Ranking Renovation Loans from Best to Worst

In our previous post, we explained that renovation home equity loans are special because they are based on what the future value of your home will be AFTER the renovation. This key factor dramatically increases how much homeowners can borrow for their renovation.

But there is more than one type of renovation loan out there - in fact there are actually 5 different primary options. At RenoFi, the first thing we help homeowners with is understanding which type is best for you. Even though we do the hard work for you, we figured some homeowners would still like to understand all of the options available, hence this post.

Here are the rankings, from best to worst, with the analysis below:

  1. Renovation Home Equity Loan
  2. Single Close Construction To Permanent Loan (CTP)
  3. Fannie Mae Homestyle Loan
  4. FHA 203k
  5. Two Close Construction To Permanent

1) Renovation Home Equity Loan

How They Work: This is a new type of home equity loan that uses the future value of the home, post renovation, to calculate the Combined-Loan-To-Value (CLTV) ratio used in home equity lending. Thus, as a home equity loan, it doesn’t require homeowners to refinance their first mortgage. With so many homeowners locking in historically low rates in recent years, this is a highly attractive option for many homeowners.

Pros

  • Does NOT require homeowners to refinance their first mortgage meaning homeowners can keep their low rates and avoid restarting the clock on their mortgage.
  • Lowest rates - for 10 or 15 year terms, homeowners can lock in fixed interest rates LOWER than the current rate for a 30 year fixed first position mortgage.
  • Lower fees - because the loan doesn’t require you to refinance your entire mortgage, you’ll pay less in closing costs because it’s based on a smaller base.
  • Can borrow $50k up to $1 million+
  • By financing over 10 to 20 years, the overall cost of the loan in the long run is as low as it gets.
  • Single close means you only sign one set of documents and pay one set of closing costs.

Cons

  • Because Home Equity loans typically max out at 20 year terms, the monthly payment for these loans are often a bit higher than other Renovation Loans that are over 30 years.

2) Single-Close Construction To Permanent Loan (CTP)

How They Work: This is a construction loan that converts to a permanent mortgage, most commonly a traditional 30 year fixed mortgage. In this case, this new loan replaces your current first mortgage, so in that way it’s exactly like refinancing.

Pros

  • Low monthly payment - Like a traditional mortgage, because you are able to spread payments over 30 years, your monthly payment is as low as it can be.
  • Very low rates - You are getting the best traditional mortgage rate you can get.
  • Can borrow $1 million+
  • Options to convert to a traditional 30 year fixed or specialty loan offerings like Adjustable Rate Mortgages (ARMs)
  • Single close means you only sign one set of documents and pay one set of closing costs.

Cons

  • Because you are refinancing, you might be refinancing into a higher rate.
  • Because you are refinancing, you are starting the clock over on your mortgage which slows down the rate at which you build equity.

3) Fannie Mae HomeStyle Loan

How They Work: This is a construction loan that converts to a permanent mortgage, most commonly a traditional 30 year fixed mortgage. In this case, this new loan replaces your current mortgage, so in that way it’s like refinancing. This is exactly like #2 on our list, the single close construction to permanent Loan (CTP), but it’s the conforming loan variation - that means, instead of being offered by private banks, this loan is insured by Fannie Mae, a government sponsored agency. This affiliation with Fannie Mae comes with some pro’s and con’s:

Pros

  • Ability to borrow up to 95% of the future value of the home (the after renovation value), though this requires you to pay Private Mortgage Insurance (PMI) if you go above 80%. As a point of comparison, private banks often limit Renovation Loans to 80%, and while some will allow you to go to 85% or 90% loan to value, we've never seen any that allow up to 95%.
  • Single close means you only sign one set of documents and pay one set of closing costs.
  • The standards for a borrower are not as stringent as you'll find with the private bank offering, meaning elements like your credit score don’t need to be as strong to qualify.

Cons

  • Higher rate - Fannie Mae HomeStyle mortgage rates are typically higher than the rates you can get by doing a CTP through a private bank.
  • Only available on conforming loan limits which varies by area. But for homeowners in the Philadelphia area, this maxes out at $453,100. You can find your conforming rate limit here.
  • Because you are refinancing, you might be refinancing into a higher rate.
  • Because you are refinancing, you are starting the clock over on your mortgage which slows down the rate at which you build equity.

4) FHA 203k (Full)

How They Work: This is a construction loan that converts to a permanent mortgage, most commonly a traditional 30 year fixed mortgage. In this case, this new loan replaces your current mortgage, so in that way it’s like refinancing. This is exactly like #4 on our list, the Fannie Mae HomeStyle, but instead of being insured by Fannie Mae, this is insured by the FHA, also a government sponsored agency. This affiliation with the FHA also comes with some pro’s and con’s:

Pros

  • Ability to borrow up to 96.5% of the future value of the home (the after renovation value), though this requires you to pay Private Mortgage Insurance (PMI) if you go above 80%. As a point of comparison, private banks often limit Renovation Loans to 80%, and while some will allow you to go to 85% or 90% loan to value, we've never seen any that allow up to 96.5%.
  • Single close means you only sign one set of documents and pay one set of closing costs.
  • The standards for a borrower are lenient. For homeowners who don't have great credit scores, this is your best option.

Cons

  • Higher rate - FHA 203k mortgage rates are higher than all other Renovation Loan options.
  • In addition to the higher rate, FHA mortgage insurance is required upfront AND annually for the life of the loan. FHA loan limits are even lower than the conforming loan limits used by Fannie Mae. This varies by area but for homeowners in the Philadelphia area, this maxes out at $385,200. Find loan limits nationwide here.
  • Because you are refinancing, you might be refinancing into a higher rate.
  • Because you are refinancing, you are starting the clock over on your mortgage which slows down the rate at which you build equity.

5) Two-Close Construction To Permanent Loan (CTP)

How They Work: This is two separate loans. You start with a short term construction loan, usually 12 months. Then, once the renovation is complete, you take out a new loan, usually a 30 year fixed mortgage that pays off the construction loan. In a world where banks offer great single close options, it almost never makes financial sense to opt for a two-close, two loan process over a single.

Pros

  • None

Cons

  • You have to paying closing costs twice.
  • You have to go through the loan paperwork process twice.
  • You don’t lock your permanent rate in until after construction is complete.
  • You have risk that something in your life comes up and prevents you from securing the permanent financing.

Side-by-Side Comparison

Here is a side-by-side comparison for a quicker view:

Renovation Home Equity Loan
Single-Close Construction To Permanent Loan (CTP)
Fannie Mae HomeStyle Loan
FHA 203k (Full)
Two-Close Construction To Permanent Loan (CTP)
Is this a mortgage?
Yes
Yes
Yes
Yes
Yes
1st or 2nd mortgage?
2nd
1st
1st
1st
1st
Require refinance of existing mortgage?
No
Yes
Yes
Yes
Yes
Typical Interest Rate
3.25%
4.25%+
4.875%
5%+
4.25%+
Loan Limit (Renovation Cost + Mortgage)
$1,000,000+
$1,000,000+
$453,100
$385,200
$1,000,000+
Loan Term (max)
20 years
30 years
30 years
30 years
30 years
Credit Score Required
700+
700+
620+
580+
580+
Loan to Value
Up to 95%
Up to 95%
Up to 95%
Up to 96.5%
Up to 80%
Can be used for building new home?
No
Yes
No
No
Yes
Restrictions on type of improvements?
No
No
No
Yes
No

And that’s it! Now you’re way better informed on renovation loans than most homeowners!