What are home renovation loans and how do they work?
U.S. home renovations, remodeling, and improvements were at an all-time high in 2020. In one study alone, 39% of participants said they undertook a home improvement project. Real estate experts forecast this trend to continue this 2021.
Another study looked into how much the average US homeowner spent on such projects. It found that home improvement activities led to an average spending amount of $8,305. That’s on top of $3,192 on home maintenance services.
Eleven grand is already a lot, but that’s only for basic improvements. As such, many homeowners turn to renovation loans to finance bigger projects.
What exactly are these loan programs, though, and how do they work? Are they a good financing method, and if so, when should you consider getting one yourself?
We’ll answer all these questions in this comprehensive guide, so be sure to read on!
What Is a Renovation Loan?
A home renovation loan is a loan that funds home renovations, remodels, and repairs. In many cases, it comes in the form of a mortgage with a higher loan (or principal) amount. The larger amount accounts for the costs of renovating a “fixer-upper.”
According to the website Plenti, though, a renovation loan can also be a small personal loan. In this case, you can take out a smaller amount, say $2,000, to upgrade a house or fix problems with an existing home. Many renovation loans that fall under personal loans don’t require collateral.
How Does a Renovation Loan Work?
Mortgages, refinancing programs, and home equity loans are common renovation loans. How exactly a renovation loan works depends on which of these loan types you apply for. Their requirements also vary, as small unsecured loans may have laxer lending requirements.
Renovation mortgage loans are renovation loans and mortgages rolled into one. If you qualify, the lender gives you the funds to buy the house itself and to renovate or repair the property. Like a standard mortgage, you pay it back every month for a period of usually 10 to 30 years.
Most people take out renovation loans to purchase “fixer-uppers.” Most of these properties require major repairs to become habitable. This process is what the real estate industry refers to as “house flipping.”
Despite the work required to make these properties livable, they account for about 5% of US home sales. Many who purchase these fixer-uppers are property investors or “house flippers.” However, individuals also buy and then renovate fixer-uppers for personal use.
Cash-Out Refinancing Loan
When you refinance an existing mortgage, you take on a new loan with a lower interest rate or a better term. A cash-out refinance pretty much works the same way, except you also get cold, hard cash. You can then use the funds for home repairs, remodels, or renovations.
A cash-out refinance combines your existing mortgage balance with the “cash loan.” For this reason, your new mortgage will show a higher balance and monthly payments. That’s because you’ll have two loans to pay back: your mortgage and renovation loan.
Home Equity Loan
Home equity loans also go by the name “second mortgage” or “home equity installment loans.” These consumer loans allow you to borrow money if you have enough equity in your home. It’s a “second” mortgage since the home’s equity serves as the loan’s security or collateral.
With that said, the amount you can borrow on a home equity loan depends on how much your current equity is. It also factors in the difference between your home’s market value and how much you still owe on it.
You can think of a home equity loan as a way to “liquidate” what you’ve already invested in your home. You’re not selling it, though; instead, you’re only using that as security for a renovation loan. Once you receive the funds, you can start renovating, remodeling, or fixing your home.
Home Equity Line of Credit (HELOC)
If home equity loans are lump-sum loans, home equity lines of credit are similar to credit cards. Instead of receiving cash, a lender extends you a credit amount based on your equity. Like a home equity loan, though, a HELOC also uses your equity as a form of collateral.
With a HELOC, you get access to revolving credit that you can use for home renovations. You then pay back what you’ve borrowed every month, just like how you would with a credit card. You can then “reuse” that portion you’ve paid back for future renovation needs.
Unsecured Personal Loan
Unsecured personal loans are popular traditional home renovation loan alternatives. That’s because, unlike traditional renovation loans, unsecured personal loans don’t require collateral. That means you won’t be “exchanging” your home or equity for a loan to fix up your house.
However, these personal loans are often smaller, as you don’t need collateral. For that reason, they’re mostly for smaller renovations, upgrades, or repairs.
What Do Renovation Loans Cover?
A renovation mortgage loan is the only home renovation loan that you can use to buy a property and fix it up. It’s a new loan designed to help borrowers buy a home that they can then fix later on. Borrowers can use the extra funds to renovate, remodel, or repair any part of the house.
Most renovation loans can help cover the costs of major structural repairs, though. For example, even unsecured personal loans can help you get an old roof replaced in its entirety. You can also use the funds to install or upgrade heating and air conditioning systems.
Renovation loans can also help pay for energy updates, waterproofing, and mold remediation. Of course, you can use whatever funds you have left to push through with your desired renovations. You can expand that kitchen, add a master’s bathroom, or even invest in a solar photovoltaic system.
When Is It a Good Idea To Take Out a Loan for Home Renovation?
A renovation loan may be a good idea if you’re sure the improvements will save you money in the long-run. For example, let’s say you have plans of buying a home with a low asking price but needs a lot of work. Before you leap at the first renovation loan offer, consider how much the repairs will cost first.
If the repair costs are well below the property’s current value, a renovation loan may be a good idea.
You can also benefit from a home renovation if your project can make your abode safer and more secure.
An example is fixing all existing plumbing and roofing leaks and moisture issues. Do note that early studies found that one in two US homes has dampness or mold problems. So, these issues not only lead to water damage; they can also cause mold-related health woes.
For starters, excessive indoor molds can give rise to poor indoor air quality (IAQ). Unfortunately, poor IAQ can raise your risks of impaired lung functions. Some studies even associate molds with the development of asthma in children.
A renovation loan can give you the funds you need to say, re-pipe your home and get your roof repaired. In doing so, you can address the root cause of leak-induced dampness and mold problems. This helps you boost your home’s safety, so taking out a renovation loan may be a good idea in this case.
Making a Renovation Loan Work For and Not Against You
The most recent Experian report revealed that the average US FICO score reached 710 in 2020. This classifies as a “good score,” something that lenders favor and prefer. So, if your score has improved, you may already be eligible for a low-cost traditional mortgage.
That means you may not have to settle for a fixer-upper just because it costs less than a ready-to-move-in home. Your score may be good enough to let you access a higher loan amount at an affordable rate.
If you really want to buy a fixer-upper, you should still get a better renovation loan rate if you have a good score. However, make sure you get the property assessed first to determine if it’s worth it.
If you’re an existing homeowner, consider a cash-out refinance if you find a better loan offer. For example, there may be a cash-out refinancing program that will let you lock in a lower mortgage rate. Your score may have improved enough to qualify you for this financing offer.
Taking Out a Renovation Loan for a Healthier, Safer Home
As you can see, renovation loans can be a good option if you want to buy a fixer-upper that will save you in the long run. The same goes for if you want to carry out massive projects designed to make your home safe and more secure. If any of these are true in your case, then consider applying for a home renovation loan.
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