Refinance to pay for home improvements
Whether you’re remodeling your kitchen, updating bathrooms, or completing other home improvement projects, renovations aren’t cheap.
To help cover the cost, some homeowners will drain a good portion of their savings or use a personal loan. But there may be a better way to get the cash you need.
Borrowing from your home equity via a cash-out refinance or renovation refinance could help you pay for home improvements at an ultra-low rate. And it will improve your home value at the same time. So this strategy is often a win-win.
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Refinancing is one of the best ways to fund home improvements. If you have enough equity, you can borrow thousands at a low interest rate — while increasing the value of your property at the same time. That means there’s a great return on investment, too.
Five loan options that allow you to refinance for home improvements include:
- Cash-out refinancing
- FHA 203k loans
- Fannie Mae HomeStyle loans
- Freddie Mac CHOICERenovation loans
- VA renovation loans
Other good options to pay for renovations include a home equity loan or home equity line of credit (HELOC). These ‘second mortgages’ let you borrow cash without refinancing. So they can be helpful if you want to leave your current mortgage in place.
Mortgage rates are still at historic lows. So any of these renovation refinance options can result in ultra-affordable financing on your home improvements.
Cash-out refinance for home improvements
Cash-out refinancing involves replacing your current mortgage with a new loan of a higher amount. You then receive a lump sum payment for the difference at closing.
You can use the money for any purpose — including home improvements. And since the cash is yours to manage, the lender won’t have to review your renovation plans or approve them.
Your home’s current value determines the amount of money you can receive with a cash-out refinance.
For a primary residence, a cash-out refinance typically has a maximum loan-to-value ratio of 80 percent. That means you need to leave at least 20 percent of your home equity untouched, which will limit the amount of cash you can withdraw.
With a cash-out refinance, you receive a lump sum payment at closing. You can use the funds any way you want.
This type of refinancing is available with different mortgages including conventional, FHA, and VA loans. Unfortunately, USDA loans do not allow cash-out.
A cash-out refinance is a cost-effective way of paying for home improvement projects since you’re able to borrow at a lower rate compared to using personal loans or a credit card.
But this type of refinance isn’t without drawbacks.
For starters, cashing out your equity increases your mortgage balance. And since refinancing involves getting a new mortgage, you have to meet credit and income requirements before you’re approved.
Refinancing also involves paying closing costs again (origination fees, appraisal, discount points, etc). But, since home improvements can seriously boost the value of your home, the upfront cost is often worth it.
Renovation refinance for home improvements
A cash-out refinance is a good option for many homeowners, but it isn’t the only one. You can also use a renovation refinance loan to pay for home improvements.
A renovation refinance has similar benefits. You can get cash for a home remodel or upgrade, and the rate on a renovation refinance is often far lower than a credit card or personal loan.
There are a few key differences between a renovation refinance and a cash-out refinance, though.
For example, with a renovation refinance your home’s estimated value after improvements determines the borrowed amount. So this type of loan might be an option when you don’t already have enough equity built up to borrow from.
Also, you don’t receive a lump sum of cash at closing with a renovation refinance. Your lender places funds in a separate escrow account and then pays the contractor at different stages of the remodel.
Your lender will also request a detailed renovation plan to estimate the home’s value after improvements.
Types of renovation refinance loans
Renovation refinance requirements vary depending on the program. The right loan depends on a number of factors, such as the extent of improvements, your credit score, and the amount you need to borrow.
Here’s a look at four different types of renovation refinances:
1. FHA 203(k) refinance
The Federal Housing Administration’s FHA 203(k) loan wraps the cost of a home renovation into the mortgage loan. This is an option when buying a fixer-upper property and when refinancing a current mortgage.
Limited FHA 203(k)
You can get up to $35,000 for home repairs or minor improvements like new countertops, flooring, and other projects to improve the aesthetics of your home.
You can use a contractor or complete some projects yourself, with approval.
Standard FHA 203(k)
The Standard FHA 203(k) loan doesn’t limit the amount you can borrow for home improvements, as long as your total loan amount is still within FHA’s local loan limits.
The primary difference between a Standard 203(k) and a Limited 203(k) is that the former provides funds for more extensive home improvement projects such as a room addition. Keep in mind, though, you can’t use this refinance for luxury projects like installing a swimming pool.
You can refinance up to 96.5% of your home loan, but to qualify you need a minimum credit score of 580.
The main drawbacks to a Standard FHA 203(k) loan are that the process is more complex than a Limited 203(k), and fewer lenders offer them.
2. Fannie Mae HomeStyle renovation refinance
Fannie Mae’s HomeStyle renovation refinance limits the cost of renovations to 75% of the home’s estimated appraised value after the completion of upgrades.
You can use funds for improvements “that are permanently affixed to the property and add value,” like a bathroom or kitchen remodel, permanent landscaping, or a room addition, as well as luxury items like an in-ground swimming pool, hot tub, tennis court, or outdoor kitchen.
You can use this loan for smaller improvements, too, like new floors.
With the HomeStyle refinance, your lender must approve the contractor and you’re required to submit renovation plans in-advance.
You’re then given 12 months to complete the work. Eligible properties include primary residences, one-unit second homes, and one-unit investment homes. The minimum credit score to qualify is 620.
3. Freddie Mac CHOICERenovation loan
Freddie Mac’s CHOICERenovation loan is similar to the HomeStyle renovation refinance, in that you’re able to refinance up to 75% of the home’s estimated appraised value after completing all renovations. It’s also for improvements that are permanently affixed to the property and add value, including luxury items.
Eligible properties include primary residences, one-unit second homes, and one-unit investment properties.
Freddie Mac also has the CHOICEReno eXPress mortgage for smaller home improvement projects like doors, windows, interior/exterior painting, and other minor repairs.
You can finance renovations up to 10% of the home’s estimated value after the completion of the project. To qualify you’ll need a minimum 620 credit score.
4. VA renovation refinance loan
If you’re eligible for a VA mortgage, another option is a VA renovation refinance. To qualify, you must have lived in the home for at least 12 months, and your loan-to-value can’t exceed 90 percent.
This loan has limitations, though.
You can only use a VA renovation loan for repairs or upgrades that improve livability of the home — like repairing or replacing windows, doors, siding, flooring, electrical or plumbing systems, and other major appliances.
You can’t use it for luxury upgrades or major structural changes.
Additionally, you’re required to have a VA-approved contractor, and you must complete the project within 120 days.
The VA doesn’t set a minimum credit score for its program, but lenders typically require a minimum score between 620 and 640 for a renovation loan.
The Department of Veterans Affairs also offers a VA cash-out refinance, which could be a simpler way for VA-eligible homeowners to pay for home improvements. With a cash-out loan, there’s no limit on how you can use the funds — so you can make any type of renovation you want.
Other options to pay for home improvements
A refinance only makes sense if you’re looking to replace your existing mortgage. If not, other options include a home equity loan or a home equity line of credit (HELOC).
A home equity loan comes as a lump sum of cash whereas a HELOC is a revolving line of credit you can tap on an as-needed basis.
They both generally have lower rates compared to a credit card. Plus, the interest may be tax deductible if you use funds to substantially improve your property.
The downside is that you’re using your home as collateral. So if you fall behind on the payment, you risk losing your property.
Credit cards and personal loans are other options for renovation projects if you don’t want to tap your home equity (or if you don’t have enough equity to do so).
Just know that credit cards typically have high rates, and using a lot of your available credit on a home project can decrease your credit score.
Personal loan rates can be lower than a credit card, too. But getting a personal loan often requires a higher credit score and collateral.
Collateral is personal items of value such as a vehicle title. If you don’t repay a personal loan, the lender can take your collateral.
The bottom line
If you have enough equity built up, a cash-out refinance can be a great way to pay for home improvements.
And even if you haven’t built up much equity, you might be able to use a renovation refinance loan. These types of mortgages base your loan amount on your home’s future value after renovations have been completed. So you can borrow extra money for improvements without tapping your equity.
Whichever loan you choose, be sure to shop around with a few different lenders and compare interest rates. Doing so can save you thousands on your new loan and lower the overall cost of your home improvements.