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Home Improvement Loans: Best Options for Renovating Your Home

home improvement loan options

Homeowners upgrade their houses for many reasons, but almost all of them care about getting a decent return on their investment when they sell. If you’re thinking about raising your home value by making improvements to your house, you may want to explore different home improvement loans for your home renovation project.

Financing may be a good choice for you if you don’t have enough cash to cover the costs of improving your home. Some of those financing options require equity in your home. Home equity is the difference between your current mortgage balance and the value of your home.

The more home equity you have, the more you can borrow to make home improvements. If you don’t have enough equity or don’t want to secure another loan on your home, there are other borrowing options.

We’ll cover the mechanics — and pros and cons — of different types of fix-up financing in this guide to home improvement loan options.

In this guide, we’ll cover:

Paying for home improvements

Using the equity in your home to pay for improvements and remodeling is a great way to reinvest your equity — and potentially increase the value of your home.

Return on investment, or ROI, is determined by a few things — how much a seller is willing to pay for an upgrade you’ve made, what it costs you to complete the upgrade and the cost of financing the improvement.

We’ll start with loan options that put the equity you have in your home to use, or allow you to borrow against the estimated value of your home after your improvements (this is only possible with renovation loans, which we’ll explain later).

Loans using your home equity for home improvements

One of the benefits of homeownership is being able to tap equity as it builds up over time. When you’re borrowing against home equity, it’s important to know how different mortgages work and the costs and payments associated with them so you can pick the best program for your home improvement needs.

One thing that is unique to home improvement loans is whether the loan is based on your current value or your after-improved value. To lend you money, a mortgage bank will need to determine your home’s value. When you bought your home, you most likely obtained an as-is appraisal, which is an independent third-party professional home appraiser’s opinion of how much your home is worth with all of its current features.

If you take out a renovation loan, lenders look at the after-improved value of the home. In other words, your loan is based on how much an appraiser values your home as if the kitchen is remodeled, the deck is built and the new garage door is installed. This gives you extra borrowing power.

The extra renovation lending power comes with extra hoops to jump through. Renovation lenders will need to approve your project and get a detailed cost breakdown. There will be a separate approval process of the people involved in the renovations. Licensed contractors usually need to oversee the project, significantly increasing the proposed costs if you were planning to have a handyman buddy help you in exchange for a steak dinner and a 12-pack.

Home equity loan

A home equity loan is taken out in one lump sum and paid back in monthly installments over a set time period, often 10 to 20 years. A home equity loan is secured by your residence. If you already have a first mortgage, your home equity loan becomes your second mortgage.

Most lenders limit home equity financing to 80% or 90% of your home’s value. This is commonly referred to as your loan-to-value (LTV) ratio. If you have a first mortgage, it’s called your combined loan-to-value (CLTV) ratio.

This table shows how much equity you could borrow based on these limits on a $200,000 house, with a current loan balance of $100,000.

Current Value Current Loan Balance
$200,000 $100,000
80% CLTV Maximum Home Equity Loan 90% CLTV Maximum Home Equity Loan
$60,000 $80,000

Home equity loans may have fixed or variable interest rates. Closing costs usually include an appraisal on the property. Try a home equity loan calculator for an idea of how much you might be able to borrow.

Pros

  • Leaves first mortgage alone
  • No restriction on use for renovation
  • Fixed monthly payment
  • Lower costs compared to cash-out refinances or renovation loans
  • Interest may be tax deductible
  • No limits on how you choose contractors for work

Cons

  • Higher rate for credit scores below 760
  • Loan is based on the current value of your home
  • Could lose your house if you default

Home equity line of credit (HELOC)

A home equity line of credit (HELOC) works like a credit card, except it’s secured against your home. Instead of taking out one large lump sum like a home equity loan, you can withdraw money on the line as you need it.

The monthly payment is based on the amount charged. HELOC lenders may allow an interest-only payment option, making the monthly payment very low. You usually can draw on the line for the first five to 10 years during your draw period.

After the draw period ends, the remaining balance must be paid in fixed installments of 10 to 20 years. Most HELOCs come with variable rates. Closing costs are often minimal, and bank HELOCs may not require a full appraisal.

Pros

  • Leaves first mortgage alone
  • Lower minimum payment if interest-only option is chosen
  • No restriction on use for renovation
  • Charge and pay off as needed
  • Low closing costs
  • No limits on how you choose contractors for work
  • May not need appraisal
  • Interest may be tax deductible

Cons

  • Higher rate with credit score below 760
  • Variable rate
  • Loan based on current home value
  • May have prepayment penalty
  • Could lose home if you default

FHA Title 1 loan

An FHA Title 1 loan is a home improvement loan offered by approved lenders through the Federal Housing Administration (FHA). It’s designed to finance light-to-moderate home renovation projects. A Title 1 loan functions like a home equity loan — you receive the funds in a lump sum. If you borrow $7,500 or more, it will be secured by your home. The payments are based on a fixed-rate installment schedule of 12 to 20 years, depending on the type of home you are financing.

One major difference from a home equity loan or HELOC is that a Title 1 loan doesn’t require any equity in your home. The loan is made based on the cost of the improvements, plus allowable fees. Another big difference from other home equity loans is that Title 1 loans have no income or credit qualifying requirements. As long as you aren’t in default on your current mortgage or any other federal debt, you may be eligible.

Only basic upgrades can be made, such as replacing a roof or adding air conditioning. The maximum loan amount for a single-family home is $25,000.

Pros

  • No equity needed
  • No income requirement
  • No credit score requirement
  • Loan based on costs of improvements, plus fees
  • Interest tax deductible

Cons

  • Limits on the type of renovations allowed
  • $25,000 maximum loan for single-family residence
  • Could lose house if you default

Cash-out refinance

As mentioned above, home equity loans, HELOCs and Title 1 loans are also known as second mortgages. Another way to tap equity is by taking out a new first mortgage for more than you owe, paying off your current mortgage and pocketing the difference. This is known as a cash-out refinance, and the amount of equity you can borrow depends on the type of new loan you’re seeking.

Because the closing costs are based on a percentage of your loan amount, they tend to be higher on cash-out refinances because you are borrowing more to pay off your current loan and take the extra cash to pay for home improvements. The other big advantage over all of the renovation loans we’ll discuss a little later — you can use the funds in whatever manner suits your home improvement needs. There are no special project or contractor approvals for any of the standard cash-out refinance programs.

Here are the most common cash-out refinance programs.

Conventional cash-out refinance

Conventional loans are the most popular loan type for buying and refinancing a home. They allow you to borrow up to 80% of the value of your home without requiring any mortgage insurance. Private mortgage insurance (PMI) protects the lender if you default, and the annual premium is paid monthly on most conventional mortgage loans with less than 20% equity.

You can choose a fixed-rate or adjustable-rate mortgage (ARM). Borrowers with higher credit scores will get the best rates and the lowest payments on conventional cash-out refinances.

Pros

  • Lower rates than home equity loans or HELOCs
  • No restriction on use of funds for renovation
  • No limits on how you choose contractors for work
  • Interest may be tax deductible

Cons

  • Higher closing costs compared to home equity loans, HELOCs and Title 1 loans
  • Harder to qualify with lower scores
  • Loan is based on current home value
  • Could lose house if you default
  • More documentation required for approval

FHA cash-out refinance

If you apply for a refinance before Sept. 1, 2019, you’ll be able to borrow 85% of the value of your home with an FHA cash-out refinance. However, after that date, you’ll be limited to 80%.

FHA cash-out refinances require mortgage insurance regardless of how much equity you have. They are a good option for borrowers with lower credit scores or those who need additional flexibility qualifying for financing. The mortgage insurance can be expensive — both a lump-sum upfront mortgage insurance premium (UFMIP) and monthly mortgage insurance premium (MIP) are charged on every FHA loan.

Pros

  • Lower rates than home equity loans or HELOCs
  • No limits on contractors chosen for work
  • Qualify with lower FICO Scores
  • Interest may be tax deductible

Cons

  • Mortgage insurance is required regardless of equity
  • Loan is based on current home value
  • Could lose house if you default
  • There may be appraisal-required repairs
  • Higher closing costs
  • More documentation needed for approval

VA cash-out refinance

Current and retired members of the military may be eligible for VA cash-out refinancing up to 100% of the value of their home until November 2019. New VA requirements will limit cash-out loans to 90% after that date.

VA home appraisals may require you use the cash to fix specific items in your home, especially if there is a lot of deferred maintenance. Depending on where you live, the VA may require additional inspections, such as termite reports or well inspections.

Pros

  • No mortgage insurance requirements regardless of equity
  • Lower rates than conventional cash-out refinances, home equity loans or HELOCs
  • No credit score minimum
  • Interest may be tax deductible

Cons

  • Must be veteran or active-duty service member to qualify
  • May require funding fee
  • Loan is based on current home value
  • Could lose home if you default
  • Appraisal may require repairs to meet VA minimum property requirements
  • Higher closing costs
  • More documentation needed for approval

FHA 203(k) renovation refinance

Much like the Title 1 loan, the FHA 203(k) loan is designed to finance home improvements even if you currently have no equity in your home. The loan is made based on after-improved value, and the program allows for higher loan amounts and bigger renovation projects than the Title 1 loan program. The program effectively allows you to borrow against future equity created by the value you gain from home improvements.

The priority is on making sure the property is safe and habitable. FHA 203(k) lenders won’t allow luxury upgrades such as pools or custom upgrades such as theater rooms. Besides the approval process needed for contractors to do your home improvement, the FHA will also assign a U.S. Department of Housing and Urban Development (HUD) inspector who will be part of the process until the home is built.

Pros

  • No equity needed
  • Loan based on after-improved home value
  • Lower FICO Score requirements
  • Higher loan amounts than Title 1 loans
  • Interest may be tax deductible

Cons

  • Limits on type of renovation
  • Requires a HUD-assigned inspector
  • Higher total costs, including mortgage insurance
  • Could lose house if you default
  • Extra approval process for contractors and project

Conventional renovation loan

If you’re looking to make extra upgrades, including luxury items that aren’t allowed under the FHA’s 203(k) renovation program, a conventional renovation loan is a good choice. As with other renovation programs, the loan amount is based on the value of the home after improvements.

The Fannie Mae Homestyle® Renovation Mortgage allows you to borrow up to 97% of the after-improved value of a single-family residence.

Pros

  • No equity needed
  • Loan based on after-improved home value
  • Luxury upgrades can be added
  • Lower rates for better credit scores
  • Interest may be tax deductible
  • More flexibility with contractors

Cons

  • Higher FICO Scores needed
  • Could lose house if you default
  • Extra approval process for contractor and project

Other loans to finance home improvements

Use a credit card

If the project costs are relatively low (a few hundred to a few thousand dollars), paying by credit card might be a viable option. There might be rewards or cash back, and if you can pay off the balance quickly, it might makes sense.

Cards with 0% introductory rates can give you up to 21 months to make purchases and pay the balance without accruing interest.

Pros

  • No liens on house
  • Approval process is simpler
  • No appraisal on home

Cons

  • Credit score could drop if cards maxed out
  • If you don’t pay the balance on a deferred-interest card, you will end up paying much more than you expected
  • Interest is not tax deductible

Take out a personal loan

Personal loans typically require no collateral, unlike home equity financing. If a homeowner runs into financial trouble, the personal loan can be included in a bankruptcy proceeding without putting your home at risk of foreclosure.

Interest rates can be low for those with excellent credit. Typical terms range from two to five years for amounts of up to $50,000.

Pros

  • No liens on house
  • Simple online application process with minimal documentation required
  • No appraisal on home

Cons

  • Loan amount caps may give you less home improvement funding
  • Interest not tax deductible
  • Rates usually higher than mortgages

Borrow against retirement

Some companies allow employees to borrow against their 401(k) accounts. Interest rates are usually low (you’re borrowing from yourself) and there are no fees. However, if you leave the company, the loan must be paid in full or it becomes taxable. There is a 10% penalty as well. Taxes and penalties for early withdrawals can be substantial.

Pros

  • No liens on house
  • Easy to qualify for based on vesting in 401(k)
  • Very little paperwork
  • No appraisal on home

Cons

  • May have a penalty if you don’t pay back
  • Loss of opportunity to grow retirement fund value on the balance of the loan

How to qualify for home improvement loans

Qualifying for any type of loan that uses your home’s equity starts with the same basic process you followed when you bought your home. The lender runs a credit report and verifies your income to determine your ability to repay the loan.

A title company checks for liens on your home, and may request an appraisal. You’ll want to pay especially close attention to the debt-to-income (DTI) ratio maximums. DTI is a measure of how much total debt you have compared to your before-tax income. Lenders will scrutinize this ratio to make sure you aren’t over-borrowing.

The section below provides a snapshot of what it takes to qualify for each type of home improvement loan we’ve discussed.

Home equity loan

  • Income verified/DTI maximum: Yes; 43% DTI
  • Asset verified: No
  • Credit report: Yes; 760 or higher for best rate
  • Title needed: Reduced
  • Appraisal: Maybe

HELOC

  • Income verified/DTI maximum: Yes; 43% DTI
  • Assets verified: No
  • Credit report: Yes; 760 for highest rate
  • Title needed: Reduced
  • Appraisal: Not usually

FHA Title 1 loan

  • Income verified/DTI maximum: Yes; 45% DTI
  • Assets verified: Not usually
  • Credit report: No minimum required, but no federal defaulted loans
  • Title needed: Full
  • Appraisal: Full

Conventional cash-out refinance

  • Income verified/DTI maximum: Yes; 45% to 50%
  • Assets verified: May be needed
  • Credit report: 620 minimum
  • Title needed: Full
  • Appraisal: Full

FHA cash-out refinance

  • Income verified/DTI maximum: Yes; 43% recommended
  • Assets verified: May be needed
  • Credit report: 580 minimum; 500 with exception
  • Title needed: Full
  • Appraisal: Full

VA cash-out refinance

  • Income verified/DTI maximum: Yes; 43% recommended
  • Assets verified: May be needed
  • Credit report: No minimum requirement
  • Title needed: Full
  • Appraisal: Full

FHA 203(k) renovation refinance

  • Income verified/DTI maximum: Yes; 43% recommended
  • Assets verified: May be required for reserves
  • Credit report: 580, but lenders may require higher
  • Title needed: Full
  • Appraisal: Full

Conventional renovation loan

  • Income verified/DTI maximum: Yes; 43% recommended
  • Assets verified: May be required for reserves
  • Credit report: 620, but lenders may require higher
  • Title needed: Full
  • Appraisal: Full

Credit card

  • Income verified/DTI maximum: No; no DTI maximum
  • Assets verified: None verified
  • Credit report: Credit score for rate and maximum line
  • Title needed: None
  • Appraisal: None

Personal loan

  • Income verified/DTI maximum: Loan amount may be capped based on income
  • Assets verified: No
  • Credit report: Credit score will determine rate and maximum
  • Title needed: None
  • Appraisal: None

401(k) loan

  • Income verified/DTI maximum: No maximum
  • Assets verified: Sufficient balance and vesting to support loan
  • Credit report: None
  • Title needed: None
  • Appraisal: None

For most loans involving home equity, the lower your credit score, the less you’ll be able to borrow. The most notable exceptions are the VA and FHA cash-out refinance options. FHA Title I, FHA 203(k) and FHA cash-out refinances offer the most flexibility for credit-challenged borrowers who aren’t eligible for a VA loan.

Top 5 home improvements in 2019 for return on investment

Before you get the sledgehammer out and start knocking down walls, you might want an idea of which projects are recouping the most in value, and how much you’ll shell out to complete the projects. The costs and ROI may vary by location, so check out the project cost and the potential benefit to values in your area.

The home improvements listed below will get you the best value returns on your home improvement investment.

Most of the improvements that made the Top 5 for best return on improvement dollar investment are to the outside of your home. Curbside appeal is something real estate agents talk about a lot, and that first impression can have an impact on a potential buyer before they even walk through your front door.

A minor kitchen remodel tops the list for best ROI for improvements inside the home, so the money spent to have a nice updated kitchen is worth the expense when it comes time to sell.

Getting the best deal on a home improvement loan

Studies have shown it pays to shop around for any type of loan. You can see how much other homeowners have saved shopping for the best mortgage rate by checking LendingTree’s Mortgage Comparison Shopping Report.

Credit card and personal loan companies may compete for your business by waiving fees or offering cashback rewards. You can keep track here.

Your credit score will have the most impact on the rates you get for any type of loan. You can obtain your free credit score before you start rate-shopping — and get tips on how to improve it.

The ultimate goal with any home is to own it free and clear of any debt. Home improvements may help increase the value of your home, but every loan secured by your home lengthens your path to a mortgage payoff party.

It’s always best to minimize the amount of equity you borrow against. When it comes time to sell the home or pass it down to the next generation, you or your heirs will have a loan-free residence.

 

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