If more time under your roof is opening your eyes to improvements you’d like to make, you might be wondering whether to take out a home renovation loan. You’re not alone.
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The right financing can put a renovation within reach. Here are some options to help you pay for your home renovation and key questions to consider.
Should You Get a Home Renovation Loan?
“The million-dollar question is: Is now the right time?” says John Ulzheimer, a credit expert who has worked at FICO and the credit bureau Equifax.
Act now? Is this renovation must-do or nice to have? Some home renovations are necessary because they involve structural or mechanical repairs, such as fixing a foundation or installing a new HVAC system. Other projects are purely cosmetic.
Regardless, property value must be a key factor in your decision to finance a home renovation, Ulzheimer says.
“We always look at resale value,” he says. “If you turn a $500,000 house into a $900,000 house because of the renovations, a big upside is the increase in value of the home, which is normally well in excess of what you’d spend on a renovation.”
Act later? Ongoing supply chain issues could affect your renovation project. “You have to ask yourself, ‘Can I live with what I’m in now? Or am I so desperate for a new kitchen, garage or master bath that I can’t wait?'” Ulzheimer says.
Options for Financing Home Renovations
You can pay for your home renovation in cash or finance it with:
“Generally speaking, it’s about balancing how flexible the funds are when you actually get the money (with) the interest and other costs you will pay by borrowing the money,” says Brian Walsh, senior manager of financial planning at fintech company SoFi.
Cash-Out Refinancing
A cash-out refinance replaces your mortgage with a new loan for more than what you owe, and you receive the difference in cash at closing.
You could improve your mortgage interest rate, access thousands of dollars and stretch out payments with a new loan term. Requirements for cash-out refinancing depend on the lender, but you will usually need a credit score of at least 620 and a sizable amount of home equity.
One big downside is that because a cash-out refinance is a secured loan, “you could be putting your house at risk if you go into default,” Ulzheimer says.
Others are that you restart the clock on interest charges, and the loan will require upfront closing costs.
HELOCs or Home Equity Loans
Both of these loans allow you to borrow against the equity in your home, giving you access to cash for renovations. A HELOC is a revolving line of credit similar to a credit card, and you only pay interest on what you borrow.
“You’re borrowing money against the value of your house that is not encumbered by another loan,” says Ulzheimer, adding that the process is simpler than cash-out refinancing. “Lenders typically do a drive-by appraisal and do not need an exact value like they would with a cash-out refi or first mortgage.”
Also called a second mortgage, a home equity loan usually has a fixed interest rate and gives you a lump sum with repayment terms of five to 30 years. You will know exactly what your monthly payments will be and when you will pay off your loan.
You will immediately pay a home equity loan, including interest, unlike with a HELOC, Ulzheimer explains.
Generally, lenders require 20% equity in your home to qualify for a home equity loan or line of credit. According to the credit bureau Experian, you typically need a FICO score of at least 680 to qualify for a home equity loan or HELOC.
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Personal Loan
If you want to renovate but are reluctant to risk your home as collateral, you may want to look at an unsecured personal loan. The average interest rate on a 24-month personal loan in May 2023 was 11.48%, according to the Federal Reserve.
“If someone has a good credit score and high income compared to monthly debt payments, they could be a good candidate to explore a personal loan because they would get approved at the best interest rate,” Walsh says.
Still, personal loans are not typically used for home renovations, Walsh says. “The only times we would suggest it is if they have to do the renovations and there are no other options,” he says.
Fannie Mae HomeStyle Renovation Mortgage
This is a conventional mortgage that lets borrowers finance renovations with a home purchase or as a refinance. Borrowers must find a lender that offers HomeStyle Renovation loans because Fannie Mae backs the loans but does not directly lend money to consumers.
You can use the loan on pretty much any type of property, including manufactured homes. Improvements do not have to add value to your property, but proposed renovations must be evaluated during the appraisal process.
Refinance loans are limited to 75% of the “as completed” appraised property value; purchase loans are limited to 75% of the lesser of the purchase price plus renovation costs or the as-completed appraised property value.
Note that for certain transactions and for first-time buyers, at least one borrower must complete a homeownership education course.
FHA 203(k) Mortgage
Buyers can finance their renovations or their purchase and their renovations in one loan. Two types of 203(k) loans, limited and standard, cover different types of projects.
A limited loan lets you borrow up to $35,000 to pay for property repairs or improvements, including those identified by a home inspector or FHA appraiser. These could include remodeling the kitchen, painting the interior or purchasing new carpet.
A standard 203(k) loan can help you finance larger structural repairs, such as adding or replacing roofing. Loans must be at least $5,000 and no specific limit is set, but the property value must fall within the FHA mortgage limit for the area.
You may be required to work with a consultant from the Department of Housing and Urban Development. Borrowers also need to work with FHA-approved lenders and have a credit score of at least 500, according to Rocket Mortgage.
Choosing the Right Home Renovation Loan
This multistep process from Walsh can help you decide whether to finance or pay cash for your home renovations.
1. Assess the scope of the project. Think about the costs, including whether you can live in the home during the entire project. What is the timeline for the renovation?
How important is the project? “It’s important to be really honest and determine if it’s something you really have to do, like fix a leaky roof, or if you want to do a project like build a patio,” Walsh says.
2. Understand how the renovation will affect your property value. “Especially if you plan on selling your home in the not-too-distant future, a project could make sense if it will have a drastic increase in property value,” Walsh says.
3. Review your renovation financing options. “Think about how you will repay the loan and how the loan will impact the rest of your finances,” Walsh says.
Working with a financial planner can help you determine whether a home renovation loan is a wise choice. “Legally, they have to tell you what is in your best interests and not what is in the company’s best interests as you work through the options,” Walsh says.
If the timing and numbers make sense, renovation projects can make home sweet home even sweeter. “Sometimes, you need to be told you should just hold off for a couple of years and save the money rather than going into debt for something that will make you happy in the short term,” Walsh says.