When you get a cash-out refinance, home equity loan, or home equity line of credit (HELOC), you can use the money you receive for any purpose, including home improvement. So, what’s the point of a renovation refinance loan?
Well, sometimes, this loan is the only way to get the home improvements you want because those alternatives are all based on the existing market value of your home.
However, the amount you can borrow with a renovation refinance loan can be determined by the likely future value of your home once your improvement projects are completed.
So, suppose your home’s value is currently much lower than your neighbors’ properties due to defects or being outdated. That could limit your borrowing ability.
But a renovation refinance loan is your chance to catch up with — or exceed — your neighborhood’s standards.
Key takeaways
- A renovation refinance loan could let you improve your home while avoiding high-interest personal loans and credit cards
- Always run the numbers before you borrow large sums. You need to see the impact of a different mortgage rate and new closing costs
- Remember, interest on loans for home improvements is sometimes tax deductible. Check with a tax professional about your case
Cash-Out Refinance for Home Improvement
While a cash-out refinance isn’t technically a renovation refinance, it’s often used for renovations and home improvements.
A cash-out refinance allows you to replace your current mortgage with a new, larger mortgage and receive the difference as cash, which you can use for any purpose—including home improvements. This option lets you leverage your home’s current equity to fund renovations or upgrades without taking out separate financing like a personal loan or home equity line of credit (HELOC). This can be an appealing option if you have significant equity built up in your home, as it can help fund substantial home improvements while keeping a single mortgage payment.
Most types of mortgages permit cash-out refinances, including:
- Conventional and conforming loans, including ones branded Fannie Mae or Freddie Mac
- FHA loans, which are partly guaranteed by the Federal Housing Administration
- VA loans, which are partly guaranteed by the Department of Veterans Affairs
Only USDA loans disallow cash-out refinances. But, providing you qualify for the loan you want, you can switch your type of mortgage (and lender) when you take any refinance.
So, you might choose to move from a USDA loan to one that allows a cash-out refinance. Or from an FHA loan to a conventional one if that helps you escape mortgage insurance premiums earlier.
How a Cash-Out Refinance Works
With a cash-out refinance, you request a higher mortgage amount than you currently owe. You get the difference in the form of a check or electronic transfer.
That money can be used for any purpose, but many people put most or all the proceeds into home improvements, thus boosting the value of their homes.
Money spent on those improvements is sometimes tax deductible. You should check with a tax professional before assuming that your windfall plans will qualify.
If you have a ton of “equity” (the amount by which your home’s market value exceeds your mortgage balance), you may have enough cash to pay for all your home improvement plans with a straight cash-out refinance.
However, if your equity is limited (your home’s worth only a bit more than you owe on your mortgage), your cash-out refinance may not raise enough to cover your projects.
This is where renovation refinance loans come in. As long as you qualify for a big enough mortgage, you can borrow more with these than your limited equity would normally allow. We’ll get into the details next.
Types of Renovation Refinance Loans
Unlike a traditional cash-out refinance, which is typically based on your home’s current market value, a renovation refinance loan lets you borrow based on the future value of your home after improvements are completed.
There are four major refinance types available across the U.S. These are all overseen by major government agencies that want to promote sustainable housing in America. As such, they come with more lenient guidelines than private construction or renovation loans offered by some banks.
- FHA 203(k) refinance
- Fannie Mae HomeStyle
- Freddie Mac CHOICERenovation
- VA renovation refinance
Here’s more about each program.
1. FHA 203(k) Refinance
All FHA loans can be helpful for those with lower credit scores. The FHA’s minimum score is only 580 with a 2.25% equity remaining after the refi — or 500 with a 10%. Some lenders may require higher scores.
The lender will look at the future value of the home, repair costs, your existing loan balance, and other factors to determine your maximum loan amount.
You must qualify for the loan, including meeting debt-to-income (DTI) ratios. Typically, lenders like to see a DTI of 43% to 45%, but some allow higher.
The FHA 203(k) comes in two flavors. As of Nov. 4, 2024, the FHA 203(k) Standard is for repairs over $75,000. But, if you don’t need that much, a Limited 203(k) lets you complete smaller repairs and is easier to complete.
The FHA insists you use a contractor it has approved for the work. And any improvements you make yourself won’t count towards your home’s final, post-renovation appraisal.
2. Fannie Mae HomeStyle Renovation Refinance
Fannie Mae loans require a minimum credit score of 620. You need retained equity of 3% looking at post-repair value.
Unlike with FHA, you can contribute your own “sweat equity.” In other words, if you do some of the work yourself, that can count for up to 10% of your post-reno appraisal.
The big advantage of Fannie loans is that you can stop paying for mortgage insurance as soon as your mortgage balance drops below 80% of your home’s value. Most FHA borrowers are on the hook for mortgage insurance for as long as the loan lasts. And mortgage insurance can add hundreds of dollars to your monthly payment.
3. Freddie Mac CHOICERenovation Refinance
Fannie Mae and Freddie Mac share the same regulator. So, it’s no surprise their mortgage products are close to identical.
And everything we wrote about Fannie’s HomeStyle loan also applies to Freddie’s ChoiceRenovation mortgage.
So which one should you choose? Much depends on the lender you select. Some lenders work only with Fannie Mae, others with Freddie Mac. Some work with both. The lender may be able ot leverage slight differences between each program and agency to your benefit.
4. VA Renovation Refinance
It’s a truism in the mortgage industry: If you qualify for a VA loan, you’d need a very good reason not to get one.
You don’t need any down payment or retained equity. Your debt-to-income ratio can range between 41% and 50%. Your credit score can be as low as 580, although most lenders prefer 620 or even higher. Best of all, mortgage rates for VA loans are often the lowest in the market.
VA loans are widely available. But those for VA renovation refinances are much less common.
Many top VA lenders in the country don’t offer renovation options. Still, if you shop widely enough, you should be able to find one.
One other fly in the ointment: You must complete all repairs and improvements within 120 days of the loan closing, which can be tight for major projects.
Which Option Is Best?
There is no “best” option. Your choice is individual and must be based on your circumstances, needs, and financial goals.
And you may find you have no choice at all. For example, if your credit score is 581 and you see no quick way to improve it, you’ll have to go with an FHA 203(k) loan unless you’re eligible for a VA loan. And even those who are eligible may struggle to find a willing VA lender.
Generally, if you qualify for a conventional, conforming loan from Fannie Mae or Freddie Mac, one of those is likely to be your best choice, certainly if your new mortgage balance will be close to 80% of your home’s value.
In that case, you might eliminate mortgage insurance premiums.
Your principal task at this point is to find the least costly financing for the work you want done. So, see this exercise as one of dollars and cents. Just remember to think of the long term as well as the short.
Should You Refinance to Fund Home Renovations?
Refinancing to fund home renovations can be a smart choice, especially if you can secure a favorable interest rate. For homeowners with higher mortgage rates or substantial equity, a cash-out refinance can help consolidate your renovation costs into one loan at a potentially lower interest rate, making it a cost-effective solution for larger projects.
However, it’s essential to weigh a few factors to ensure refinancing is the best option for you. Refinancing could increase your monthly payment if your current mortgage rate is much lower than the available rates. In that case, you may want to consider alternatives like a HELOC or home equity loan, where only the additional amount is subject to the new rate.
But if you don’t have enough equity for those options, or you’re facing significant repair needs, refinancing may still be worth it—particularly if you plan to stay in your home long enough to benefit from the improvements. Not only can renovations boost your property’s value, but they can also enhance your comfort and enjoyment of your home.
Ultimately, refinancing for renovations can be an excellent choice if you secure a competitive rate and have a clear plan for the improvements you want to make. Focus on renovations that add long-term value or address essential repairs for the best financial benefit.
