Sometimes in the dead of winter, homeowners start to think of making some changes to their home. Just to freshen up the place and move some things around. Maybe upgrade the kitchen with new appliances and while they’re at it put in some new flooring as well. What about new hardwood floors throughout? Maybe a completely remodeled master bath would do the trick? Whatever the project, homeowners can pay cash or they can tap into the equity they have in their home.
Here are three ways you can use the equity in your home to easily finance your remodeling project.
Top 3 Home Loans for Remodeling
The simplest approach is with an equity loan. This method taps into the current equity in the property and recorded as a second, subordinated loan. An equity loan can be in the form of a line of credit to be used as needed or as a single loan amount to be used to finance the project as a Home Improvement Loan. A line of credit will be a variable rate loan and you will be charged interest only on the amount you actually use, not the total line of credit available. A home improvement loan on the other hand can also be found as a fixed rate loan. Because an equity loan is in a subordinate position, the rates will be slightly higher compared what you will find with a first lien. The closing costs with either are extremely low.
The FHA 203(k) Loan
This government-backed loan program has been around for a long time but seldom used due to the approval and construction process being somewhat cumbersome. However, most of those processes have been streamlined as the 203(k) loan is relatively simple. The 203(k) loan can be used to finance a purchase along with renovations as well as refinance an existing mortgage along with planned renovations.
There is a bit of legwork that needs to be done before the lender will approve the loan application for a 203(k) loan. First, the borrower will work with a 203(k) consultant who will oversee the entire project. The borrower will walk through the property with a licensed contractor, who may also be an approved 203(k) consultant, and identify the work that will need to be done. For example, let’s say the homeowners want to tear down a wall and expand the living area as well as putting in a new kitchen. The plans and specifications are then drawn up by an architect and the costs of the remodel are calculated. The plans, the costs and the loan application are submitted to the lender for an approval.
The lender will then order an appraisal for the property as part of the approval process. For a purchase transaction, the borrowers will put down the minimum 3.5% down payment based upon the value of the property as if the improvements have already been completed. Once the loan is approved, the lender sets aside the necessary funds that will be used to fund the project. The lender then issues funds to the contractor as the renovations are being made. The contractor does not receive a lump sum at the outset to complete the remodel but instead the funds are released in stages, called draws. At each draw, the lender sends an inspector to the property to verify what has been completed then approves another draw for the contractor to continue. Once the contractor states the project has been completed, the lender sends an inspector for a final inspection to verify all the work has been done.
Because the 203(k) loan is a brand new first lien, it will have a slightly lower rate compared to a second lien in the form of an equity loan or home improvement loan. There will be standard closing costs with a 203(k) loan but they are typically rolled into the final loan amount.
Fannie Mae’s HomeStyle Loan
A loan program similar to the 203(k) loan is the Fannie Mae HomeStyle Renovation loan. Again, this is a new first lien that can be used to purchase a property and make repairs and renovations as well as refinance an existing mortgage. The process is much the same yet there is no licensed consultant needed that will oversee the project.
The borrowers will provide the list of renovations that will be made to the property and like the 203(k) loan the lender will order an appraisal that will determine the value of the property as if the renovations have been completed. The HomeStyle is a way to tap into the “as repaired” value of the property up to 50 percent of the final value. You may also roll in your closing costs into the HomeStyle loan.
Which is Better?
If you have a smaller project, a home equity loan is a good choice if you already own the property and have sufficient equity in your home. The 203(k) loan and HomeStyle loan are remarkably similar yet some lenders ask for a higher credit score for the HomeStyle loan over the 203(k) program. The minimum down payment for a 203(k) loan is just 3.5% compared to the minimum 5.0% required for the HomeStyle. With a conventional HomeStyle loan with a down payment of less than 20% is made, there will be mortgage insurance. However, because the appraised value is based upon the “as completed” approach, mortgage insurance may not be required if there is at least 20% equity in the property. With the 203(k) loan, there is both an upfront mortgage insurance premium rolled into the loan amount as well as an annual premium paid in monthly installments.
For your situation, speak with a lender that is experienced with all three. The equity loan is relatively simple but the HomeStyle and 203(k) does require more oversight. When evaluating these two loans, it’s extremely important to work with a lender that knows these programs inside and out and helps you choose the program right for you and your project.
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