Financing Home Improvements

July 21, 2000, Revised March 22, 2004, November 24, 2006, December 11, 2006

"I want to make major renovations to my home. I know they will substantially enhance its value. What is the best way to get the financing I need?"

Using a Home Equity Line of Credit

If you have substantial equity and good credit, a home equity line of credit (HELOC) is the simplest way to obtain the financing you need. A HELOC may be pricey, especially if the combined total of the HELOC and your current mortgage takes you above 100% of property value, but you need not have it very long. After the renovations are completed, you can refinance based on a new appraisal that will reflect the value added by the renovations.

The drawback of the HELOC for financing improvements is that HELOC lenders base the amount of credit they offer on the current value of your property. This means that if you don't have much equity, you may not be able to borrow enough to finance the planned improvements.

Using Future Value Financing

If the renovations are too costly relative to your equity to be covered by a HELOC, consider financing based on the value of your home once the work is complete. This is termed "future value financing".

Future value financing is complicated by the difficulties involved in forecasting how various types of improvements will impact property value. There is a greater potential for error in estimating future property value than in determining current value. Lenders offering future value financing may rely on appraisers who specialize in valuing renovations.

Lenders may also feel the need to control the disbursement of funds to make sure that the work is done properly, as they do on construction loans. Lender surveillance could be a nuisance, or it could be a blessing if you can't or don't want to supervise the work yourself.

Most lenders don’t offer future value financing because it is so complicated. Among those who do are Wells Fargo and GMAC Mortgage.

Using FHA Section 203K

Consumers who are purchasing a home that needs major repairs may apply for an FHA Section 203K loan that allows you to buy and renovate with a single mortgage. Section 203K loans are a type of future value financing but with the lender protected against loss by FHA.

A Section 203K deal involve an on-site inspection by three parties in addition to the buyer/borrower and the lender. A consultant inspects the property to determine the improvements that are required, a contractor does the same in order to price the improvements, and an appraiser provides an estimate of future value after the improvements have been completed. These precede the funding of the loan, which is only partial. After the seller is paid, the balance is placed in an escrow account, from which funds are withdrawn to finance each improvement as it is made. The consultant signs off on the improvements at each stage.

Diane Vitalo, a loan officer in Rhode Island, says that:

"While it is a little more involved than a regular mortgage, the 203k is neither difficult nor complicated. A lender who is well versed in the FHA products can close this loan in 30 - 40 days. In addition to purchasing a home with this product, a homeowner may use it to refinance and add repair costs to the loan.

I service primarily first time buyers in the $50,000-$150,000 price range and find the FHA products to be the best around. Down payments are low, sellers can help with closing costs, repairs can be financed at time of purchase or within a refinance. The interest rate is lower than those of home equity lines."

Consumers looking to renovate their current house, or to buy a house that requires renovations, need to find the lenders who provide these types of financing in their area. Mortgage brokers will usually know who these lenders are.