Real Estate

What Is a Home Renovation Loan?

June 21, 2021

Are you hoping to finance some future home improvements or a big remodel? If so, keep reading to learn about home renovation loans.

Whether you need to repair your foundation or make some minor improvements to your guest bathroom, a home renovation loan, construction loan, or home rehab loan are just some of the ways to fund the materials, installation, and other expenses needed to complete your project.

Home renovation loans can be an attractive home remodel financing option for some and an unwanted financial risk for others.

What are home renovation loans and how do home renovation loans work? If you’re curious to see if a home renovation loan is the best option for you, you’ve come to the right place.

This blog will cover an array of topics to help position you for a financially responsible home renovation endeavor.

How Does a Renovation Loan Work?

First things first—what is a renovation loan?

A home renovation loan is a personal loan option used to cover home renovation costs–including home improvement and remodeling. While a home equity loan for a remodel might be better suited for larger, more long-term projects like a major kitchen remodel, home renovation loans are a practical option for more minor fixes and updates to your home.

Not sure if a home renovation loan will cover the renovation funds needed for your project? Here are a few common renovations that this type of loan can be used to pay for:

Patio remodeling
Solar panel installations
Landscaping
Kitchen remodeling
Bathroom redesign
Roof replacement
Basement finishing
Home repairs

As you can see, versatility is one of the major advantages of this loan program. The other benefits for the borrower include:

Fast disbursement – Once approved, home renovation loans arrive in your bank account quickly.
Fixed monthly payments – You’ll pay your loan back in monthly payment installments, generally within a loan term of one to five years.
Fixed interest rates – While some loans carry unpredictable variable interest loan rates, you’ll know your future payment schedule as soon as you take out your loan.
Unsecured access to renovation funds – There is no legal claim made against your house as collateral by the lender.

So what’s the downside?

One drawback to home renovation loan options is that they may have higher interest rates than other borrowing alternatives, especially if you are looking for a jumbo renovation loan.

Other potential negatives to renovation financing include:

May require more paperwork detailing project plans
Not eligible for tax benefits
Lower borrowing limits and loan amounts
May require origination fees
Expensive late fees

Do the pros outweigh the cons for you? Let’s have a look to see if you meet all the necessary qualifications for home renovation loan approval.

How Do You Qualify for a Renovation Loan?

After asking how do home improvement loans work? The next step is figuring out if you qualify.

Requirements for this type of loan can vary depending on the lender, but you’ll generally need the following:

A solid credit score – This one is about as standard as they come. While there are ways of qualifying for a loan when you have low or no credit, it will likely come with a higher interest rate. Having a good credit score is not the only factor a loan officer will consider, but a score that sits between 610 and 640 or higher will raise your chances of approval.
A steady income – Another standard requirement when applying for a home improvement loan is an annual salary report. Again, the minimum required earnings per year will depend on each lender but could be as low as $15,000 to $20,000 per year.
A low debt-to-income ratio – This is another way for lenders to determine the borrowing risk of granting you a home improvement loan. Debt-to-income (DTI) ratio is the amount of your monthly income that goes towards making monthly debt payments. According to Forbes, a DTI ratio to aim for in order to increase your chances of approval is 36 percent.

Before applying for a home improvement loan, you’ll want to assess your current financial situation and be prepared for any possibility of denial. If you’re worried you won’t be approved, you may want to consider an alternative path like using a co-signer or shopping around to find lenders with fewer requirements.

How Hard Is It to Get a Renovation Loan?

If you meet the qualifications listed in the previous section, getting a home renovation loan should be a relatively simple process.

Start with the following:

Get an estimated idea of the costs for your home improvement project.
Contact a contractor if you’re planning to outsource the labor.
Make a budget accordingly.

Expenses will vary depending on the project itself, the type of materials needed to complete it, and the size of the space.

For renovations made to your entire home, the average costs are between $19,800 and $73,200. In contrast, a single bathroom remodel can range from $5,000 to $25,000 on average.

Keep in mind that home renovation projects don’t always go off without a hitch. It’s possible you’ll run into an unforeseen problem midway through your project, so you may want to factor this into your budget just in case.

Once you’ve planned your expenses and compared loan rates, you’ll be ready to apply. Most loan application processes will follow a similar trajectory.

Here’s a look at what a borrower can expect:

Fill out a loan application – Whether it’s an online or in-person application, most lenders will ask you to fill out a document providing basic personal information. You’ll also need to state the purpose and desired amount for the loan.
Provide proof of identity – In order to apply, lenders will need to know that you are 18 years of age or older and a citizen of the United States. You’ll likely need to present two forms of identification like a driver’s license, passport, or birth certificate.
Provide proof of address – Another risk a potential lender will want to assess is the stability of your residence. Providing a utility bill or proof of home insurance should suffice.
Verify your income – As you now know, lenders will need to know that your salary meets their minimum requirements. When applying, be prepared to show a pay stub, tax return, or bank statement in order to verify this.

Equipping yourself with the right documents and a detailed outline of the renovation costs of your project will help to alleviate the stress of applying for a loan.

Improving Your Credit Score

Worried that your credit score might negatively impact your chances for loan approval?

Here are a few strategies you can start working on now to improve it for future loan requests:

Minimize your credit usage (aim for 30% or less)
Stay on top of your monthly payments
Limit the number of hard credit inquiries
Use a secured credit card (one that is backed up by a cash deposit)

If you’re not sure that a home renovation loan is a realistic choice given your current financial situation, it may be time to consider alternative methods of reaching your project goals.

Other Renovation Financing Options

Now that we’ve fully answered the question, what is a home improvement loan, you might realize that the risks could outweigh the rewards.

Whether your home renovations are a necessity or a desirable way to improve your day-to-day life, taking out a home renovation loan is never your only payment option. There are a number of alternative routes for homeowners who would prefer to avoid the high-interest rates and lower borrowing limits of home renovation loans.

Here are some alternative renovation loan options to consider as a homeowner:

Paying in cash – While this is a low-risk option, it will likely require strict budgeting or may cut into savings you had allocated for something else.
Using a credit card – Keep in mind that this option may have even higher interest rates and could negatively impact your credit score.
Applying for a home equity loan – These loans tend to have lower interest rates than home renovation loans. However, keep in mind that you’ll still be taking on debt.
Applying for a home equity line of credit (HELOC) – A HELOC for home improvement generally has minimal closing costs, but monthly payments are not fixed, so they could be subject to fluctuation over time.
Sale-leaseback – Your home is your biggest asset—and it’s possible to convert your equity to cash without moving. All you need is to find a sale-leaseback buyer who’s willing to let you stay in your house for as long as you like.

Start Renovating Your Home With a Sale-Leaseback

Embark on a long-awaited kitchen remodeling adventure, freshen up the landscaping, or turn your basement into a functional space you’d actually like spending time in. Whatever your project goals are, a sale-leaseback program can provide you with a solution to help you set the ball in motion.

Instead of taking on debt by applying for a home renovation loan, convert your home equity into cash with a sale-leaseback solution. The process is easy, fast, and flexible by taking a holistic approach that doesn’t just rely on credit score and income type.

Key Takeaways

If you’re hoping to finance some future home improvements or a big remodel, there are home renovation loans you can use to achieve your goals. However, be sure to do your research and talk to a financial advisor beforehand so you can be aware of how the process works and any alternative solutions that may work better for you.

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