Owning a fixer-upper has been a fun journey for our family. But it hasn’t always been easy. Besides not always having running water and never having central A/C, we’ve also had to figure out how to finance all the repairs our home needs.
I’m happy to say that we’re now well on our way. Soon, we’ll be closing on a mortgage that will allow us to pay contractors to finish the rest of the work on our home.
Going through this process has taught me quite a bit about options for financing a fixer-upper. And there are plenty of excellent options out there. In this article we’ll talk about when financing a renovation makes sense and share five of the best ways to pay for a remodel.
Overview of the 5 Ways to Pay for Your Remodel
- A second mortgage
- Cash-out refinancing
- Renovation loans
- Unsecured debt
When Should You Renovate?
Before we talk about how to pay for a remodel, it’s important to understand when it makes sense to renovate and when it doesn’t. Mortgage lender James Dix says that The length of time in which you plan to stay in the home should be a significant variable.
The key is to think about breaking even. If you’re investing tens of thousands of dollars into your home, you’ll still have at least 80% equity when you’re done. You could break even really quickly. In fact, you could likely turn around and sell the home, getting your money back out of it immediately.
But if you’re going up to 90% or more of your equity, think long and hard about putting money into renovating your home. This is especially true if you think you’ll sell in the next five years.
Dix recommended checking online to see what renovations are adding the most value in your area and then focusing on those renovations. As a general rule, he said, kitchens, baths, and adding square footage that’s where you get the most bang for the buck. . . Your least bang for the buck is the things that have to be done, but they’re not sexy. So roofs, plumbing, electrical, HVAC systems, etc.
When in doubt, talk to a local appraiser or realtor if your goal is to make your home easier to sell at a higher price. However, if you’re not looking to sell, the decision becomes an easier one. As long as you keep yourself at that 80% threshold, or a little higher if you must, you’re likely making a good investment in your home remodel.
How to Pay for Home Renovations
You can do many value-adding home renovation projects for a relatively small amount of money. For instance, painting is a cheap way to upgrade the look of your home. Or you could lay a new floor in a tiny bathroom to modernize it. These upgrades could cost just a couple thousand dollars.
In this situation, it probably doesn’t make sense to go through the lengthy second mortgage or refinancing process. Instead, you may want to simply make a plan to save up cash ahead of time to avoid paying interest. Looking for some money-saving ideas? Here are 92 ways to start saving more of your income.
In addition to trimming your expenses, you may also want to consider adding a side hustle. Perhaps you could drive for a food delivery service (which has become incredibly popular during the pandemic) or walk dogs for a few nights each week. Check out these 75 side hustle ideas for more inspiration.
2. A second mortgage
A home equity line of credit (HELOC) or home equity loan can both be decent options for financing minor home renovations. A HELOC is a revolving loan on your home, meaning it works like a credit card where you can spend up to the line of credit and pay it down multiple times over the life of the loan. Home equity loans, on the other hand, are fixed-rate, fixed-term loans.
Both of these options are technically second mortgages. You can often take out a HELOC or home equity loan for up to 80% to 90% of the equity in your home. These loans come with a lien against your home. So, if you default, the bank will be able to foreclose on your home just as with a regular mortgage.
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That can sound a little scary, but using your home as collateral gives you access to lower interest rates. Plus, the interest you pay on a second mortgage usually qualifies for the mortgage interest tax deduction, just like interest paid on a regular 15- or 30-year mortgage.
Dix recommends homeowners look into a home equity loan first. This is mainly because interest rates are so low right now. HELOCs typically have variable interest rates. The interest rates right now are favorable, said Dix, but the interest rate is usually tied to prime. And while prime is low right now, we have every reason to believe that prime is going to go up in the coming years.
His bottom-line advice for consumers? Don’t take out a second mortgage, especially a variable-rate option, unless you’re able to pay it off within the next three years.
If you have some equity built up in your home and can pay off the cost of your renovations within a few years, a home equity loan might be a good option for you. But if you know you’ll be in the market to sell soon a HELOC may be a better option since they usually have very little closing costs and you wont have to worry as much about breaking even.
3. Cash-out refinancing
With a cash-out refinance, you’ll refinance your home and take cash out at closing. As with a second mortgage, this option will only work if you currently have equity in your home. Terms vary, but you can typically borrow up to between 80% and 90% of the current value of your home.
With a cash-out refinance, said Dix, You’re going to get a fixed rate, fixed term. You’re going to get low payments because you can go all the way out to 30 years on that. This is especially true in 2021 as mortgage rates have dropped to all-time lows.
On the flip side, you’ll have to pay closing costs that typically range from 2% to 5% of the loan amount. This exact cost can vary depending on whether or not you decide to pay points at closing and other factors. Closing costs on a cash-out refinance can be similar to those you expect to pay when buying a home.
However, there are some cash-out refinance options that have no closing costs. In this case, you’re basically rolling the costs you would have paid in closing into a slightly higher interest rate. If you’re not planning to stay in your home long, as well discuss briefly below, a no-closing-cost loan could be a better option.
A cash-out refinance can be a great option for DIYers. Renovation loans (which well cover next) require you to pay a contractor for at least some of the renovation costs. But with a cash-out refinance, the bank just hands you a big check at closing. You can do with that what you will, whether its paying a professional to upgrade your bathroom or putting in some sweat equity to do it yourself.
4. Renovation loans
Renovation loans are products that are built specifically for fixer-uppers. They come in two main flavors, which well detail below. But the thing they have in common is that you actually borrow against your homes future appraised value, which gives you more money to work with for renovations.
With FHA 203(k) loans, for example, you can take out up to 110% of your homes future value. Let’s say your home is currently worth $100,000 but would be worth $125,000 when you get finished with it. In this case, you could borrow up to $132,000 (125,000 x 110% = $132,000).
Renovation loans, like the other financing options listed above, have their pros and cons. For one thing, according to Dix, they’re often going to have a little bit higher interest rate, and they’re going to have a little bit higher closing costs. This is true of both types of renovation loans. And its certainly something to consider when shopping for ways to make your fixer-upper dream a reality. Below, we break down two conventional renovation loans as well as two FHA options.
Fannie Mae HomeStyle and Freddie Mac ChoiceRenovation
Fannie Mae and Freddie Mac each offer renovation loans which allow you to borrow up to $548,250 for your home. Fannie Mae’s product is called HomeStyle while CHOICERenovation is the name of Freddie Mac’s option.
With either program, you’ll be taking out a conventional loan. That means credit requirements will be somewhat strict. And you’ll need to make a down payment of at least 3.5%.
HomeStyle and CHOICERenovation are cheaper than the FHA 203(k) loan. But they do have one major caveat. You can only utilize up to 50% of the homes future value for renovations.
This might knock out these programs as options for you. But if you can qualify for one of these loans, Dix recommends it. The loans typically come with better interest rates. And you don’t have to pay PMI if you have at least 20% equity in your home.
FHA 203(k) and Title 1 Loans
The 203(k) program is administered by the FHA, which means that it has lower credit requirements than conventional loans. However, it also has a monthly mortgage insurance premium (MIP) that stays for the entire life of the loan. The only way to escape paying monthly MIP on an FHA loan is to refinance later.
The FHA 203(k) loan has two different options. The first option is the Limited 203(k) which covers up to $35,000 in renovation costs. But the renovations cannot include structural or health and safety renovations. The streamlined loan is cheaper and easier to administer since it doesn’t require several inspections during the renovation.
The regular or full 203(k) is more complicated. But it can cover any type of work, including structural renovations, and you can borrow up to 110% of your homes future appraised value. With a full 203(k), the limit on the total mortgage amount varies by location. You can find out here how much you could borrow under the 203(k) loan.
FHA Title I loans are secondary renovation loans that can be used in conjunction with a 203(k) loan. But Title I loans are more flexible in that they can be used to fund remodeling projects for manufactured homes, multifamily properties, and investment properties in addition to single-family homes. Loan limits range from $5,000 to $60,000 depending on your property type.
If you can qualify for the HomeStyle or CHOICERenovation, they’ll likely save you some money and some interest costs. If not, FHA loans are good choices. Plus, you can always refinance to a cheaper conventional mortgage a few months (or years) after your renovations are complete.
5. Unsecured debt
With each of the loans listed above, your home will be used as collateral. This adds security for the lender, which typically translates to lower rates for borrowers. But it also means that if you aren’t able to make your loan payments, your home could be foreclosed on.
With unsecured debt, such as credit cards and most personal loans, no collateral is required. This means that you wont be placing your home at risk by financing your renovations.
But there are downsides to unsecured debt too. For one, they’re typically less flexible with their credit requirements. And they also tend to have higher interest rates. For example, while 30-year mortgage rates are near 3%, the average interest rate on personal loans is 9.58% and the average credit card interest rate is 14.61%.
But if you use a 0% introductory APR credit card to pay for your remodel, you could get an interest-free introductory period of 12 months or longer. In this case, a credit card could actually be your most affordable way to finance low-dollar projects. If you do choose to use a credit card, though, just be absolutely certain that you’ll pay it off before interest charges kick in.
Personal loans, meanwhile, could be a good option if you need to cover an emergency home repair. While most traditional loans take weeks to close, its common for personal loan lenders to offer same-day or next-day funding.
You’ll need to consider your personal situation and unique needs to decide which is the best way to pay for your remodel. If you’re looking to make a relatively small update, saving up to pay cash or using a 0% APR credit card may be your best options.
But second mortgages, cash-out refinancing, and renovation loans are likely to be your three top financing choices for high-dollar renovations. And, finally, if fast funding is your top priority, you may want to consider applying for a personal loan.