3 Reasons Why You Shouldn't Use a Construction Loan for Your Renovation

There’s a better financing option for your home improvements.

If you’re reading this article, someone probably told you the best way to finance your home renovation is with a construction loan. Sorry, but to put it bluntly, you’ve been given bad advice!

We get it; you need a lot of money to turn your current home into your dream home, and construction loans sound great because they allow you to borrow based on the value of your home after the renovation is complete.

Construction loans used to be the only option...until RenoFi Loans.

Whether you talked to your bank or a friend who went through a similar process, they most likely didn’t mean to intentionally steer you in the wrong direction, but today’s market has changed in a good way!

Now, RenoFi Loans also provide renovation financing using the after renovation value that allows you to borrow more.

Which is why it’s really unfortunate that many people who shouldn’t be using construction loans for their renovations still are, simply because they think it’s their only option for home improvements.

Before we talk about the new financing options available, let’s look at the three reasons why a construction loan is no longer the best choice of funds for most renovation projects:

1. You are forced to refinance and pay more.

Were you one of the lucky people to lock in an awesome mortgage rate when they were at all-time record lows? Virtual high five! After a smart move like that, you’re probably not trying to give it up, and we don’t blame you.

Unfortunately, with a construction loan, you’re required to refinance your home, which means losing that great first mortgage rate you earned in the process.

You might be refinancing into a higher rate.

Refinancing can sometimes kill two birds with one stone; you get a better rate and the money you need to do your renovation. But if you’ve recently refinanced, there’s no need to go through the process again and incur more fees. Or even worse, refinance into a higher interest rate.

How much money will you lose with a higher rate?

For example, say your current rate of 3.5% becomes 5% after refinancing.

Let’s do the math:

That 1.5% difference will cost you tens of thousands of dollars and possibly $100k+ in additional financing costs.

You may be wondering - who would ever refinance into a higher rate? Surprisingly, 60% of homeowners do refinance into a higher rate, because they think that’s the only way to get the cash out that they need.

It’s not worth it!

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

The RenoFi team is standing by to help you better understand how RenoFi Loans work and the projects they are best suited for. Have a question - Chat, Email, Call now...

2. You’ll pay higher closing costs.

Refinancing into a higher interest rate isn’t the only part that stings. With the refinance requirement of a construction loan, you’ll have to pay closing costs based on the new value of your mortgage + your renovation budget, as opposed to just on the renovations alone.

Just how much higher?

For example, if you have a $500k mortgage and a $200k renovation budget, you’re forced to pay closing costs on a $700k loan versus a $200k loan.

Let’s do the math:

3% in closing costs means a construction loan’s closing costs will add $15,000 in costs! That’s $15,000 that could be funding your renovation instead.

Lenders fees for construction loans are higher than any other loan type.

In addition to closing costs, the lender’s fees are also higher for a construction loan as compared to a typical refinancing or other types of loans.

That means on top of the usual loan origination and processing fees, appraisal fees, etc., you’ll be footing the bill for all the additional underwriting costs, contractor background checks, and construction inspections throughout the process — just to name a few.

Again, this ends up being thousands of dollars more when all is said and done.

3. You won’t get your money right away because of the complicated draw process.

In reality - construction loans are a pain in the butt — for both you and your general contractor. Ever notice that when you Google “how do construction loans work?” the answers are never short and sweet? That’s because the process isn’t either.

Construction loans require:

  • Frequent property inspections
  • Small withdrawals based on project milestones
  • Lots, and lots of paperwork

Why are construction loans more complicated than other loans?

Construction loans were originally intended for builders to turn a bare plot of land into a beautiful new home, and this created a lot more risk to a lender in terms of collateral.

As a result, stringent requirements were implemented throughout the process to protect the lender.

Instead of getting all of your money to your contractor up front, you can only get the money in installments - giving you and your contractor a huge headache.

Take a look at a construction loan draw schedule… yeesh.

Photo Credit: Real Estate Finance HQ

Unfortunately, whether you’re building a house from scratch or just completing a renovation on an existing home, construction loans are one-size-fits-all and not based on specific needs — meaning that you have to adhere to these same requirements no matter what.

Some contractors will refuse jobs because of these complications.

This translates to extra tasks like working with your contractor to create a draw schedule, organizing — and waiting on — inspection visits, the involvement of project supervisors, and the frequent communication with your lender requiring detailed plans and information throughout the construction process (which your contractor will hate too).

If you don’t have to go through these extra steps, why would you?

RenoFi Loans: The better construction loan alternative.

The one alluring quality of a construction loan is the ability to borrow more money based on your home’s after renovation value. But a construction loan is no longer the only way to borrow against your home’s increased value.

Introducing: renovation home equity loans — which offer that same attractive increased borrowing feature without all the downsides discussed above.

RenoFi Loans have:

  • No requirement to refinance
  • No higher closing costs
  • No complicated draw process

Check out this side-by-side comparison - you’ll see that RenoFi Renovation Home Equity Loans (on the left), beat out all of the other construction loan options.

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 onlyConforming 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

In other words, by choosing a RenoFi Loan, you can get the most money for your renovation project without the higher monthly payments, additional costs, frequent headaches, and a refinancing requirement.

The main things you need to know about RenoFi Loans are:

  • You can borrow between $25k and $500k
  • Fixed rates as low as 4% (varies by state and lender)
  • Terms of up to 20 years
  • Ability to borrow up to 90% of your home’s after renovation value
  • The full loan amount is available at closing
  • You won’t need to refinance your existing mortgage

Sounds too good to be true? See how much you can borrow with the RenoFi Loan Calculator now.

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

The RenoFi team is standing by to help you better understand how RenoFi Loans work and the projects they are best suited for. Have a question - Chat, Email, Call now...