A Renovation loan (FHA 203(k)) or the Fannie Mae Homestyle renovation loan is designed to finance home improvements and work best when refinancing or purchasing a home. Estimates to complete the work must be obtained prior to loan approval and the cost of those improvements can be rolled into the loan amount. Generally the work must be completed in the next six months and are paid through proceeds of the loan.
The ideal situation could be the purchase of a home that is not exactly the way you want it. It may need carpet, paint, new windows and perhaps a new bathroom or kitchen to make the home perfect. The FHA 203(k) loan has two levels. A streamlined loan for improvements costing less than $35,000 is relatively straightforward and is ideal for cosmetic upgrades. A standard FHA 203(k) loan can finance major renovations including adding a room or remodeling a kitchen or a new roof.
This is one loan with one payment. It is important to note the FHA loan will have attractive interest rates but will have the added expense of mortgage insurance.
Home Equity Line of Credit
A Home Equity Line of Credit (HELOC) is best used when you already own a home with a current first mortgage on the home at market interest rates. You may simply need funds for a renovation or repair. With sufficient equity in your home you can set up a line of credit that you can access as needed in your project. HELOC’s will have a variable interest rate generally at prime +1.5% – 2.5%. Currently the prime rate is very low so this option can be very attractive and best used if you are in a position to pay it off in the next five years or so.
A federally insured reverse mortgage or Home Equity Conversion Mortgage (HECM) can be a valuable tool in financing home renovations. In this case all borrowers on the loan would need to be 62 years of age or older, and have the ability to pay property taxes, HOA and insurance. The unique benefit of a reverse mortgage is that there are no required monthly payments. Instead, interest and the mortgage insurance costs are added to the outstanding loan balance. Functioning much like a HELOC, funds are accessed only when needed.
Available funds can be used for renovations to make the home safe such as remodeling a downstairs bathroom and converting a bedroom, avoiding the need to use stairs every day. Available funds can remain parked for use in an emergency somewhere down the road.
By: Clay Selland, CPA, CEO, Signet Mortgage Corporation