There really is a loan product for just about every situation, and renovation loans are ideal to help you create the home of your dreams. Let’s see how renovation loans can help you finance your dream home and how to make the most of your renovation loan.
The Benefits of a Renovation Loan
A renovation loan allows you to finance the purchase of a home and property repairs in one loan package. They’re a great option if you fall in love with a home that would benefit from restoration or could use some remodeling to fit your vision. Even if you already own and want to make improvements, you can use a reno loan, too. Some of the most common renovation loan types include FHA 203(k), FannieMae HomeStyle, VA Renovation, home equity line of credit (HELOC), and cash-out refinance. Rehab loans are extremely flexible in that they can be used to fund necessary renovations (like a roof replacement or HVAC repairs) or optional modifications (think a kitchen upgrade or new deck). Depending on the program you choose and what renovations you complete, you could claim a tax deduction or credit; be sure to consult a tax advisor to discuss your options. The most significant benefit of renovation loans is that, unlike a HELOC or a cash out refinance, the loan is based on the After Improved value. There’s no need for buyers or sellers to be apprehensive of reno loans—home renovation loans give you extra freedom and opportunity that doesn’t exist in a move-in-ready property.
What You Should Know
Renovation loans offer a fixed rate, ONE loan to borrowers with one closing. Simply put, it’s one payment, one interest rate. This is much simpler for a homeowner as opposed to a HELOC that would add a 2nd payment to the borrower’s budget and typically would have a fluctuating rate (and thereby payment) with the Prime Rate.
Another bonus the renovation loan offers new homebuyers is that they can finance up to the first 6 months of mortgage payments into their loan. While this is not to be construed as a “vacation” from your mortgage payment, financing mortgage payments alleviates the borrower from paying rent on an apartment and a new mortgage payment while work is being completed.
A renovation loan may not be for everyone, though. If a homeowner would like to do the work themselves for instance, this isn’t allowed with these programs. Renovation loans do require the work be completed by a licensed contractor. I see this as a good thing, though. Home renovation on your own is a huge undertaking and can lead to costly mistakes down the road if work is not properly permitted or not professionally done.
Another key point is some programs limit what types of repairs can be included in the loan. For instance, if you are looking to build a pool or an outdoor kitchen, FHA and VA won’t allow it, but the HomeStyle loan does. It’s important to review your renovation list with your loan originator at time of pre-approval.
The rates on Renovation loans are different than those offered on standard purchases. They typically run ¼% to 3/8% higher. However, if the borrower can elect to buy down the rate with points, oftentimes bringing the rate within the range of a standard loan. The buyer can even finance a portion of that point into their loan!
Things to Keep in Mind for a Successful Renovation
Have a third-party consultant conduct a feasibility study to estimate needed and desired renovations. The results will allow you determine how realistic your plan is, how much you can expect the restoration to cost, and whether it complies with local zoning laws. Bring your “champagne dreams” to the appointment with the consultant and be prepared to pare down your list based on the loan amount for which you are qualified. The consultant also serves as a bid reviewer to ensure the borrower’s final contractor bid isn’t over or underestimated. This gives a borrower peace of mind that the contractor is being realistic in their bid.
Only use a licensed contractor to work on your home. It may be tempting to cut costs by using amateur handyman friends or completing your own projects, but you will be limited in how much financing you can use to fund DIY endeavors. Your contractor should be licensed in your state and be lead paint certified if the house was built before 1978. With a professional contractor, you can be more confident the reno will be done properly and have high-quality results. Remember, renovation loans are based on the After Improvement Value (AIV).
Be realistic with your budget. A good rule of thumb is that for every $10,000 you want to make in repairs, it will add $45-55 to your monthly payment. Identify what can stay or be removed but keep the big picture in mind. Don’t underestimate how much repairs will cost, either. Always consult with a loan originator to review the budget and project estimate.
If you have any questions about renovation loans, contact one of our licensed Mortgage Loan Originators. If you are ready to begin the home buying process, click here to get started!
The pre-approval may be issued before or after a home is found. A pre-approval is an initial verification that the buyer has the income and assets to afford a home up to a certain amount. This means we have pulled credit, collected documents, verified assets, submitted the file to processing and underwriting, ordered verification of rent and employment, completed an analysis of credit, debt ratio and assets, and issued the pre-approval. The pre-approval is contingent upon no changes to financials and property approval/appraisal.