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Remodeling/Home Improvement Loans: Which Is the Best Loan for You?

Why move when you can improve!

A major home improvement or remodel can cost a lot of money, especially if you’re making structural changes. Even though shortages of building materials are easing, there is still a shortage of labor that could make your project take longer. The rise in interest rates has caused more people to stay put and improve the home they live in with the hope of having to borrow less and still have the space and improvements they need. There is a lot to consider (see our article Things to Consider with a Home Renovation), but one of the first things you need to decide is how you will get the financing to pay for modest to major improvements. 

The big question is which type of loan is the best one for you and your project? 

Home Equity Loan (HEL) 

With a HEL, you borrow against your home’s equity—the difference between what your home is worth and what you still owe on your mortgage. If you have a mortgage, you continue making those monthly payments, while also making payments on your home equity loan. You must have enough equity in your home to qualify—typically at least 20%. 

You can usually borrow up to 85% of your home’s value, depending on the lender and your financial profile. You’ll receive the money in a lump sum. Your HEL will have a fixed interest rate over the lifetime of the loan. Repayment terms generally range from five to 30 years. 

Pros 

  • Typically comes with a lower interest rate than other types of loans because it is secured by your house and has  less risk for the lender. 
  • Is paid out as a lump sum, so if you know exactly how much you need to borrow for a big, one-time project like a remodel, this can be an advantage. 
  • Your payments won’t fluctuate because home equity loans have fixed rates. 
  • You could qualify for a tax deduction* on the interest, if you use the funds to “buy, build, or substantially improve your home.” Check with your CPA or tax advisor to be sure you are following IRS rules. 

Cons 

  • In addition to what you owe on your existing mortgage, you’ll have another loan to repay at the same time. Be sure you can make two loan payments before you get a home equity loan. 
  • You must pay closing costs. Talk to your lender about the percentage they are based on . The amount you’re borrowing should make the cost worth it. 
  • If you decide to sell your house, you’ll have to settle both your first mortgage and your home equity loan. This could leave you with very little, or maybe no cash proceeds from the transaction. 
  • If you end up needing more money than what you borrowed, it might be better to go with a revolving credit line such as a Home Equity Line of Credit (HELOC) that allows you to borrow repeatedly. 

Home Equity Line of Credit (HELOC) 

A HELOC is like a HEL, but you can borrow from it up to a preapproved limit, pay it off, and borrow from it again. Interest rates are adjustable; they can rise and fall over the loan term. Interest is only due on your outstanding balance and not on the entire line of credit granted. You can borrow only a portion of your maximum loan amount, making your payments and interest charges lower. Your credit score, income and home’s value all help to determine your maximum loan amount. HELOCs have a set loan term that varies in length, depending on both the lender and the borrower, but they can last as long as 30 years. This usually is divided into two periods that may include a 5-10-year draw period and a 20-year repayment period. 

Pros 

  • A good option if you are financing several less expensive or longer-term remodeling projects over time. 
  • Closing costs are minimal to none. 
  • You don’t have to take money from your account until you need it, and payment varies by the amount borrowed. 
  • The credit line or draw period is up to 10 years. 
  • You can re-use the funds that you repay. 

Cons 

  • Loan rates are adjustable. Your rate and payment can go up and down. 
  • Repayment terms can change, for example if your credit score goes down. 
  • Rates are typically higher than for a HEL. 
  • By the end of the term, the loan must be paid in full or the HELOC can convert to an amortizing loan. 

Construction Loan 

A construction loan is a short-term, interim loan for financing the cost of construction. It’s not usually their intended use, but construction loans can be used to finance home renovations. Before you take out a construction loan, you need to produce a builder’s contract, construction timetable, designs and a budget. All this needs to be done before beginning the loan application process. 

Pros 

  • They’re based on the home’s after-renovation value, which increases the borrowing power. 
  • You make no payments during the remodeling period.  
  • You don’t have to have a lot of equity in your home. 
  • The contractor only receives payment for the work performed, and you only pay interest on what’s paid out. 
  • You save money if construction costs are below the original amount of the loan. (Not likely.) 

Cons 

  • Most construction loans require a minimum credit rating of 620. 
  • There is a complex withdrawal process that can be frustrating for both the homeowner and the contractor working on the renovations. Borrowers don’t control the funds because they’re paid directly to the builder. 
  • The property will be subject to several inspections during the renovation.  
  • Loan proceeds are released as project goals are met, which could result in delays.  
  • You must refinance your current mortgage. This can be costly if your rate is lower than the current rate.  
  • Closing costs are based on your outstanding mortgage balance and renovation budget.  

Renovation Loan or FHA 203(k)** 

Renovation loans, or FHA 203(k)** loans, can be used for home renovation and are insured by theFederal Housing Administration(FHA). This allows you to both purchase and renovate your new home and make one monthly payment to cover both costs. Conventional loan borrowers may qualify for these loans through Fannie Mae (HomeStyle Renovation) and Freddie Mac (CHOICE Renovation). 

Cash-Out Refinance 

A cash-out refinance replaces your existing home loan with a new, larger loan. The difference between the two loans is the amount of cash you withdraw from the total equity in your home. There are no restrictions on the use of withdrawn cash, so you could use it for home improvements. The amount of equity you have in your home is the deciding factor in how much cash you’ll be able to access with a cash-out refinance.  

Cash-out refinance closing costs vary in their percentage of the total loan amount and are deducted from your “cash-out” at closing. Most lenders require you to retain 20% equity in your house after the cash-out is complete. This means having aloan-to-value (LTV) ratio of 80%. Maintaining 20% ownership of the property means you can avoid having to payprivate mortgage insurance (PMI). If you need cash for home improvements, have enough equity, and interest rates are favorable, a cash-out refinance might be the right solution for you. 

Get Advice from Your Citywide Loan Agent 

Whether you need cash for some minor home improvements or a major remodel, your Citywide Loan Agent will help you  research all the options and figure out the best type of loan for your specific needs. For expert loan advice, call us today at 

(866) 508-5515. 

*Citywide Home Loans, LLC does not provide tax advice. The consumer should always consult a tax advisor for information regarding the deductibility of interest and other charges in their particular situation. 

**Citywide Home Loans, LLC is an FHA Approved Lending Institution and is not acting on behalf of or at the direction of HUD/FHA or the Federal government.