How do Renovation Construction Loans Work?

You fell in love with your new home, and then you lived in it. Over time, things have started to look worn and frayed. The kitchen no longer excites you the way it used to. You wake up one day and your bathroom feels cramped and outdated. You keep catching yourself daydreaming about all the ways you could make your home feel new again. You don’t want to sell your home, but you want to make some changes. Sound familiar? Fear not. It’s completely normal.

Whether you bought and fell in love with your home but feel it needs some updates or you’ve just purchased a new home that has a ton of potential but needs some work to make it your own, home renovations are the answer. However, they can be costly.

If it’s time for you to look into a home renovation but you don’t have the cash in hand to pay out of pocket, you can use your home itself to make it happen. There are three popular ways to use the equity you’ve built in your home to finance a renovation project.

  1. Cash-out refinance loanA cash-out refinance lets you replace your existing mortgage with a new home loan based on the amount you still owe on your home. In short, you take your original home loan amount, subtract the money you’ve paid so far against the principal, and then start a new mortgage on the remaining amount. The difference between the original amount and the new amount comes to you as a lump cash payment you can use to fund your renovation, consolidate your debt, or fulfill other financial needs. NOTE: You’ll have to pay closing costs again and the term of the mortgage starts all over. It could be another 15, 20, or 30 years. Make sure you don’t use the cash payment to run up debt you won’t be able to pay off.
  2. Home equity loanIf you don’t want to start your mortgage term all over again and you can handle an additional monthly loan payment, a home equity loan may be the best option for you.A home equity loan is a separate loan based on the equity you have built up on your home. Typically, you can borrow up to 80% of that amount. Home equity loans are sometimes referred to as a “second mortgage,” as they become a second monthly payment. You may have up to 15 years to pay this loan off and many lenders cover the closing costs for you. NOTE: You’ll need to pay closing costs and fees, which can range from 2% to 5% of your loan amount. You’ll also have two mortgage payments instead of one, so be prepared for that extra home-related payment.
  3. Home equity line of credit loanA home equity line of credit (HELOC) gives you the greatest flexibility. Essentially, a HELOC works like a credit card that borrows against the equity of your home. Once you set up your line of credit, you don’t have to begin using it right away. You can also use it in whichever way you see fit. Fund a renovation project or pay for a vacation – it’s all up to you. Plus, when you pay back charges, the money returns to your equity – making it possible for another even larger line of credit. NOTE: Interest rates vary and lines of credit usually come with annual fees.

Ways to plan ahead and include renovation in your first mortgage

Some people purchase a home with specific upgrades or remodeling in already mind. In these cases, you can fold renovation costs into your mortgage at purchase. Here are three of the most common ways to do that.

  1. FHA 203(k) loansThese mortgages are designed for first-time homebuyers. They allow you to add expected renovation costs to your mortgage loan principal. These loans require a down payment as low as 3.5% but give you only six months to get the work done. You’re required to use a licensed contractor for renovations, so the money cannot be applied to DIY projects.
  2. Fannie Mae® HomeStyle® renovation loanThe HomeStyle renovation loan is similar to the 203(k) loan but it gives you more freedom with how you spend it. The 203(k) Loan can be used only for non-luxury projects, while the HomeStyle loan can be used to add a pool, a hot tub, or just about anything else. These loans require a minimum 5% down payment.Requirements to get this loan:
    • A credit score of at least 720
    • A certified contractor must prepare a cost estimate
    • Funds must go into an escrow account rather than directly to you

Choose the loan that works best for you

Now that you have an overview of how you can finance your home renovation, the next step is to determine which works best for you. As your Mortgage Specialist, I am standing by ready to help you make your choice. When you contact me, I will show you the pros and cons of each option and the cost in dollars and cents. Looking forward to speaking with you to help arrange the process of turning your home into your dream home.

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