Wrap your renovation costs into a refinance
During the recession, many homeowners lacked the funds for home renovation projects and were wary about spending money on a declining asset. Now that home values are rising, remodeling projects are regaining their popularity.
Remodeling activity has been improving for the past four quarters, according to the Joint Center for Housing Studies of Harvard University's Leading Indicator of Remodeling Activity (LIRA) released in July 2013. The report estimated that $133.7 billion was spent on remodeling in the second quarter of 2013, an 8.6 percent improvement over the second quarter of 2012.
Rising home values give homeowners more options for paying for a renovation, says Bill Trees, vice president and national program manager for renovation lending for Wells Fargo Home Mortgage in Colorado Springs, Colo.
"The decision is different for each consumer, but you can use cash, refinance with a renovation loan or take out a home equity loan," he says. "Most banks today will do a combined loan-to-value of a first mortgage and a home equity loan up to 80 or sometimes 90 percent, but that may not be enough to pay for a renovation."
Refinance renovation loan
If you have less than 20 percent equity, a renovation loan may be the best financial option, suggests Brian Koss, executive vice president of Mortgage Network in Danvers, Mass.
Refinancing via renovation loans, specifically FHA 203(k) and Fannie Mae HomeStyle Renovation loans, allow you to wrap home improvement costs into a new mortgage. The loan amount is based on the combination of your home's current appraised value and estimates of the renovation costs.
For example, if your home is worth $200,000 and you want to spend $30,000 on repairs, your new loan amount would be $230,000. You can also wrap closing costs and fees into the loan.
Sue Pullen, senior mortgage advisor for Fairway Mortgage in Tucson, says homeowners should consider refinancing with a renovation loan more often than they do.
"A lot of lenders don't know about these programs, but it's much better to refinance than to charge your remodeling projects to a credit card or to use up all of your cash," says Pullen. "The qualifications for renovation loans are the same as they are for any other refinance in terms of your credit score and your debt-to-income ratio."
Koss says that FHA loans usually require a credit score of 640 or above, while Fannie Mae usually requires a score of 680 to 720 or above. He says the FHA is more lenient on debt-to-income ratios than Fannie Mae, but says the higher mortgage insurance premiums on FHA loans make them less attractive.
"The interest rates on both loan programs are about one-fourth to one-half percent higher, or sometimes as much as 1 percent higher than standard loans," says Koss. "You're paying that higher rate on the entire balance including your renovation costs. Some people take out these loans and then refinance into a lower rate after the work is completed."
FHA 203(k) loans, available only to owner-occupants, have two options:
- The streamline loan can be used for up to $35,000 in renovation costs
- The standard loan is unlimited but requires a minimum renovation of $5,000
Structural repairs can only be made with the standard program, and neither allows you to pay for a luxury item such as a swimming pool.
"If you do the full 203(k) loan you're required to have a HUD consultant evaluate the plan and contractor bids," says Koss. "There are also time restrictions on these loans to make sure that the homeowners actually complete the work as intended."
The HomeStyle Renovation loans, available to owner-occupants, investors and for second homes, have no minimum spending requirement, but the maximum spent on repairs can be no greater than 75 percent of the home's after-repair value ($150,000 on a $200,000 home).
You can only borrow up to the maximum loan limit for your area.
Renovation loan steps
Trees says you should start by estimating the cost of your project and consulting a lender for preapproval. You'll need bids from contractors for the final loan approval.
"One drawback to these renovation loans is that you can't change the loan amount," says Koss. "You can't have a 'while you're at it' moment with your contractor because you can only do work that was approved by the lender."
Once you've been approved for a loan, the lender will release funds to the contractor on a schedule so that the work can be completed, says Pullen. Final payments are distributed after the work is completed and inspected.
"It's extremely important to work with a lender who understands the different renovation loan programs and has experience," says Pullen. "They're more complicated because of the involvement of the lender with your contractors but they're a great option for some homeowners."
Michele Lerner, author of "HOMEBUYING: Tough Times, First Time, Any Time", has been writing about personal finance and real estate for more than two decades for a variety of publications and websites including The Washington Post, The Motley Fool, Investopedia, Insurance.com, HSH.com, SavingsAccount.com, National Real Estate Investor magazine, The Washington Times, Urban Land magazine, NAREIT's REIT magazine and numerous Realtor associations.