house payment should be no more than 28% of your gross monthly income. That includes principle, interest, insurance, taxes. For second mortgages, the maximum debt-to-income ratio rises to 42%.
Remember, loan-to-value determines how much money you can borrow. Your debt-to-income ratio determines the monthly payment for which you qualify.
Lenders follow two rules to minimize their financial risk:
1.Your house payment and any other debt should fall below 36% of your gross monthly income.
2.Your house payment should be no more than 28% of your gross monthly income. That includes principle, interest, insurance, taxes. For second mortgages, the maximum debt-to-income ratio rises to 42%.
Remember, loan-to-value determines how much money you can borrow. Your debt-to-income ratio determines the monthly payment for which you qualify.
Interest Rates for Your Home Improvement Project
Remember when we said that your credit score was the most important aspect for borrowing money? Nowhere is this more clear than with the interest rate charged for your loan.
With a strong credit rating, you pay a lower interest rate and can enjoy better loan terms. There are many ways to finance a home improvement project. We'll talk more about ways to finance your project below.
With a strong credit rating, you pay a lower interest rate and can enjoy better loan terms. There are many ways to finance a home improvement project. We'll talk more about ways to finance your project below.
About Your Loan Term
If you have long-term financing, you will have lower monthly payments, but the total amount of interest you pay will be higher. When the life of the loan is shorter, you do have a higher monthly payment, but you'll pay far less in interest.
If you can swing it, go with the shorter term loan.
If you can swing it, go with the shorter term loan.
Oh, Those Points
Nobody likes them but they are a fact of life. When you close on your loan, the lender can charge you points. One point equals 1% of the loan. Basically, points are interest paid in advance, and they can lower your monthly payments.
And if your credit is less than perfect? Yes, you'll probably have to pay points just to get the loan. It's pay to play in the banking world.
And if your credit is less than perfect? Yes, you'll probably have to pay points just to get the loan. It's pay to play in the banking world.
What are the Options When Financing Your Home Remodel?
FHA 203(k) Renovation Loans
If you bought a fixer upper, this home renovation loan is worth a look-see. This government-backed loan gives you the necessary funding to both purchase the home and to pay for the renovations.
There are two types. The first is called Standard 203(k). It's designed for major repairs to your home. Think fire or flooding damage, foundation issues, room additions and floor repairs.
The second is Limited 203(k), also called Streamline. It covers less extensive repairs under $35,000. It includes upgrades and cosmetic improvements, and replacing outdated appliances.
Both loans are a fixed interest rate loan. You can learn more about both of these loans here.
Fannie Mae HomeStyle Renovation Loan
Fannie Mae, the Federal National Mortgage Association, offers this as an option for a home improvement loan. There are two types, fixed rate or adjustable rate mortgage, ARM.
Borrowers cannot incur remodeling costs of more than "75% of the lesser of the sum of the purchase price of the property plus renovation costs, or the 'as-completed' appraised value of the property.'' Check out the HomeStyle Renovation Mortgages: Loan and Borrower Eligibility requirements to learn more.
Freddie Mac Renovation Mortgage
Just like Fannie Mae, Freddie Mac offers renovation loans for single family and multiple unit dwelling properties. The loan can also be applied to investment properties or second homes.
These loans can also be either an ARM or fixed rate. ARM loans have loan terms from 15-30 years.
Jumbo Loan Renovation Mortgage
What if you have a higher priced home or a larger home that exceeds the 2022 Federal Housing Finance Agency's conforming loan limit?
You can add renovation costs through what is called a jumbo loan renovation mortgage. These loans allow you to make major upgrades like kitchen and bath overhauls, pools and outdoor patios.
Also available as either a fixed rate or adjustable rate mortgage, the max amount you can borrow is $250,000 for renovations or 30% of the completed cost.
Construction Loans
Building a new home? Chances are you may consider a construction loan. You can borrow up to 75% of your home's after the improvement value. This is great for higher valued homes.
It does require two closings. One with the construction lender and then one for the permanent financing which will give you your new mortgage amount.
Essentially, you pay off the construction loan first, or more commonly, convert it to a new mortgage loan.
Cash Out Refinance
We touched on this one earlier, but let's take a deeper look. A cash out refinance is a great option if you have enough equity in your home. Essentially, you are borrowing against the equity. You can get 30-year fixed loans. But as we said earlier, it's a significant savings to pay it off earlier with a shorter loan term.
With this loan, your lender will first pay off your existing mortgage as well as the closing costs on the new mortgage. The balance between the two is your cash out which can be used any way you want.
You're consolidating your existing mortgage so you don't have two loan payments. That makes it more convenient to pay it back. However, this option could cost you more in the long run if it takes years longer to pay off what you owe on your home.
Home Equity Line of Credit
A home equity loan is a popular way to pay for home renovations. A HELOC is an open line of credit you can use for whatever you want. It can even be used to pay for a new car. It's up to you.
The HELOC is tied to the current value of your home. You can borrow between 85%-90% of its market value. It all depends on the available equity in your home.
Interest rates are generally tied to the prime rate. So they can fluctuate. Even so, it can be the least expensive way to finance larger home projects.
Home Equity Loan
Similar to a home equity line of credit, this loan, too, is based on the equity in your home. But that's where the difference ends. A home equity loan has a fixed interest rate and fixed payments for the term of the loan. It's a lump sum paid back over a set term.
Both a HELOC and a home equity loan are types of a second mortgage. The difference is a HELOC works like a credit card. You borrow what you need and pay it off in monthly payments. A secured loan, the home is the security for the loan.
With both of these loans, if you fail to make payments, you are at risk of losing your home.
Personal Loans
A personal loan is another option to pay for home renovations if you don't want to use your home as collateral. This loan can be a secured loan or unsecured, but generally, it's the latter. You get a fixed interest rate with a fixed repayment period.
Credit Cards
Credit cards are an expensive way to pay for home renovations, but it is a popular option for many people. NerdWallet found that 34% of people planned to use credit cards to pay for their home improvement.
Keep in mind if you charge $10,000 in renovation costs on a card that earns you 2% in rewards, you'll only get back $200. And, when the bill comes due, unless you pay the balance in full, you're looking at hefty interest rates which will easily eat up your $200 in rewards.
You could consider a combination of a personal loan and credit cards as an option. Still, it's an expensive way to finance your remodel.
If you bought a fixer upper, this home renovation loan is worth a look-see. This government-backed loan gives you the necessary funding to both purchase the home and to pay for the renovations.
There are two types. The first is called Standard 203(k). It's designed for major repairs to your home. Think fire or flooding damage, foundation issues, room additions and floor repairs.
The second is Limited 203(k), also called Streamline. It covers less extensive repairs under $35,000. It includes upgrades and cosmetic improvements, and replacing outdated appliances.
Both loans are a fixed interest rate loan. You can learn more about both of these loans here.
Fannie Mae HomeStyle Renovation Loan
Fannie Mae, the Federal National Mortgage Association, offers this as an option for a home improvement loan. There are two types, fixed rate or adjustable rate mortgage, ARM.
Borrowers cannot incur remodeling costs of more than "75% of the lesser of the sum of the purchase price of the property plus renovation costs, or the 'as-completed' appraised value of the property.'' Check out the HomeStyle Renovation Mortgages: Loan and Borrower Eligibility requirements to learn more.
Freddie Mac Renovation Mortgage
Just like Fannie Mae, Freddie Mac offers renovation loans for single family and multiple unit dwelling properties. The loan can also be applied to investment properties or second homes.
These loans can also be either an ARM or fixed rate. ARM loans have loan terms from 15-30 years.
Jumbo Loan Renovation Mortgage
What if you have a higher priced home or a larger home that exceeds the 2022 Federal Housing Finance Agency's conforming loan limit?
You can add renovation costs through what is called a jumbo loan renovation mortgage. These loans allow you to make major upgrades like kitchen and bath overhauls, pools and outdoor patios.
Also available as either a fixed rate or adjustable rate mortgage, the max amount you can borrow is $250,000 for renovations or 30% of the completed cost.
Construction Loans
Building a new home? Chances are you may consider a construction loan. You can borrow up to 75% of your home's after the improvement value. This is great for higher valued homes.
It does require two closings. One with the construction lender and then one for the permanent financing which will give you your new mortgage amount.
Essentially, you pay off the construction loan first, or more commonly, convert it to a new mortgage loan.
Cash Out Refinance
We touched on this one earlier, but let's take a deeper look. A cash out refinance is a great option if you have enough equity in your home. Essentially, you are borrowing against the equity. You can get 30-year fixed loans. But as we said earlier, it's a significant savings to pay it off earlier with a shorter loan term.
With this loan, your lender will first pay off your existing mortgage as well as the closing costs on the new mortgage. The balance between the two is your cash out which can be used any way you want.
You're consolidating your existing mortgage so you don't have two loan payments. That makes it more convenient to pay it back. However, this option could cost you more in the long run if it takes years longer to pay off what you owe on your home.
Home Equity Line of Credit
A home equity loan is a popular way to pay for home renovations. A HELOC is an open line of credit you can use for whatever you want. It can even be used to pay for a new car. It's up to you.
The HELOC is tied to the current value of your home. You can borrow between 85%-90% of its market value. It all depends on the available equity in your home.
Interest rates are generally tied to the prime rate. So they can fluctuate. Even so, it can be the least expensive way to finance larger home projects.
Home Equity Loan
Similar to a home equity line of credit, this loan, too, is based on the equity in your home. But that's where the difference ends. A home equity loan has a fixed interest rate and fixed payments for the term of the loan. It's a lump sum paid back over a set term.
Both a HELOC and a home equity loan are types of a second mortgage. The difference is a HELOC works like a credit card. You borrow what you need and pay it off in monthly payments. A secured loan, the home is the security for the loan.
With both of these loans, if you fail to make payments, you are at risk of losing your home.
Personal Loans
A personal loan is another option to pay for home renovations if you don't want to use your home as collateral. This loan can be a secured loan or unsecured, but generally, it's the latter. You get a fixed interest rate with a fixed repayment period.
Credit Cards
Credit cards are an expensive way to pay for home renovations, but it is a popular option for many people. NerdWallet found that 34% of people planned to use credit cards to pay for their home improvement.
Keep in mind if you charge $10,000 in renovation costs on a card that earns you 2% in rewards, you'll only get back $200. And, when the bill comes due, unless you pay the balance in full, you're looking at hefty interest rates which will easily eat up your $200 in rewards.
You could consider a combination of a personal loan and credit cards as an option. Still, it's an expensive way to finance your remodel.
Is a Home Improvement Loan Tax Deductible?
Home improvement loans are not tax deductible because they are not secured by a property or a home. Instead, they are considered personal loans.
However, home equity loans and home equity lines of credit are tax deductible because they are secured by a property.
Another caveat. Repair work or maintenance fixes to your home for existing damage or to prevent deterioration is not considered a capital improvement. According to the law, you are returning the home back to its baseline condition.
Therefore, it does not increase the value of the property. For example, painting a bedroom or replacing a window is considered a repair, not a capital improvement.
Capital improvements are generally more extensive as well as expensive, and they increase the value of the property. Some examples are: additions such as adding a bathroom, a garage, patio, or deck.
With capital improvements, you can only claim the deduction when you sell your home.
However, home equity loans and home equity lines of credit are tax deductible because they are secured by a property.
Another caveat. Repair work or maintenance fixes to your home for existing damage or to prevent deterioration is not considered a capital improvement. According to the law, you are returning the home back to its baseline condition.
Therefore, it does not increase the value of the property. For example, painting a bedroom or replacing a window is considered a repair, not a capital improvement.
Capital improvements are generally more extensive as well as expensive, and they increase the value of the property. Some examples are: additions such as adding a bathroom, a garage, patio, or deck.
With capital improvements, you can only claim the deduction when you sell your home.
Conclusion
As you can see, there are many options when you need to borrow money to improve your home. If you have a lot of equity in your home, you can use it as collateral. Keep a first mortgage with a new second mortgage attached.
If you don't want to use your home as collateral, you can get a new loan, use a personal loan, to make the repairs you need. Lastly, you can use credit cards. (We don't recommend that option.)
Bottom line: borrow wisely!
Should you opt for a refinance or you buy a fixer upper and use a government backed loan for your home improvements and mortgage, turn to Lilly Title & Settlement as your closing agent.
We're a woman-owned company in Staunton, VA, and we perform title and settlement closings almost anywhere. Our attention to detail and thoroughness has won us a 5-star rating with our clients!
If you don't want to use your home as collateral, you can get a new loan, use a personal loan, to make the repairs you need. Lastly, you can use credit cards. (We don't recommend that option.)
Bottom line: borrow wisely!
Should you opt for a refinance or you buy a fixer upper and use a government backed loan for your home improvements and mortgage, turn to Lilly Title & Settlement as your closing agent.
We're a woman-owned company in Staunton, VA, and we perform title and settlement closings almost anywhere. Our attention to detail and thoroughness has won us a 5-star rating with our clients!
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