Taking out a loan to renovate your house might not seem like a good idea because after all, you might be adding to your list of debts and paying off your interests. However, if done properly, taking out a renovation loan can make great financial sense, especially if you’ll be flipping your home and selling it for a higher value than when you got it.
Potentially, a renovation loan can actually net you profit, but only if your renovation project is successful and if your loan rates are friendly. In general, there are five different types of renovation loans available to homeowners, and while different lenders might have different rates according to your location, these five loan options all have similar aspects.
Renovation Loan Option 1: Fannie Mae HomeStyle Renovation Loan
One of the most common renovation loans available, the Fannie Mae HomeStyle Renovation loan allows homeowners to borrow money for a house that requires repairs or to refinance their existing home, so they have funds for improvement.
This type of loan is preferred by a lot of homeowners because it allows them to pay for both their mortgage and their renovation loan in one monthly payment. However, this usually takes longer to close than a regular mortgage loan and it has a strict credit score and debt-to-income ratio requirements.
Renovation Loan Option 2: FHA 203(k) loan
The FHA 203(k) loan, or the Federal Housing Administration 203(k) loan or simply a rehab loan, is a type of loan available to homeowners with homes that are at least 1 year old, with a renovation project that costs at least $5,000.
There are two types of FHA 203(k) loans:
- Limited 203(k): an FHA 203(k) loan that’s capped at $35,000
- Standard 203(k): an FHA 203(k) loan available for major renovation or rehabilitation
The credit score and down payment requirements are less stringent and strict than a Fannie May HomeStyle loan, but an FHA 203(k) loan isn’t available for houses that will be sold within 90 days.
Renovation Loan Option 3: Home Equity Loan or HELOC
A HELOC is a fixed-rate, lump-sum loan that is paid out monthly, with the amount to be paid remaining the same throughout the entirety of the loan terms. A HELOC can also come with a line of credit and a revolving balance, making it perfect for homeowners with major home improvement projects that require several large payments.
A HELOC loan is usually lower than unsecured personal loans and you only pay interest in the amounts that you withdraw from your line of credit. However, HELOC loans have your home as collateral, which means there is the possibility of losing your house if you’re unable to make payments.
Renovation Loan Option 4: Cash-out Refinance
A Cash-Out Refinance Loan allows homeowners to refinance their mortgage for a higher amount based on the home’s previous mortgage and current equity. The difference is then taken out as cash. A cash-out refinance loan also has no restrictions on how you use the money and the loan is based on the current home’s value.
Just like the HELOC, cash-out refinance loans put up your house as collateral, so missed payments may result in the lender foreclosing. However, cash-out refinancing loans have lower interest rates that make them easier to pay over time.
Renovation Loan Option 5: Personal Loan
A personal loan allows homeowners to borrow directly from a lender without tapping into their home equity. This loan is unsecured, which means you don’t have to put up your house as collateral. The money that is lent can also be used for any purpose, with funding often being given quickly and without home appraisals.
However, because the loan is unsecured, lenders generally require FICO credit scores of 740 and up, with interest rates being generally higher than the other loan options.
The right kind of renovation loan can potentially net you a higher profit. As long as you plan out your finances properly, you won’t encounter problems that will put you into trouble.