Here’s What You Have to Consider Before Taking Out a Home Improvement Loan

Whether you’re looking at a Fannie Mae HomeStyle loan, an FHA 203k, or a good old home equity loan -- borrowing to make home improvements isn’t a decision to take lightly.

For any of these types of loans, the most important question any home buyer can ask is “What sort of house improvement can I buy with this loan?” The reason: it’s all too easy for a buyer to jump into a renovation loan in order to buy an extreme fixer-upper, without realizing that the house may be a total disaster.

You may fall in love with the potential of a place, especially if it has some old-world charm, while completely ignoring the rotting rafters over your head or the undulating floors. And while some of this may be fixable with the right loan product, there will always be cases where no amount of money can make a home habitable.

But if you’ve found a good fixer-upper (or you’re already living in one) and you’re ready to make the leap, here’s what you need to know.

Choosing the Right Home Improvement Loan

The home improvement loans on the market are very similar to one another. The 203(k) is easier to qualify for, being an FHA product, and allows for a lower down payment of just 3.5 percent on a primary residence. The FICO score minimum is in the high 500s, so you can expect to pay mortgage insurance. But if you’re working on your credit, obtaining this loan and then refinancing in the short term could be a great game plan.

The HomeStyle loan from Fannie Mae is a more flexible product when it comes to what you can buy. As long as your plans will improve the property and the value is there, you can buy any sort of property -- even a rental -- and renovate it with this loan. HomeStyle can also be combined with a newer loan program called HomeReady, which allows for a three percent down payment on a primary residence.

Loans for Energy Efficient Home Improvements

There are entirely separate loan programs for energy efficient home improvements, like the PACE loan. PACE stands for property assessed clean energy, and these products are available in 35 states as of 2018. PACE loans can help fund improvements like the addition of solar panels and energy-efficient appliances.

However, they have their downsides, too. PACE loans are financed as a tax assessment, meaning the debt stays with your house. If you decide to sell your house, you may have a difficult time. If you can’t make the PACE payments, you can lose your house -- and finally, having a PACE loan makes it difficult or impossible to refinance your original mortgage. To learn more, check out our blog on PACE loans.

Restrictions on Contractors with Home Improvement Loans

If you’re the type of buyer who wants to work on home improvements yourself, you may have trouble doing so with the aforementioned loans. Generally, lenders want you to use contractors that they approve of -- since they need to know that the improvements are going to be done correctly. It makes sense, after all: the bank is taking a risk by offering you a renovation loan, and to mitigate that risk, they need to ensure your home will rise in value.

If you’re currently living in your fixer-upper, have built up some equity, and you want to make home improvements yourself, a home equity loan might be the better option. Home equity loans or home equity lines of credit don’t have stringent requirements for their use. You can utilize these products to raise the value of your home without having to follow a bank’s guidelines.

Home improvement loans are a great way to get into the house of your dreams (or fix the nightmare you’re living in). However, it pays to stay informed, so ask your lender lots of questions upfront before opting for a home improvement mortgage. And as always, home.loans is here to help guide you through the tricky stuff.