What Is a Home Renovation Loan and Should You Think About One?

For many homebuyers, a picture-perfect, move-in ready home is the dream. For others, a project house they can get for a discount and then put their personal stamp on is too good to pass up. The problem with many of these “project houses,” though: coming up with the money to complete the projects.  Once you’ve depleted your savings to gather the funds for your down payment and closing costs, there may not be much left over to knock down that wall between the kitchen and living room, redo the counters and cabinets, and put in new hardwood flooring. Add in the costs of new furniture and hiring movers, and it could be years before you’re finally ready to make those improvements.  This is where a home renovation loan can help.  What is a home renovation loan? Although they are growing in popularity, home renovation loans are not anywhere near as prevalent as FHA loans for first-time buyers. “According to the Mortgage Bankers Association (MBA), first-time home buyers account for more than 75 percent of FHA home purchases,” said FHA Handbook. But maybe they should be. After all, a home renovation loan can scratch a few different itches: 1.  It feeds into that tempting renovation craze, offering an opportunity to redo a home with funds that are tied into your loan.  2.  It allows buyers who can’t afford a move-in home, or who are making offers and losing out on those homes, to purchase something that is likely more affordable.3.  It gives buyers a chance to build equity quickly. Here’s how it works. Renovation loans bundle funds for the home purchase and renovation. There are a few different options from which to choose. Here are the most popular: Fannie Mae’s HomeStyle Renovation loan—The Fannie Mae HomeStyle loan is a single-close loan that includes the cost of home repairs in the overall loan amount. This loan can be used for repairs that an appraiser requires, or for changes the homeowner wants to make, and it can be used to pay for both structural and cosmetic repairs. The Fannie Mae HomeStyle Renovation mortgage requires a 5% down payment and is open to investors, as well. “With a down payment of less than 25%, you’ll need a credit score of at least 680,” said Interest.com. “If your debt-to-income ratio is higher than 36% but less than or equal to 45%, your credit score needs to be 700 or higher.” The funds can be used for repairs, renovations, or energy improvements. “The only restriction is that the changes must be permanently affixed to the property and add value.” FHA 203(k)—Similar to the HomeStyle loan, this option is government-backed and has lower credit score requirements. Keep in mind that FHA loans require mortgage insurance premiums if you have less than a 20% down payment, which can raise your monthly payment. The FHA also requires the borrower to pay an upfront fee, which will make your initial out-of-pocket costs higher.   FHA 203(k) Loan Options Limited 203(k) Loan (formerly Streamline): Purpose: Ideal for repairs, upgrades, or remodeling that do not require structural work (e.g., kitchens, bathrooms, painting, appliances). Budget: Up to $75,000 in renovation costs. Requirements: Generally no minimum repair cost, but repairs must be completed within 9 months. Contractor: Licensed contractors must be used, but a HUD consultant is not required. Standard 203(k) Loan: Purpose: For major rehabilitation, including structural alterations (e.g., additions, foundation work, reconfiguring rooms). Budget: No specific maximum repair limit, but total loan must fall within local FHA mortgage limits. Requirements: Repairs must exceed $5,000, and a HUD-approved consultant is required to oversee the project. [1, 2, 3, 4, 5] FHA’s 203(k) loan “requires a minimum credit score of 500 with a down payment of at least 10%; a credit score of 580 or higher allows a down payment of 3.5%,” said MarketWatch. “These loans can’t be used for work that the FHA deems a luxury, such as installing a swimming pool.”