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Construction loan for home renovation

Has your kitchen been in dire need of a makeover? Have you been dreaming about the addition of a hot tub when life turns into an icy winter wonderland? Or perhaps you need to install a home office to adapt to a remote work lifestyle? 

So, what’s holding you back?

If your answer is “money,” welcome to life in 2022. You’re in the same boat as pretty much everyone else.

But did you know that you don’t have to wait until you have enough cash in your pocket to turn your house into a home? And you also don’t have to go through the lengthy process of taking out a construction loan for a home renovation. There are mortgages specifically intended for funding home improvement projects. But, before we dig into that, let’s go over what construction loans are all about.

What are construction loans?

A construction loan is a short-term loan that’s used to finance the costs associated with building a custom home from the ground up. These costs typically include labor, land, permits, and building materials. 

Although the most common purpose of these loans is to finance an entire home built from scratch, they can be used for large home renovation projects as well.

If you choose to take out a construction loan to build a new house, you’ll need to refinance into a permanent loan once your home is built. And, if you opt for the less popular route of using a construction loan for home renovation, you’ll need to refinance your home according to its estimated value post-remodel.

Should you use a construction loan for a home renovation?

Construction loans in Minnesota allow you to borrow money based on the value of your home after you’ve completed the renovation. This increases your borrowing power, which is why homeowners are sometimes tempted to take out a construction loan over other types of financing. 

Now, unless your home reno project is a big one— like building an addition to your property or expanding your home, opting for a construction loan likely won’t be worth it.

Here’s why:

Construction loans require refinancing. What does this mean? It means you lose that amazing first mortgage rate you locked in. You also only receive funds in small increments throughout your building process. These withdrawals are based on project milestones; and thus, can delay your renovation’s completion and force you to adhere to your bank’s schedule. Lastly, you’ll most likely have a higher interest rate with a construction loan than you had with your traditional mortgage. 

So, if you’re not going to use a construction loan for a home renovation, then how do you get the funding for your home project?

Let us introduce home improvement loans.

What are home improvement loans?

A home improvement loan, also called a renovation loan, is any type of loan used to repair a house. These can be big or small repairs or a renovation such as an entire kitchen remodel. 

Renovation loans are a good idea if you want to boost your home’s retail value and aesthetic appeal or if you’re buying a house that you intend to revamp. Typically, these loans are a mortgage that comes with extra money that can be used for renovations.

For example, a home renovation loan could be in the form of a HELOC, an unsecured personal loan, a home equity loan, a government loan, or a cash-out refinance on your existing mortgage. In some cases, it can also be a standard mortgage loan with extra funds to finance home improvements.

A terrific resource when your home needs a facelift

A home improvement loan is worth considering when you don’t have enough cash to finance repairs or renovations yourself. Likewise, these loans are a good option if you want to purchase a home with a low asking price that’s in need of a serious makeover. 

What’s alluring about home improvement loans is that they give you the same increased borrowing feature based on the post-reno value, without all the drawbacks that occur if you use a construction loan for a home renovation. This means that you’ll receive the entire loan amount right off the bat, which will make the renovation process easier for you and your constructor.

Additionally, with a renovation loan, you won’t have the requirement to refinance once your project is complete. You also won’t have to pay high closing costs.

Before you take out a home repair loan

The two main points of consideration before taking out a home improvement loan are finding a licensed builder to work with and establishing a realistic budget.

Decide on using a contractor or a DIY project

If your home makeover is going to be a DIY project, then you can scratch this section and skip to budgeting. However, if you’re considering hiring a contractor to help with your home improvements and ensure everything is built safely, make sure you find one who’s qualified and experienced. Not only will a skilled contractor boost your home’s aesthetic appeal, but they’ll also increase your borrowing power. This is because your lender will want to be assured that you’re working with a builder who will be able to complete your renovation properly and successfully.

Get real about your budget

Whether you use a home improvement loan or a construction loan for your home renovation, you’ll need to have a detailed budget. As part of the underwriting process, your lender will want to see a breakdown of the renovation costs from start to finish. 

So before you get attached to that sleek, induction stove top with tons of smart features or those contemporary porcelain tiles to line your new dual shower system, make sure you have a realistic budget. Here are a few tips to help you figure out a budget.

  • Research the average costs of similar projects in your area
  • Factor in costs for unforeseen fees or any other surprises that could come up
  • Figure out if you’ll need to rent a place to stay during the renovation
  • Write down the projected costs for the supplies, materials, and labor fees.

Types of home improvement loans

If you don’t want to use a construction loan for your home renovation, there are many other ways you can fund your home improvement project. A few popular options are taking out a HELOC, a personal loan, or doing a cash-out refi.

HELOC

A home equity line of credit (HELOC) lets you tap into your home’s equity to fund your renovation project. Because your home will serve as collateral, you should only consider this option if you expect you’ll be able to comfortably repay the loan.

Is a HELOC right for you?

If you have a good amount of equity in your home— usually, you need at least 20% to qualify, a HELOC could be a good option for you. Likewise, if your renovation will be a multi-phase or long-term project, a HELOC will give you the flexibility to access your line of credit whenever you need to.

Personal loan

Personal loans are unsecured loans because they’re not backed by your home or any other asset. The interest rate will depend on your credit history and is typically higher than the rate for a HELOC since the loan isn’t secured.

Is a personal loan right for you?

If you don’t want to borrow against your home’s equity, or if you don’t have enough equity to tap into, a personal loan can be a smart choice for your renovation. Borrowers with strong credit scores who prefer a quick payout may benefit from a personal loan for financing small to midsize projects. So, if your project isn’t going to be huge, a personal loan is the better option compared to a construction loan for a home renovation.

Cash-out refi 

If you choose to do a cash-out refinance, you’ll refinance your current mortgage for one with a lower rate and take the difference between the two loans in cash. You can use the cash for any type of property improvement project, whether that’s a basement renovation, a bathroom makeover, or spicing up your home theater with new seats and surround sound technology.

Is a cash-out refi right for you?

If you opt out of getting a construction loan for your home renovation, a cash-out refi is a great choice if you can snag a lower rate than what you currently pay on your existing mortgage. Likewise, a cash-out refi is well-suited for big improvement projects such as a complete kitchen revamp or room addition.

The smartest way to Minneapolis home improvement

Construction loans for home renovations aren’t your only option for turning your house into a home. A home improvement loan could be your ticket to boosting your property’s value and enhancing your lifestyle. 

If you’re ready to get the kitchen of your dreams or add the four seasons porch you’ve always wanted, talk to one of our mortgage experts today. We’ll help you find the best possible option for your specific situation and preferences.

 

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