Are you considering renovating your kitchen, installing a pool or outdoor living space, adding a bedroom or home office, or adding a granny flat (aka casita or accessory dwelling unit)? Have you been told you don’t have enough equity to finance your desired project? Would you like to finance upgrades to a home you are purchasing? A renovation loan could be the ideal product to complete your improvement project.
Home improvement financing:
A home improvement loan is a secured loan that provides funds for renovating or upgrading a home. These loans can be:
• A purchase money mortgage that includes funds for improvements
• A standard cash out refinance
• A renovation loan that uses the “as improved” value when your “as is” value is not high enough to fund your project with a standard cash out refinance
When to use a renovation home loan:
A renovation loan can be used to purchase a home that requires extensive upgrades before moving in. Very simply, you can avoid spending hard earned cash to improve a home by financing the improvements into the acquisition loan, thereby limiting the total savings needed for down payment and post-purchase upgrades.
A renovation loan can allow you to purchase a home that might otherwise require a cash offer. This key feature may help you purchase at a discount because homes that require cash buyers limit the universe of potential buyers. Homes in poor condition are commonly purchased by “flippers” who pay cash and bid below the fair market price to ensure a profitable transaction. Further, a renovation loan used to acquire and improve a home allows you to quickly build equity.
For those with significant equity in their home, a standard cash out loan could provide the funds required for the desired project. These use the current “as is” value to determine the max loan amount. Conventional cash out loans typically allow the loan amounts up to 80% of the home’s current value. For example, if your home is worth $700,000, the max loan is $560,000.
Assuming a conventional cash out loan can pay off the current loan, finance closing costs and fund project costs, you probably don’t need a renovation loan.
When the “as is” value is not high enough to approve a loan that pays off the current loan, finance closing costs and funds the project cost, a renovation loan should be considered. These use the “as improved” value when determining the max loan amount. For example, assuming the “as is” value of the home is $700,000 and the proposed improvements will add $150,000 to value, the “as improved” value will be $850,000.
Renovation loans underwritten to conventional loan guidelines allow the max loan amount to be 95% of the “as improved” value. Therefore, if the “as improved” value is $850,000, the max loan amount in a high cost area is $807,500.
Counterintuitively, Fannie Mae Homestyle loans commonly price somewhat better than standard cash out loans because they are not considered cash out, a distinction that limits the adjustments to price based on loan purpose (namely, cash out versus no cash out).
A home improvement loan can also be underwritten as a FHA 203(k) loan. While the Fannie Mae Homestyle loan is commonly preferred to the FHA 203 (K) because the mortgage insurance requirements for FHA are relatively expensive, there are circumstances where FHA is the best option. This can happen when debt-to-income ratios or credit scores don’t meet conventional loan guidelines.
Home improvement loan projects:
A standard cash out loan can be used for any improvements and involves no post-funding interaction with the lender. Instead, you get all the proceeds needed for the project at close. Contractors will provide a progress payment schedule that spells out when funds are needed to continue the project. With a standard cash out refinance, you can pay your contractor whenever they need a progress payment.
Fannie Mae HomeStyle loans can be used for most any improvement project. They can be used for primary residences, second homes, single family investment homes and warrantable condos. The lender escrows the loan proceeds and disburses during the course of construction, using a five draw system. This adds helpful oversight to ensure the contractor doesn’t get paid before progress milestones are complete.
Be aware, when the “as improved” value is critical to approving a sufficiently large loan amount, consideration needs to be given to improvements that will increase the home’s value. Very simply, a $100,000 improvement project may not increase the home’s value by that amount.
The FHA 203(k) loan can be used for specific improvements such as replacing flooring, plumbing and roofs, removing safety and health hazards and upgrading to accommodate a person living with a disability. However, the loan cannot be used for luxury upgrades, such as installing a swimming pool or hot tub. This loan is only for primary residences and cannot be used for second homes or investment properties.
Like the Fannie Mae HomeStyle loan, the FHA 203 (K) involves escrowed loan proceeds and a five draw payment schedule.
Home improvement pitfalls:
You may not want to commence a home improvement project unless you plan to own the home long enough to enjoy the upgrades. For example, if you want a pool but only plan to retain the home for a year or two, you may not get the cost of the pool back when you sell.
Improvement projects frequently include change orders and cost overruns. Therefore, you should budget for around 10% above the contractor’s bid to ensure you have the resources to accommodate a change you may want to make during construction. Improvement projects commonly take longer than expected, particularly when supply chains are snarled up. Delays can present real issues if you cannot live or work from home during the construction process.
At Eagle Nest Realty & Mortgage Inc., we have first hand experience with ground up construction and major remodeling. Coupled with our real estate agent and mortgage lending background, our experience provides valuable perspective that will help you navigate the home improvement journey.
We have relationships with local contractors that would be pleased to help you design and complete your desired improvements. Our contractors are experts at anticipating problems (such as challenges associated with tying into existing structures) so their bids will be more accurate. To compare contractor bids, it is important to have a clear understanding of what is included and not included in your bid. Some contractors allocate material costs (such as appliances) that are not aligned with your expectations, so it is a good idea to shop for the homeowner selected options before finalizing the material cost portion of your contract.
We have over 20 years of mortgage brokering experience and have nurtured relationships with top quality lenders that will help us secure the most advantageous loan product for your home improvement project.
Call us today at 760-806-0035 to discuss your home improvement plans or use the Contact Us button to schedule an initial consultation.
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