Can You Add Renovation Costs to Your Mortgage?

You have just found your dream home. It’s a quaint Cape Cod in the heart of downtown, just minutes from work. The only catch? The 1920s plumbing needs to be replaced – a project that’s slated to cost $20,000.

Fortunately, you have options to finance the project. Depending on the home and your creditworthiness, you might be able to negotiate a larger mortgage to cover the cost of needed renovations. In fact, lenders offer mortgages specifically designed for fixer-uppers. Some even offer loans for homeowners who want to remodel their current property.

Read on for more information about how you can finance a home that needs TLC.

WHAT IS A RENOVATION MORTGAGE LOAN?

A renovation mortgage loan allows home buyers to purchase and remodel a fixer-upper. This financing option is similar to a conventional 15-year or 30-year mortgage, except that the lender offers additional money to fund repairs.

As a homeowner, you’ll have the flexibility of determining exactly which projects you want to tackle. However, your lender will hold you to a timeline (normally six months). They’ll also require that you select a professional contractor.

Since renovation mortgages are a rarity in the home lending world, there are two primary options available to home buyers:

  • Fannie Mae HomeStyle Renovation Mortgage
  • FHA 203(k) Rehab Loan

FANNIE MAE HOMESTYLE

The Fannie Mae HomeStyle Renovation Mortgage allows home buyers to bundle a property’s purchase price and repair costs into one loan. Since these loans are backed by a government agency, lenders can offer better rates even to those with less-than-perfect credit.

To qualify for a HomeStyle loan, you must have:

  • Sufficient cash reserves to put down 3-5% of the total loan amount.
  • A credit score of at least 620.
  • A debt-to-income ratio of less than 50% (monthly debts divided by monthly gross income)

WHAT CAN A HOMESTYLE MORTGAGE BE USED FOR?

A HomeStyle loan can be used to purchase and renovate almost any property – from single-family homes to multifamily investment properties.

This financing option is also flexible as far as which projects you choose to take on. As long as the repairs are completed within 12 months of the loan origination, you can fund projects such as:

FHA 203(K) REHAB LOAN

An FHA 203(k) loan – also known as a mortgage rehabilitation loan – allows home buyers to roll real estate and renovation costs into one mortgage. This loan is backed by the Federal Housing Administration (FHA) and can take the form of a fixed-rate mortgage or adjustable-rate mortgage.

To qualify for an FHA 203(k), you must have:

  • A credit score of at least 500.
  • Enough cash for a 3.5% down payment if you have a credit score of 580 or higher. If your credit score is lower, you’ll need enough cash for a 10% down payment.
  • A debt-to-income ratio of no more than 43%.

WHAT CAN AN FHA 203(K) LOAN BE USED FOR?

Generally, any upgrade that increases the value of a home is covered under an FHA 203(k) loan. For example, you may choose to:

  • Update plumbing
  • Repair the existing HVAC system
  • Enhance the home’s accessibility
  • Install a porch
  • Make energy-efficient modifications
  • Overhaul landscaping

Luxuries such as swimming pools, hot tubs, and outdoor fireplaces aren’t covered under an FHA 203(k) loan

PROS & CONS OF A RENOVATION MORTGAGE LOAN

Remember that quaint Cape Cod in the heart of downtown? A renovation mortgage loan can help you move in, fix those leaky pipes, and live happily ever after.

But there are some downsides to a renovation mortgage. Namely, they may command a higher interest rate. You’ll also be expected to jump through innumerable hoops to get the money you need.

PROS OF A RENOVATION MORTGAGE LOAN

  • Allows you to purchase a home that may otherwise be ineligible for financing.
  • Provides the cash you need to make necessary repairs.
  • Offers a lower interest rate than personal loans, credit cards, and other debt instruments.

CONS OF A RENOVATION MORTGAGE LOAN

  • Lender typically has oversight on use of renovation funds.
  • Requires extra paperwork, inspections, and appraisals.
  • If you don’t use the money wisely, you could end up owing more than your home is worth.

RENOVATION FINANCING FOR EXISTING HOMEOWNERS

So far, we’ve discussed financing options for home buyers looking to purchase a fixer-upper. But what if you want to make modifications to your current residence?

As a homeowner, you can either:

  • Increase your existing mortgage with a cash-out refinance or 
  • Take out a second mortgage with a home equity loan/HELOC

The best financing option for you depends on your estimated renovation budget as well as your income and monthly expenses.

 

INCREASING EXISTING MORTGAGE TO PAY FOR RENOVATIONS

Do you want to upgrade your dark basement into an at-home gym? Or maybe you want to give your kitchen a facelift? No matter the vision behind your remodel, you might be able to fund it with a cash-out refinance.

A cash-out refinance essentially replaces your existing home loan with a larger one. This new, shiny loan pays off your original mortgage. Then, you get to pocket the difference at closing and use the cash for anything you’d like.

You may wonder: “What’s the catch?” The downsides of a cash-out refinance include:

  • A larger mortgage with higher monthly payments.
  • A higher interest rate.
  • Closing costs that run from 2-6% of the loan amount.

TAKING OUT A SECOND MORTGAGE TO PAY FOR RENOVATIONS

If you need extra money for renovations, it’s possible to secure a second mortgage either with a home equity loan or a home equity line of credit (HELOC for short).

HOME EQUITY LOAN

A home equity loan allows homeowners to borrow against their equity. This loan acts as a second mortgage and is amortized over five to 20 years.Though you can use the money from a home equity loan for about anything – from upgrading your en suite bathroom to adding a three-car garage – you risk losing your home if you default on the loan.

HELOC

A HELOC allows homeowners to borrow against their equity too. However, rather than receiving a lump sum, you’re granted access to a revolving line of credit over a five- to 10-year period.

As with a home equity loan, defaulting on a HELOC could result in foreclosure. HELOCs are especially risky because they come with a variable interest rate that changes based on market conditions.

YOUR DREAM HOME IS WITHIN REACH

No matter if you’re a first-time home buyer purchasing a fixer-upper or an existing homeowner gutting your kitchen, finding the cash for repairs is tricky. Though lenders offer loans for home renovations, you still need to be aware of the loan terms and other clauses before signing on the dotted line.

At Portico, our general contractors have witnessed the stress that comes with securing financing. To make the renovation process easier on homeowners, we always offer a free project estimate. We also do everything in our power to stick to your budget.

To learn more about how Portico can make your dream home a reality, contact us today.