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You know that repairs and renovations aren’t always in the budget as a homeowner. Fortunately, there are mortgages and loans to pay for home renovations, whether it’s patching your roof, upgrading your kitchen, or a few minor repairs. Even without savings, you can finance the project with a home renovation loan.
What is a home renovation loan?
A home renovation loan is a type of loan that finances renovations, remodeling, or repairs for a home. The mortgages and loans to pay for home renovations can be:
- Secured by the home itself
- Included in your mortgage with additional funds to make improvements
- Unsecured loans or lines of credit
- Drawn from the equity in your home
The loan option you choose affects the interest rate you have, your monthly payment, the amount you can borrow, and whether or not you need to refinance your existing mortgage.
How do home renovation loans work?
Home renovation loans come in a variety of different financing packages, and each work in unique ways:
- Mortgage with additional funds for renovations – You can simplify paying for home improvements by taking out a larger mortgage and using those extra funds to finance home improvements.
- Unsecured personal loan – Instead of using your home as collateral like with a mortgage, you can get an unsecured loan, sometimes called a home improvement or renovation loan, through a bank, credit union, or online lender. The amount you can borrow and the terms are based on your creditworthiness and finances.
- Home equity loan – Often referred to as a second mortgage, a home equity loan is a loan paid out in one lump sum, which is then repaid over a period with fixed monthly payments. Be careful not to miss payments — like a first mortgage, this type of loan is secured by your home, so if you stop paying, you could jeopardize your ownership of the property.
- Home equity line of credit (HELOC) – A HELOC is also a secured loan, and most have variable interest rates, which means your payments can fluctuate based on market conditions. Before considering a HELOC, ensure you have at least 15 percent to 20 percent equity in your home.
- Government loans – While you must qualify for a government loan, such as the Fannie Mae HomeStyle or FHA 203(k) rehab loan, it could save you on the costs of insurance and interest. Government loans might also have restrictions on the use of the loan, such as only using funds to make renovations that improve the home’s livability.
How to decide which loan type to use
Before deciding on a loan for your renovation, set a timeline and budget. For example, do you need the work done within a few weeks, or are you more flexible? If you’re flexible, you might be able to save more money for the home renovation or work on improving your credit score in the interim.
Next, determine the cost of the project and what you’ll be able to afford. When you’re shopping for mortgages and loans to pay for home renovations, having an estimate and a budget can give you a better sense of which loan type would be a fit.
The best home renovation loan will match your specific needs and your goals for the project. Give yourself a range of options so that you can find one that makes the most sense based on your financial situation (income, credit score and your home’s equity) and preferences, such as how and when you’d like to pay back the loan.
Alternatives to loans
If you prefer not to take out a loan, there are alternative options to finance your home renovations:
- Credit cards – If you’re doing minor upgrades, using a credit card could work. Some credit cards have a 0 percent APR introductory period, meaning you don’t pay any interest on your outstanding balance until this period ends. Some cards come with rewards, so the more you spend on renovations, the more cashback you could earn. Suppose you can’t pay off the balance before the end of the introductory period. In that case, however, you could end up paying higher interest rates — much higher than the interest on other types of home renovation loans.
- Cash-out refinance – A cash-out refinance replaces your existing mortgage for another mortgage for more than what you owe on your home. The difference is paid to you in cash. However, to do a cash-out, you’ll need to pay for an appraisal, origination fees, taxes, and other costs relating to closing, and you must have at least 20 percent equity in your home. Unless you refinance for a shorter term, you’ll be extending the life of your loan, as well.
- Save up and pay cash – While saving up to pay for home projects is the ideal situation, it isn’t always possible.
Deciding how much to spend on a home improvement project is tricky, but finding the right mortgage and loans to pay for the renovation can be even trickier. Before choosing a home renovation loan, have a realistic idea of what the project might cost, and get your credit score and report so that you know how lenders will view you as a borrower. Then, with research, you might find a reasonable rate that aligns with your budget.