The pros and cons of home improvement loans no one’s talking about

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April 10, 2018.

Here’s a common misconception among homeowners: If you don’t have enough home equity, you won’t be able to pay for your home improvement project. True or false?

Thankfully, even with current limited equity, there are several loan options available to homeowners and buyers looking to fund a renovation. It all comes down to meeting with your loan officer, finding the right loan program, and determining how much funding you may qualify for. The even better news? The home remodeling market is expected to stay strong through 2025.

Why choose Cornerstone? Because getting you into your new house (and closing on time) is our top priority.

Can you use your mortgage to pay for home renovations?

In most cases, yes. A home renovation loan is ideal for a homebuyer or a homeowner interested in taking on a minor to major home improvement project. With a home renovation loan, as long as the improvement will add sufficient value to your home after completion, you’ll roll the cost of buying a house or refinancing your mortgage into the cost of fixing it up.

Available options for home renovation loans may include:

HomeStyle® Renovation Program

• For homeowners and homebuyers.
• All-in-one home improvement loan.
• For owner-occupied primary residences and second homes.
• Financed renovations cannot total over 50 percent of the as-completed value of a house.
• Offers conventional financing with a minimum 5-percent down payment.
• Used for almost any home improvement that is permanently affixed and adds value to the property.

FNMA Postponed Improvements Program

• For homebuyers.
• For new construction* and existing homes, as well as owner-occupied primary residences and second homes.
• Financed renovations cannot total over 15 percent of the as-completed value of a house.
• Offers conventional financing with a minimum 5-percent down payment.
• Used for almost any home improvement that is permanently affixed and adds value to the property, like the HomeStyle renovation loan.
• Project deadlines apply.

FHA 203(k)

• For homebuyers and homeowners.
• Only for owner-occupied primary residences.
• Limited loan program has maximum repair amount of $35,000; standard/full loan program has maximum repair amount that does not exceed the county’s FHA loan limit.
• Project deadlines and contingencies may apply.

FHA 203(k) Limited with an HUD REO home

• For homebuyers who purchase an HUD REO home, plan to live in the property for at least a year, and offer HUD full asking price.
• Typically has a low down payment.

What are the pros and cons of home renovation loans?

Homeowners and homebuyers can take advantage of home renovation loan benefits like:

• Little money down. “The main benefit is being able to put together your home purchase and renovations into one loan and not having to put much down,” Kristin Vaughan at Cornerstone Home Lending, says. “This is opposed to finding someone to do the renovation loan separately after closing, which will be at a higher interest rate and normally requires more down.”
• More financing available. As mentioned above, a borrower using a home renovation loan could borrow more than a home would initially appraise for before adding the value of the improvements, which is not the case for any other loan type. Marcie Hines at Cornerstone, says, “This allows a family to use instant equity in their new home, to be used for upgrades such as a new kitchen, remodeling the bathroom, etc., which is pretty neat!”

Some disadvantages of a home renovation loan may include:

• Must choose a contractor in advance. A disadvantage to taking out a home renovation loan, says Vaughan, is that you have to have your contractor selected, along with your plans and specs, before the appraisal is ordered. This normally has to happen within two weeks or less of going under contract, depending on how far out the closing date is. “You also are locked in to what you choose, as you can’t make changes after the fact as that could change the appraised value and could affect the loan,” she explains.
• More stringent plans required. The process that a borrower goes through is a bit strenuous, Hines qualifies. As Vaughan explained, you have to find a licensed contractor — excluding family members and DIY. A contractor must then lay out a bid schedule that is extremely specific, Hines says, “We’re talking how we take the countertop out. What we do with the trash from the demo. How we install the new countertop, and so on, for every single renovation made. Most of our borrowers hope that they can do a ‘Chip and Joanna’ style flip, and that’s just not the case with this program.”

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What else?

• Because of these specifics, slight delays are possible. “I normally recommend the closing date being a bit longer than we normally close deals in as you are working with contractors, making design decisions, etc.,” Vaughan says.
• When choosing a contractor, make sure to let them know what type of loan you’re getting. This way, your contractor will understand how the process works. Vaughan adds, “We are happy to provide the contractor with that information if they aren’t familiar with it.”

How do you qualify for a home improvement loan?

There are two parts to qualifying for a renovation loan:

1. Borrower approval. This is similar to qualifying for a normal loan as far as debt-to-income ratios, reserve requirements, credit scores, and other financial areas are concerned, Sharla J. Ellis, Senior Vice President at Cornerstone, says.
2. Project approval. Ellis explains that this step requires a review of the plans (if you plan to do structural work), specifications, cost breakdown, and certain documentation needed from the contractor. The appraisal of the property is not ordered until the project items have been received.

You’re ready to renovate: What should you do next?

As you plan your renovation project, don’t bog down in the details. Ellis suggests contacting a seasoned and experienced loan officer with a renovation financing background first. “He or she can walk you through the ins and outs of these amazing loan products,” she says. “They will help answer your questions and tailor a program that fits your project needs and meets your financing objectives. Renovation loans are a great way to ‘make your home your own!'”

*Not for completion of the property.

For educational purposes only. Please contact a qualified professional for specific guidance.

Sources deemed reliable but not guaranteed.