A renovation home loan combines the cost of a home purchase and money for renovations in one mortgage. There’s only one closing and one loan when buying a new home or refinancing an existing home. The lender has oversight of the renovation funds, including the budget, vetting of the contractor, and disbursement of funds for renovation work as it is completed.
The borrower, their property, and their lender must all meet criteria set out by the remodel home loan program to qualify, which can present a challenge. Qualifying lenders in particular can be hard to find. That’s because most lenders must maintain a custodial account for the renovations over the course of an entire year, which requires extra work and resources. However, if you can find a lender that can handle the process, renovation loans can be a convenient way to improve a promising fixer-upper.
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Types of Home Loans That Can Include Renovations
Most mortgages will not include renovations in the loan amount. Renovation mortgages are niche products serviced by a fraction of lenders. Buyers and properties must also meet certain requirements, which we’ll outline below.
There are several different types of home loans you can apply for that are eligible for adding renovation costs to the mortgage.
1. FHA 203K
An FHA 203(k) is a mortgage serviced by the Federal Housing Authority in which the cost of repairs is combined with the mortgage amount. It’s different from a traditional FHA loan that does not include improvement expenses, but qualifications (credit score, down payment, etc.) are very similar.
Interest rates and terms are also similar to what you see in a standard FHA loan. However, you can expect additional lender fees to cover the extra oversight needed on a renovation loan.
The amount you can borrow is equal to either the value of the property plus the cost of renovations or 110% of the projected value of the property after rehabilitation. Borrowers must use an FHA-approved lender for this type of mortgage.
Eligible properties must be one to four units. Repairs can include those that enhance the property’s appearance and function, the elimination of health and safety hazards, landscape work, roofing, accessibility improvements, energy conservation, and more. A limited 203(k) is also available for repairs costing $35,000 or less.
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2. Fannie Mae HomeStyle
The Homestyle Renovation loan from Fannie Mae takes into account the value of the property after renovations are complete. The amount of allowable renovation money can equal 75% of the value of the property after renovations are complete.
In the world of home loans, the loan-to-value ratio (LTV) is the percentage of your home’s value that is borrowed. Many lenders limit your LTV to 80% to 85%.
A HomeStyle loan allows an LTV of up to 97%. This means it’s possible to put as little as 3% down. Some investment properties are also eligible for this type of loan. Renovations are eligible as long as they are permanently affixed to the property. Work must be completed within 15 months from the closing date of the loan.
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3. Freddie Mac CHOICERenovation
The Freddie Mac CHOICERenovation program is virtually identical to the Fannie Mae HomeStyle program. This renovation loan is for buyers who want a loan with more flexibility than an FHA renovation loan.
Like HomeStyle, renovations that are permanently affixed to the property are eligible in one- to four-unit residences, one-unit investment properties, second homes, and manufactured homes. The maximum allowable renovation amount is 75% of the “as-completed” appraised value of the home — meaning the appraised value of the home before renovations but accounting for all planned changes. The maximum loan-to-value (LTV) ratio is 95% (97% for HomePossible or HomeOne loans).
The Freddie Mac CHOICEReno eXPress Mortgage is an extension of the CHOICERenovation mortgage. The CHOICEReno eXPress mortgage is a streamlined mortgage for smaller-scale home renovations. Renovation amounts are limited to 10% or 15% of the “as-completed” appraised value of the home. Borrowers need to work with an approved lender to apply for one of these programs.
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4. USDA Purchase with Rehabilitation and Repair Loan
A USDA Purchase with Rehabilitation and Repair Loan assists moderate- to very-low-income households in rural areas with repairs and improvements to their homes. Buyers can secure 100% financing with this loan.
For very low-income borrowers, there’s a separate loan you can qualify for with a subsidized, fixed interest rate set at 1% with a 20-year term. This makes borrowing incredibly affordable.
To apply, you must have a household income that qualifies as low to moderate in your county per USDA standards. The property must be your primary residence (no investments), and rehab funds cannot be used for luxury items, such as outdoor kitchens and fireplaces, swimming pools and hot tubs, and income-producing features. Manufactured homes, condos, and homes built within the last year are not eligible.
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5. VA Alteration and Repair Loan
The VA allows qualified service members to bundle repairs and alterations with the purchase of a home. As with all VA loans, 100% financing is available on these low-interest loans.
Alterations must be those “ordinarily found” in comparable homes. Renovations are also required to bring the property up to the VA’s minimum property standards.
The loan amount can include the “as completed” value of the home as determined by a VA appraiser. Leftover money from the home loan after renovations are complete is applied to the principal.
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Other Options for Financing Home Renovations
While a renovation home loan is a great way to finance a renovation, it’s not your only option for borrowing money for home improvements. Nor is it the most flexible. Alternative loans — such as cash-out refis, home renovation personal loans, and home equity loans -– have a lot more flexibility.
Cash-out Refinance
A cash-out refinance is where you replace your old mortgage with a new mortgage, and the equity (here, the “cash”) is refunded to the homeowner. You will have closing costs with a new mortgage, but you won’t have separate financing costs for the money you’re using for renovations.
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Personal Loan
Personal loans are often used for a home remodel or renovation. Because the funds are not secured by your property, you’ll likely have to pay a higher interest rate. The bright side of funding this way means you won’t lose your home if you stop paying back the loan.
This type of loan comes with a shorter repayment period, higher monthly payment, and lower loan amount. You can find these loans through banks, credit unions, and online lenders.
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Home Equity Loan
A home equity loan is a secured loan that uses your home as collateral. That means the lender can foreclose on the home if you stop paying the loan, and so interest rates are typically lower. A home equity loan also comes with a longer repayment period than a personal loan.
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Home Equity Line of Credit (HELOC)
A HELOC is a line of credit that lets homeowners borrow money as needed, up to a predetermined limit. As the balance is paid back, homeowners can then borrow up to the limit again through the draw period, typically 10 years. The interest rate is usually variable, and the borrower pays interest only on the amount of credit they actually use.
After the draw period ends, borrowers can continue to repay the balance, typically over 20 years, or refinance to a new loan.
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Private Loan
A private loan is a loan made without a financial institution. Loans made from a family member, friend, or peer-to-peer source are considered private loans. Qualification requirements will depend on the individual or group lending the money. There are some serious drawbacks to obtaining funding from a private source, but these loans can help some borrowers in buying a home.
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Government or Nonprofit Program
It is possible to finance the cost of remodeling with the help of government programs. Federal programs like HUD have financing options for renovations, as do some state and local government agencies.
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The Takeaway
Homeowners have a lot of options for financing renovations, especially in an era when home equity is higher than ever before. Renovation home loans allow borrowers to purchase and renovate a property with one loan, but that’s not the only way you can remodel a fixer-upper. Some alternatives to renovation home loans include home equity loans, HELOCs, and personal loans.
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