Which loan is best for home renovations?
The best loan for home renovations depends on your situation. If you want to buy and renovate a fixer-upper, options like the HomeStyle loan, CHOICERenovation loan, or FHA 203k rehab loan could be ideal. If you already own your home and want to make improvements, tapping your equity with a cash-out refinance, home equity loan, or HELOC could be better.
It’s important to choose the right renovation loan based on your project and your finances. Here’s what you should know about your options.
What is a renovation loan?
Typically, a home renovation loan is a single mortgage that lets you both finance a home and renovate it. Renovation loans can be used either when buying a home or refinancing one you already own. By financing the home and the renovations together, you can consolidate your renovation costs into one low-rate mortgage rather than taking out separate loans to buy the property and pay for repairs.
How does a renovation loan work?
Renovation loans are unique because they let you borrow more than the home’s current value. Typically, the maximum loan amount is your home’s estimated future value after renovations are complete.
You’ll need detailed construction plans and cost estimates to qualify for a renovation loan. Having inspected the property and reviewed your plans and contractor quotes, the home appraiser will give an “as improved” valuation. Assuming the project is viable, you get the mortgage portion of your loan right away so you can complete the purchase or refinance.
Renovation funds are then released in stages (“draws”) as your project reaches pre-agreed milestones. You’ll need a contractor that’s happy working on that basis. It typically helps to find a contractor who has worked with renovation loan programs in the past and understands how the process should go.
Renovation loans to buy and fix up a home
Most mainstream mortgage programs have a renovation loan option. Conforming loan programs including Fannie Mae’s HomeStyle Renovation and Freddie Mac’s CHOICERenovation. Government-backed renovation loans include the FHA 203k mortgage, the VA renovation loan, and the USDA renovation loan. Note that the VA and USDA renovation options are less common and it may be hard to find a participating lender.
Let’s dig into each renovation loan in a little more detail.
Fannie Mae HomeStyle renovation loan
Fannie Mae’s HomeStyle renovation loan is fairly easy to qualify for. You need at least a 3% down payment, a reasonable debt-to-income ratio, and a minimum credit score of 620 (although this can vary by lender).
HomeStyle can be used to buy and renovate a new home or refinance and upgrade a home you currently own. There are few restrictions on how the funds can be used, although you are not allowed to knock down the existing property and build a new one (for that, you’d need a new construction loan).
Freddie Mac CHOICERenovation loan
Like Fannie Mae’s HomeStyle loan, Freddie Mac’s ChoiceRENOVATION loan is a conforming mortgage. And the two loan programs are almost identical. To qualify, you need a 3-5% down payment and a credit score of 620-660 or higher, depending on your mortgage lender. Like the HomeStyle program, CHOICERenovation allows you to either buy a home or refinance one you already own.
However, there is one important difference. The CHOICERenovation mortgage lets you finance improvements to your home’s resilience (think disaster proofing) while HomeStyle does not.
The big advantage of a HomeStyle or CHOICERenovation loan over an FHA 203k loan concerns mortgage insurance. FHA loans typically have permanent mortgage insurance that you can only get out of by paying off your mortgage, refinancing, or selling. But, with Fannie and Freddie loans, you can remove PMI payments when your equity reaches 20% of the home’s value. That can lead to big savings over the long term.
FHA 203k loan
The FHA 203k rehabilitation loan is a government-backed renovation mortgage. It can be great for those with slightly lower credit because most lenders require only a 580 FICO score to qualify for an FHA loan. The “Limited” FHA 203k loan allows up to $35,000 in renovation costs while the “Standard” FHA 203k allows you to borrow up to local FHA loan limits. Keep in mind that these loans cannot be used for luxury amenities like swimming pools.
The FHA 203k rehab loan comes with two main disadvantages compared to conforming loans:
- Its minimum down payment is 3.5%, versus 3% for a HomeStyle or CHOICERenovation loan
- FHA mortgage insurance typically lasts the life of the loan, while conventional private mortgage insurance (PMI) can be removed later on
If your credit score is high enough for a Fannie Mae or Freddie Mac renovation loan, it’s worth looking into these options first as you could save money on interest rates and mortgage insurance.
VA renovation loan
The VA renovation loan is only available to qualified service members, veterans, and select military-related groups. But it can offer real benefits to those who are eligible, including:
- No down payment required
- No ongoing mortgage insurance payments (just a one-time VA funding fee)
- VA mortgage rates are usually lower than conforming and FHA loan rates
If you’re eligible for a VA loan, these are typically the best mortgages. However, not all lenders offer VA renovation loans, so be prepared to put in some effort to track one down.
USDA renovation loan
The USDA renovation loan is available only to those purchasing a home in an area designated as “rural” by the U.S. Department of Agriculture. However, that definition is broader than many expect. You don’t need to work in agriculture or use the land for farming purposes and roughly 97% of America’s land mass is eligible.
The big advantage of USDA loans is that you don’t need a down payment. But you will need a low-to-average income to qualify. Other benefits include below-market mortgage rates and reduced mortgage insurance rates.
Like the VA renovation loan, however, USDA renovation loans are hard to come by. So you should expect to do some research if you want to find a lender offering this program.
Renovation loans for a home you already own
If you already own your home, a “true” renovation loan is not your only option. In fact, it may be easier and cheaper to borrow from your equity using a cash-out refinance, home equity loan, or home equity line of credit (HELOC).
These loans provide cash that you can use for any purpose, meaning you don’t need to have detailed construction plans and contractor quotes in order to qualify. You only need to qualify for the loan based on your credit, income, and available equity; then you can use the money for any type of renovation you want.
Also, the interest you pay on a cash-out refinance or home equity loan may be tax-deductible if you spend the money on home improvements. But you should check with a tax professional to see whether that applies to you and how much interest would be deductible.
Cash-out refinance
With a cash-out refinance, you get a whole new mortgage that replaces your existing home loan. Your new loan balance will be higher than your old balance, and you’ll receive the difference (minus closing costs) as your cash-back. Conforming and FHA loans typically let you borrow up to 80% of your home’s value using a cash-out refinance, while VA loans allow you to borrow 100% of your equity. USDA loans don’t allow cash-out refinancing.
When mortgage rates are low, a cash-out refinance is the go-to solution for many homeowners. It can allow you to cash out equity and secure a better interest rate on your home loan at the same time. But mortgage rates are now higher than they were a couple of years ago, and you should always think twice before refinancing to a higher rate. Run the figures carefully before you decide.
In addition, a cash-out refinance can come with high closing costs. Your lender may offer to cover some or all those costs, but you’ll almost invariably pay a higher mortgage rate if it does.
Home equity loan or HELOC
With a home equity loan, you get a second mortgage and leave your existing one in place. You’ll receive a lump sum at closing, which you repay in equal installments over the “term” (duration) of the loan. Usually, these loans come with fixed interest rates. Home equity loan rates are typically higher compared to a cash-out refinance, but your closing costs should be way lower.
A home equity line of credit (HELOC) is another form of a second mortgage. But it acts more like a credit card: You can borrow from the line, repay it, and reborrow as often as you want up to your credit limit. And you pay interest only on your balance. After a draw period during which you can borrow from the HELOC, you’ll enter a repayment period when you can no longer borrow and must repay your outstanding loan balance in full.
That could make a HELOC ideal if you have a drawn-out renovation project (or multiple projects) that will happen over an extended period of time. You can borrow funds as needed and you won’t pay interest on the money you’re not actively using. But HELOCs can be complicated. To learn more about HELOC’s pros and cons and explore all your options before applying.
How do I finance home renovations without equity?
All the loan options above — including renovation loans, cash-out refinancing, and home equity loans — allow you to finance home improvements using your home’s value (your equity) as security. This is often a good option because financing secured by your home is cheaper than other forms of borrowing. But there are risks, too. You’re putting your home on the line if things go badly wrong. Ultimately, if you default on a loan secured on your home, you could face foreclosure.
Depending on your circumstances, you might prefer to avoid that risk. And you may be willing to pay a higher interest rate to do so, especially if your renovations have a relatively modest budget.
Your main choices then are getting a personal loan or using your credit cards.
You may see personal loans advertised at rates that rival or even undercut those for home equity loans and HELOCs. But be aware that few applicants are approved at those rates. You’d need an exceptional credit score and very sound finances to qualify. If that’s not you, expect to pay an appreciably higher rate than on secured loans.
Credit cards usually have much higher interest rates than secured loans. So you wouldn’t want to finance extensive home renovations using plastic. One possibility is using a card with a 0% rate for an introductory period that often lasts 18 or 21 months. Then you could pay off the card or transfer its balance before you begin to pay interest. But, if you’re buying a home, don’t apply before you close or you could risk hurting your credit score and your chances of mortgage approval. And never apply for more than one card within a short period of time.
Renovation loan FAQ
Yes! There are a variety of loan options that can be used for home renovations. Those buying a fixer-upper home might consider the Fannie Mae HomeStyle loan, Freddie Mac CHOICERenovation loan, or FHA 203k rehabilitation loan. Current homeowners often finance renovations using a cash-out refinance, home equity loan, or HELOC. And if you don’t want to touch your home’s equity (or don’t qualify for the mortgage), a personal loan could be an option.
Yes, most renovation loans have slightly higher rates. From a lender’s point of view, these loans carry a little more risk. However, rates for these tend to be only slightly higher than those for purchase-only mortgages. You’ll see the difference when you start to compare shop for your loan.
The FHA 203k rehab loan is a government-backed renovation loan. It allows you to buy or refinance a property and includes the cost of renovations in your loan amount. The FHA 203k program can be a great choice for those with credit scores of 580-620. But you may find other alternatives more attractive if you have a strong credit score.
Renovation loans involve more documentation than purchase-only mortgages In addition to the standard application paperwork (like bank statements and income documentation), expect to provide construction plans, contractor quotes and specifications, work schedules, local authority permits, and anything else the appraiser needs to ensure your project is viable.
That varies between programs, lenders, and projects. If you’re using a renovation loan to buy and fix up a property, you can often borrow up to the home’s future value — its estimated cost after renovations are completed. But your loan amount will have to fall with local conforming or FHA loan limits. Those using a cash-out refinance, home equity loan or HELOC can often borrow up to 80 or 85 percent of their property value, minus their current mortgage amount.
Most renovation loans are offered through mortgage lenders, just like standard home buying and refinance loans. But the process is different. To apply, you’ll need detailed renovation plans and cost estimates in addition to the usual financial documentation. Once you decide on a loan program, reach out to a mortgage lender to find out exactly how the process works and what documentation you should prepare.
Which renovation loan is best for you?
As you can see, there’s a wide variety of renovation loans available. The best program for you depends on a number of factors, like whether you’re buying a fixer-upper or renovating a home you currently own, and what kind of shape your finances are in. Your best bet is to connect with a lender and discuss options. Your mortgage loan officer can help evaluate your plans and financial situation to determine which renovation loan is best.
