(Updated November 2014)
Need to renovate your home but don't have the cash or are low on home equity? There's a mortgage refinance loan you might not be aware of that could be just the ticket - the renovation refinance loan. This hot new lending product could be the best way to renovate your new home without breaking your personal piggy bank in the process.
"Location, location, location" is both a blessing and a curse to homeowners. Nothing compares to living in a great neighborhood. Unfortunately, it can be a nightmare if living in a great neighborhood means doing so in an outdated house.
One solution is a mortgage refinance, which can help you cash out some home equity to pay for improvements. You can also try a straight-out home equity loan. But either of these approaches are tough if you've already tapped out most of the equity from your home. And they gets downright impossible if you want to make some substantial renovations that would take you beyond the current value of your house.
Fortunately, you have another option - the renovation refinance loan.
Back to the future
The key to a renovation refinance loan is that the amount you can borrow is based not on what your home is currently worth, but on the projected future value of your home after the renovations have been completed. If your current home needs some work that will boost its value, these programs allow a lender to spot you the money (for a slightly higher rate than on a regular refinance) to make it happen. If you're purchasing an older place with the hopes of turning it into a dream home, you can use these same programs to obtain a purchase mortgage as well.
Three major loan options
There are two main renovation refinance mortgage products for low-equity borrowers - FannieMae HomeStyle Renovation Loans and the FHA 203k mortgage. Both take into account the projected improved value of your home in determining how much you can borrow. So if your home is currently valued at $230,000 but the improvements you have planned would boost its value to $280,000, you may be able to do a cash-out refinance of up to $280,000, provided the funds are used to make the improvements.
The Fannie Mae program allows you to borrow up to 50 percent of the home's improved value for repairs and improvements, with no minimum loan amount. Unlike the FHA program, which can only be used for improvements to a primary residence, HomeStyle Rennovation Loans can also be used to renovate a second home or investment property. The various fees and mortgage insurance premiums will also likely be less than on an FHA loan.
Credit requirements are stricter than on the FHA program, with a minimum FICO credit score of 680-720 usually required. The loan can be used to make either structural or cosmetic repairs, though cosmetic improvements must be permanent parts of the home (like kitchen cabinets or appliances).
There are two versions of the FHA 203(k) loan. The full version has no fixed limit on how much you can borrow to make improvements, up to the FHA loan limits in your area, though the minimum you can borrow is $5,000. This is the FHA loan you'll need if you're going to make structural repairs.
The other loan is the FHA 203(k) Streamline loan. This loan is limited to a maximum of $35,000 and can only be used to make cosmetic, rather than structural, repairs. But there's also less red tape involved and it's easier to get the loan approved.
Both FHA 203(k) products are limited for use with your primary residence only, although that can be extended to include up to a four-unit residence, as long as you live in one of them. Depending on the lender, you can qualify for FHA loans with credit scores as low as 600-640.
No bank is going to lend money based on a handshake and a verbal promise. They have specific requirements regarding the renovation refinance mortgage. First, you'll need to present complete plans of your renovation, including architectural drawings, unless you're doing cosmetic repair with the 203(k) loan. These will show the lender that your improvements change your house's value to the projected figure you have in mind.
In either case, there will be a timeline within which the work must be completed, typically less than one year.
Higher rate, delayed interest
These loans will have a slightly higher interest rate, due to the extra risk taken on by the lender. However, the first six months of interest are often folded into the overall loan, so you'll have no mortgage payment until construction is complete.
Location is a key factor in home values, and it generally inspires mortgage refinancing for homeowners who want to stay in a good neighborhood. Now, with the renovation refinance loan, you can have a home that's every bit as desirable as the neighborhood it sits in.