What Is a Home Renovation Loan & How Do They Work?

Boost your borrowing power with a loan that factors in the after renovation value of your house and tackle your entire home improvement wish list in one go.

Home renovation loans are the smartest way for homeowners to finance their entire renovation project, yet most people don’t even know that they exist or how they work.

But don’t worry.

By the time you are done reading this guide, you’ll know everything there is to know about home renovation loans and why RenoFi loans, for most homeowners, are the best type of renovation loan to finance your home improvement projects.

Specifically, we’re going to look at:

What Is A Renovation Loan?

A home renovation loan is based on one key factor: after renovation value. Renovation loans use a home’s estimated after renovation value instead of its current home value to calculate how much a homeowner can borrow. This gives homeowners the credit for the increase in home value from the proposed renovation upfront.

It’s easy to get confused about this term, given that some of the products that are offered as “home improvement loans” are actually just rebranded unsecured personal loans or credit cards that aren’t suitable for most projects due to their high interest rates, shorter terms and limited loan size. These common “home improvement loans” are not renovation loans.

Renovation loans are the ONLY type of loan that give homeowners credit for a home’s future value. Using the after renovation value ALSO helps you get the lowest rate possible, as lenders typically set rates based on the loan to value ratio (more on this later).

There are different types of renovation loans that use the after renovation value, including RenoFi loans, construction loans, Fannie Mae homestyle loans, and FHA 203ks.

Whether you’re looking to borrow to cover the cost of remodeling a single room, such as your bathroom or kitchen; a couple of rooms; your entire home; or are even looking to finance an ADU; the loan option you choose can have a huge impact. It will determine your interest rates, monthly payments, the amount that you can borrow, and whether or not you’ll need to refinance your first mortgage.

Why Do Homeowners Need Renovation Loans?

RenoFi CEO & Co-Founder, Justin Goldman, comments on the the lack of renovation financing options for homeowners:

“Paying for a renovation is a whole journey in and of itself.

“Every other major purchase we make in our life has a smart and easy financing solution attached to it.

“Buying a car? Get an auto loan. Buying a house? Get a mortgage. Going to law school? Get a student loan. Each of these is a purpose-built financial product for a specific use.

“Remarkably, until recently, most homeowners were unaware that renovation loans existed.”

You see, the two most common financial products used to pay for renovations and additions are cash-out refinances and home equity loans (or a home equity line of credit), neither of which have been designed primarily for the purpose of renovating.

These two financial products rely on the existing equity homeowners have built up based on the home’s current value. Therefore, they may work for long-term homeowners who have built up lots of equity, but they’re not set up to help recent buyers.

Thankfully, renovation loans, including RenoFi loans, are.

Unlike traditional home equity loans & cash-out refinances, renovation loans are based on what the value of your home will be AFTER the renovation. This key factor dramatically increases how much you can borrow, because it allows homeowners to tap into their future equity while also ensuring homeowners get the lowest rate possible.

How Do Renovation Loans Work?

To help you understand exactly how a renovation loan works, let’s compare a RenoFi renovation loan to a traditional home equity loan, which doesn’t use the after renovation value like renovation loans do.

Here’s a simple example:

Meet the Jenkins family. They are looking to do home improvements that will cost $250,000.

They purchased their home 5 years ago and now are ready to do the two-story addition and kitchen remodel they’ve been discussing for years.

Their home’s value today is $500,000, and they have an outstanding mortgage of $350,000.

To recap:

  • Renovation cost: $250,000
  • Current home value: $500,000
  • Current mortgage: $350,000

Now, let’s compare how much they could borrow with a typical home equity loan (see the first bar below) with what they can borrow with a RenoFi Renovation Loan:

5x

Yes, you are reading that chart right.

The RenoFi loan allows the Jenkins’ to borrow 5x more!

Most importantly, they can borrow the full amount of money needed for their renovation, whereas with the traditional home equity loan options, they would be $200,000 short!

But what exactly is happening here?

It all comes down to the difference between using the home’s current value vs the after renovation value.

The Jenkins’ are making some big improvements to their home, and its value is going to increase.

before/after

Current Value vs After Renovation Value

When it comes to traditional home equity loans, the magic number is usually 80%, meaning you can borrow up to 80% of the current home value.

So when using the current value of $500k, 80% = $400,000. But the Jenkins’ have an outstanding mortgage balance of $350,000, so $400k minus $350k = $50k.

Thus, by using loan products that use the home’s current value, they can only borrow $50k.

Now let’s compare that to using the future value of the home, $750,000. 80% of $750,000 = $600,000.

And when you deduct the outstanding mortgage balance of $350,000 from the $600,000, they can get $250,000 to renovate!

And there you have it.

By taking into consideration the future value of $750,000, the family is ready to make their renovation dreams come true.

Not only are they able to finance their entire project, but they can do it without having to refinance their awesome first mortgage and lose their lower interest rates, like they would with a traditional renovation loan.

Take the next step toward your home renovation by learning if your project is eligible.

How do I know if a RenoFi loan is right for my project?

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Ranking Home Renovation Loans from Best to Worst

By now, you hopefully understand what renovation loans are and how they work. But to recap: it’s because they are based on what your home’s value will be AFTER the renovation, and this key factor dramatically increases how much homeowners can borrow for their project.

Where things get confusing, however, is when you realize that there is more than one type of renovation loan out there.

There are four different renovation loans that are most commonly used by homeowners to fund home improvements.

At RenoFi, the first thing we help homeowners to do is understand which type of renovation loan is best suited to their situation. And even though we do the hard work for you, we figured that many would still like to understand all of the different options available.

So to help you do that, we’ve ranked each renovation loan from best to worst:

  • RenoFi Loan
  • Single Close Construction To Permanent Loan (CTP)
  • Fannie Mae Homestyle Loan
  • FHA 203k

Note - these rankings are based on the most common scenarios we see at RenoFi. For certain homeowners, what is best for them will differ based on their unique needs.

1. RenoFi Home Equity Loan

How They Work:

A RenoFi home equity loan is a new type of renovation loan that combines the best elements of a construction loan with a home equity loan. It’s the only renovation loan that doesn’t require homeowners to refinance and it’s the only renovation loan that doesn’t require the funds to be disbursed to the contractor through a messy inspection & draw schedule process. Like all renovation loans, RenoFi Loans are based on the after renovation value allowing homeowners to borrow the most money at the lowest possible rate without having to refinance.

RenoFi Loans work for existing homeowners or homeowners purchasing a new home and renovating.

For existing homeowners who locked in a super low rate on their first mortgage, being able to borrow on the after renovation value without having to refinance again makes RenoFi Loans the ideal choice.

For homeowners looking to purchase a home that needs some renovation love, RenoFi Loans allow the homebuyers to acquire the property with a traditional mortgage and then use a RenoFi Loan after closing to fund the renovations. This is much easier than trying to use a renovation loan for the purchase process.

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. Same Low Home Equity rates - for 10 to 20-year terms, rates are typically the same as a traditional home equity loan or line of credit.
  • 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 $25k to $500k *With no prepayment penalties, you have peace of mind knowing you can pay it off anytime.
  • It’s the only renovation loan that doesn’t require homeowners to refinance and it’s the only renovation loan that doesn’t require the funds to be disbursed to the contractor through a messy inspection & draw schedule process.

Cons:

  • Because home equity loans typically max out at 20-year terms, the monthly payments for these loans are often a bit higher than payments for other renovation loans with a term of over 30 years.

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

How They Work:

This is a construction loan, a type of renovation loan that converts to a new permanent first mortgage and replaces your existing mortgage in the process. So in that way, it’s like a cash-out refinance but based on the after renovation value.

Construction Loans require the money is paid to the contractor, not the homeowner, through a milestone-based disbursement schedule that requires onsite inspections by the bank.

Pros:

  • Low monthly payment - Like a traditional mortgage, because you can spread payments over 30 years, your monthly payment is as low as it can be.
  • Low rates - Rates are typically in line with the market rate for first mortgages though some lenders can charge a premium.
  • 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:

  • Many contractors simply refuse to take on projects that are using construction loans due to the headaches involved with the inspections and disbursement schedule. Learn more here in our post on Three Reasons Not To Use A Construction Loan.
  • Because you are refinancing, you might be refinancing at a higher rate.
  • Because you are refinancing, you have to pay typical closing costs PLUS the extra costs associated with the construction loan, making it one of the most expensive loans on the market from a fees perspective.
  • Because you are refinancing, you are starting the clock over on your mortgage which slows down the rate at which you build equity in your home.

3. Fannie Mae HomeStyle Loan

How They Work:

Fannie Mae homestyle loans are a specific type of construction loan (See #2 on the list) insured by Fannie Mae, a government-sponsored agency. This affiliation with Fannie Mae comes with some pros and cons:

Pros:

  • Ability to borrow up to 95% of the future value of your 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.
  • Ability to spread payment over 30 years.

Cons:

  • Higher rate - Fannie Mae HomeStyle mortgage rates are typically higher than the interest rate you can get by doing a Construction Loan through a private bank. Only available on conforming loan limits which varies by area.
  • Many contractors simply refuse to take on projects that are using loans like this due to the headaches involved with the inspections and disbursement schedule. Learn more here in our post on Three Reasons Not To Use A Construction Loan.
  • Because you are refinancing, you have to pay typical closing costs PLUS the extra costs associated with these types of loans, making it one of the most expensive loans on the market from a fees perspective.
  • Because you are refinancing, you might be refinancing at 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 in your home.

4. FHA 203k (Full)

How They Work:

FHA 203K loans are exactly like #3 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 pros like lower credit score requirements and some cons like higher rates & costs:

Pros:

  • Ability to borrow up to 96.5% of the future value of your 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.
  • Ability to spread payment over 30 years.

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. Find loan limits nationwide here.
  • Many contractors simply refuse to take on projects that are using loans like this due to the headaches involved with the inspections and disbursement schedule. Learn more here in our post on Three Reasons Not To Use A Construction Loan.
  • Because you are refinancing, you have to pay typical closing costs PLUS the extra costs associated with these types of loans, making it one of the most expensive loans on the market from a fees perspective.
  • Because you are refinancing, you might be refinancing at 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 in your home.

A Side-by-Side Renovation Loan Comparison

Here is a side-by-side comparison for a quicker view on the facts behind each different type of home renovation loan:

Renovation Home Equity LoanSingle-Close Construction To Permanent Loan (CTP)Fannie Mae HomeStyle LoanFHA 203k (Full)Two-Close Construction To Permanent Loan (CTP)
Is this a mortgage?YesYesYesYesYes
1st or 2nd mortgage?2nd1st1st1st1st
Require refinance of existing mortgage?NoYesYesYesYes
Typical Interest RateMarketAbove MarketAbove MarketAbove MarketAbove Market
Loan Limit (Renovation Cost + Mortgage)$500,000Jumbos allowedConforming only$Conforming onlyJumbos allowed
Loan Term (max)20 years30 years30 years30 years30 years
Credit Score Required660+700+620+580+580+
Loan to ValueUp to 95%Up to 95%Up to 95%Up to 96.5%Up to 80%
Can be used for building new home?NoYesNoNoYes
Restrictions on type of improvements?NoNoNoYesNo

That’s it! Now you’re way more informed on renovation loans than most homeowners!

Home Renovation Loans vs Other Financing Options

Just because you’re light on equity in your home, that doesn’t mean you should be fooled into borrowing using finance products that aren’t specifically suited for home renovations.

The right loan types do exist, you just need to know which is best-suited to your situation.

So here’s a look at how home renovation loans stack up against the other financial products you may be considering:

Home Renovation Loan vs Home Equity Loan & HELOC

A home equity loan or home equity line of credit (HELOC) allows you to borrow against the equity that has built up in your home, but if this isn’t sufficient to give you the borrowing power to get the money you need to pay for the project, you’ll likely be forced to reduce the scope of your project or find other suboptimal lending solutions to make up for the shortfall. For homeowners who have been in their homes for 10+ years, this is less likely to be an issue, but for recent homebuyers a true renovation loan is likely the way to go.

Home Renovation Loan vs Personal Loans or Credit Cards

Using personal loans or credit cards is one of the dumbest things that homeowners do when paying for home renovations, largely because these are unsecured loans which require them to have much a higher interest rate and shorter terms. They also have much lower limits on loan amounts, often $35k-$50k depending on the lender.

A home renovation loan is secured against your home and thus offers lower interest rates and more borrowing power.

Home Renovation Loan vs Cash-Out Refinance

Most homeowners shouldn’t use a cash-out refinance to pay for renovations, due to the requirement to refinance your first mortgage. Refinancing means that you’ll lose any low interest rate that you have locked in, as well as having to pay significant closing costs that typically come with first mortgages.

RenoFi home equity loans are the only home renovation loans that DO NOT require you to refinance.

To sum it up, home renovation loans offer lower interest rates & more borrowing power than other types of home improvement loans that are really just dressed up personal loans & credit cards. Traditional home equity loans & cash-out refinances are great for homeowners with a ton of equity built up, but if not, renovation loans are the way to go.

RenoFi loans are a new type of renovation loan that doesn’t require you to refinance.

So, you might be wondering if a RenoFi home equity loan is right for you.

Who Should Consider a RenoFi Loan?

A RenoFi loan is perfect for homeowners who would otherwise be considering a home equity loan or cash-out refinance that would benefit from an appraisal based on the future home value, not the current one, that other home renovation loans consider. This factor can increase borrowing power by more than 11x whilst also ensuring that the lowest possible interest rate is secured.

Think of a RenoFi loan as having the borrowing power of a home renovation loan with the ease of a home equity loan. So, let’s recap.

RenoFi Loan Recap:

BOOSTED BORROWING POWER! Like all types of renovation loans, RenoFi loans use a home’s estimated after renovation value instead of its current home value to calculate how much a homeowner can borrow, boosting homeowners borrowing power by more than 10x on average.

LOWEST RATES! After the renovation, a RenoFi loan has the same rates as a traditional home equity loan. Compared to personal loans, credit cards, traditional home equity loans or refinancing your mortgage into a higher interest rate, these are the lowest cost solution to financing your renovation.

LOWER FEES! Just like a traditional home equity loan, RenoFi loans have incredibly low fees compared to first mortgages. And because RenoFi partners with credit unions, RenoFi loans have the lowest fees in the industry!

NO DISBURSEMENT SCHEDULE! It’s the only renovation loan that doesn’t require the funds to be disbursed to the contractor through a messy inspection & draw schedule process. Many contractors simply refuse to take on projects that are using construction loans due to the headaches involved.

WORKS FOR PROJECTS OF ALL SIZES! Unlike a typical home renovation loan which only works for major home renovation projects, a RenoFi home equity loan is a good option for something as simple as finishing your basement ($25k-$50k), up to a total home remodel ($250k-$500k+).

How RenoFi Can Help

If you’re looking for the best home renovation loan to finance your renovation project, it helps to have as much information as possible.

And that’s why we’re here.

RenoFi can help you learn more about your loan options and find the best lenders available to get you started.

RenoFi renovation loans not only increase your borrowing power based on the after renovation value of your property, but they offer lower interest rates and monthly payments than almost any alternative.

Plus, we partner with awesome Credit Unions who help us offer these lower rates and give you even more flexibility based on your financial situation.

Sound pretty great? Click the button on the right to Find A Lender.