Government-backed home renovation loans
Fannie Mae’s HomeStyle Loan
One of the best-known loans for home improvements, Fannie Mae’s HomeStyle Renovation loan, allows borrowers to either buy a place that needs repairs or refinance their existing home loan to pay for improvements.
The HomeStyle loan is available from any Fannie Mae-approved lender, but there are qualification requirements:
For a primary residence, you must have a credit score of at least 620. You can check your credit score for free at myBankrate to see if you meet this criterion.
You have to make a down payment of at least 5 percent of the purchase price of the home.
A certified contractor must prepare and submit a cost estimate and details of the work to be done.
One advantage of a HomeStyle loan is that it’s just one loan; you don’t have to take out a loan for the mortgage and then another loan for home repairs. One loan reduces paperwork and closing costs.
Keep in mind that the money for the home improvements goes into a separate escrow account that’s used to pay the contractor directly. You don’t have access to those funds like you do with a home equity loan or a cash-out refinance.
FHA 203(k) loans
The Federal Housing Administration offers a home renovation loan called a 203(k). There’s typically a lower credit-score requirement for this loan than there is for a HomeStyle loan, and a lower minimum down payment of 3.5 percent.
There are two types of FHA 203(k) loans:
Limited (formerly called streamline)
A limited FHA 203(k) loan is designed for cosmetic improvements and is capped. This rehab loan can be used to finance repairs and improvements like a kitchen remodeling or a new paint job.
This type of home renovation loan is available for homes that are at least a year old. The rehab project must have a cost of at least $5,000. The agency sets mortgage amount limits by state, county or area, and you can look your area up through a searchable tool on its website.
Private home renovation loans
Home equity loan and HELOC
Another way to finance your home renovation is by taking out a home equity loan, also known as a second mortgage. This is a one-time loan, so it’s not subject to fluctuating interest rates, and monthly payments remain the same for the loan term.
A similar loan is the home equity line of credit, or HELOC. It has a revolving balance and might be best for someone who has several large payments due over time, like with a big home improvement project.
With either option, you’re pledging your home as collateral, meaning if you don’t make your payments, the lender will end up owning your house. Alternatively, you can take out an unsecured personal loan to avoid putting up your home as collateral.
But HomeStyle and FHA 203(k) loans have some advantages over home equity loans.
Cash-out mortgage refinance
A cash-out refi allows homeowners to refinance their mortgage. This mortgage will be for a higher amount than the first one, and the homeowner gets the difference in cash.
Like home equity loans and HELOCs, cash-out mortgages require homeowners to use their home as collateral. But if you’ve got a considerable amount of equity in your home, you might be able to find lower interest rates. Combine lower interest rates with the added home value derived from renovations, and you could benefit more in the long run.
You’ll need at least 20 percent equity in your home to qualify for cash-out refinancing. The total loan amount is limited to the available equity in your home. Credit score requirements vary per loan amount and value of your home, but generally start at 640.
An option for those who can’t — or don’t want to — tap home equity is applying for a personal loan from a bank, credit union or online lender. Unlike a refi or home equity loan, a personal loan is unsecured — meaning you don’t have to put up your home or any other collateral. Instead, eligibility for the loan is based strictly on your credit score, income and financial history. There’s no need for a home appraisal and funds for your renovation project can be available quickly.
Naturally, consumers with excellent credit scores of 720 or higher get the best interest rates, averaging below 10% APR. Those with good or average credit scores, between 630 and 719, can generally expect to pay interest rates ranging between 15% and 21.3%, which can be considerably lower than some credit card interest rates. Certain lenders extend personal loans to consumers with credit scores as low as 580, though rates tend to be much higher.
If a personal loan could help you further your home project, you can quickly get an idea of available lenders by entering a few pieces of information in Bankrate’s loan pre-qualification tool. You’ll learn which lenders fit your situation and what loans they have to offer.