How do renovation loans work?A renovation loan allows you to finance certain renovation and repair costs. This is ideal if you find a home that you like that just needs some renovations to become your dream home. Or if you currently live in your home, it allows you to pay for renovations and home projects that you may have been thinking about. That would be a refinance with a renovation mortgage. With a renovation loan, the lender and appraiser will determine the value of the home after the renovations are completed. This could result in a larger loan amount than if you were using the property’s current value. Your down payment for the renovation loan is based on the total renovation cost (purchase price + renovation cost). Let’s say you have a 3.5% down payment on a $250,000 home with renovations that cost $50,000. $250,000 Price + $50,000 costs – $300,000. 3.5% of $300,000 is $10,500.
A few answers about renovation loans:
- Is there a limit on how much we can use for renovation costs? Some programs will only let you spend up to $35,000 in costs. Others may limit you to 50% of the current value of the home, while some might not have any limit.
- Is there any ‘wiggle room’ on the appraised value? There are some loan programs that allow up to a 10% variance. That allows you to go 10% over the estimated future value. For example, if the total costs of the renovation and home price was $300,000 but the appraiser thought the home was only going to be worth $290,000 after the repairs were done, you might be able to make it work.
- Is a HUD inspector needed? Once your costs exceed $35,000 or if you’re doing anything structural, a HUD inspector will likely be needed. This isn’t a bad thing – however, it does add their cost as a fee (can be $400 to $1000+) and adds a few extra steps to the process.
- When does the contractor get paid? The contractor typically gets paid at different parts of the process. Some contractors like to collect all funds for the project upfront, which might not work.
One thing that isn’t allowed on most renovations loans is self-help work (where the work is done by the homeowner themselves) as well as work by unlicensed contractors. We know that this can save some borrowers money and some might opt for this – if this is the case, we’d recommend some other alternatives for financing home renovations and projects. The most popular renovation mortgages are: FHA 203k, Fannie Mae’s HomeStyle® Renovation, Freddie Mac’s Choice Renovation loan, and VA’s renovation loan – we have all of these programs and help compare the pros and cons of each one.
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We can help you compare to see if a renovation loan or another option like a Home Equity Line of Credit (HELOC) might be better.