Home renovation

How do home improvement loans work?

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A home improvement loan allows homeowners to access the funds needed to repair their home. These home improvement loans can take the form of mortgages with built-in financing or personal loans. Depending on the type of loan you receive, you may need to prove that the money was spent on the home or paid to a contractor.

How do home improvement loans work?

If you are buying a home that needs repairs, several loan options are available. How a home improvement loan works will depend on the type of financing you decide to apply for. The most popular home improvement loan options include the following programs:

Fannie Mae HomeStyle®: The Fannie Mae HomeStyle® loan is a one-time closing loan that includes the cost of home repairs in the overall loan amount. This loan can be used for repairs required by an appraiser or for modifications the homeowner wants to make, and it can be used to pay for structural and cosmetic repairs.

This loan appeals to borrowers because they only have to deal with one loan, one monthly payment and lower interest rates that cover both the purchase price and the cost of repairs. You can choose a 15 or 30 year mortgage term, as well as adjustable rate options. With a HomeStyle® mortgage, your final loan amount is based on the projected value of the home after repairs are complete. Fannie Mae’s HomeStyle® loan is a smart choice for a buyer with prime credit who has access to competitive interest rates.

FHA 203(k): This government-backed loan is similar to HomeStyle®, but is open to buyers with lower credit scores. This is usually the more expensive option of the two, as FHA mortgages have higher mortgage insurance premiums for borrowers who apply with smaller down payments. These mortgages have upfront costs that are included in the overall principal of the loan.

FHA 203(k) loans are divided into full and simplified options, and the type you need will depend on the condition of your property. The full FHA 203(k) loan is for a primary residence in need of serious or major repairs, while the Streamline loan is used to cover minor repairs totaling less than $35,000.

EZ “C” conventional: This loan can be used with conventional mortgages for non-structural home repairs that add value to the property. It covers both renovations required by an appraiser and those chosen by the borrower.

Giant renovation: A jumbo home improvement loan is like the conventional EZ “C”, but is used for more expensive homes that are not covered by other home repair loans. Giant Home Improvement Loans can be used for projects required by an appraiser or repairs the borrower wants to make. Repairs should be non-structural and add value to the home.

USDA Rural Development Home Repair Loans: The USDA offers funding through its Rural Development Program to help homebuyers obtain safe and decent housing. This financial assistance can be used to cover new appliances, foundations, siding, roofing, windows, plumbing, electrical upgrades and other upgrades needed for health and safety reasons. Program eligibility is based on income (up to 50% of area median income) and rural location.

If you can’t afford to finance your home renovations out of pocket, a home improvement loan isn’t your only option. You can also opt for a home equity loan or a home equity line of credit (HELOC), which are more affordable than personal loans. This is a preferred option if you have some equity in your home, but less than stellar credit. The difference between the two is that a home equity loan is a fixed rate lump sum, while HELOC’s variable rates fluctuate with mortgage interest rates.

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When should you consider a home improvement loan?

You should only consider borrowing money to renovate your home if you are confident that the project will reduce your long-term costs or increase the value of your property. Some home improvement projects can increase the value of your property by more than what you spend on the renovations. Attic insulation, basements, bathrooms, and front door renovations top the list for valuable repairs. If you’re hoping to improve the value of your home before you sell it, be sure to put your money where it counts.

It’s worth considering home improvement loans if a repair will save you money in the long run or make your home safer. Projects in these categories include roof repairs, new siding and updated windows to keep your home weatherproof and energy efficient.

One of the most important steps in deciding on a home improvement loan is knowing the risks and what to look out for. First, check your equity. There is a greater risk of default on a renovation loan when you have less money invested in your home.

Another mistake is to invest too much in your renovation. You don’t want upgrades to make your home too expensive compared to similar properties in your neighborhood. Be aware of the upper range of selling prices for homes in your area, or you might find that you’ve actually hurt the marketability of your home by pushing it beyond buyers’ expectations.

Finally, do not rush to renovate. Meet with several lenders, know the available rates, and remember that renovations often end up being more expensive and time-consuming than you initially thought. You need to make sure your finances can handle the burden of another home loan.

Alternatives to a home improvement loan

If you have very healthy credit and a less expensive project in mind, you can use a credit card with an interest-free promotional period as an alternative to a complete renovation loan. Isolating your project costs on a separate credit card will make it easier to separate these expenses from your usual expenses, while an interest-free offer will minimize the cost of borrowing money. Remember that it can be easy to overspend with a credit card, so make sure you can use it responsibly and pay off the balance quickly.

There’s also the cash-out refinance option, which involves refinancing your current mortgage to a higher loan amount and using the extra money for a renovation. This choice can be a good choice if you have at least 20% equity in the house, a good credit rating and low interest rate options available in the market. Carefully review current rates, lenders, and your home’s equity before choosing to refinance.

The best choice for you will vary greatly depending on your situation. If you want to do home repairs on your new home right away, the lower rates and closing costs of a home improvement loan make the most sense. If you have already accumulated some equity in your home, you can take advantage of a strong market with an equity loan to increase the value of your home. Lines of credit or cash refinancing are valid considerations when interest rates are low and your credit is healthy.