How do Home Renovation Loans Work?

When first thinking about renovating our homes, we often get lost in daydreams and fantasies of new bathrooms, kitchens, walk-in closets, and a whole host of other great renovation ideas. Eventually, though, we come back to reality and the daunting thought of the cost associated with renovations. So, how do home renovations work? Let’s dig in.

Home renovations can run anywhere from a few hundred dollars up to hundreds of thousands of dollars, and there are many different ways to pay for them. While inexpensive upgrades such as new light fixtures, countertops and windows can be paid for using either a line of credit or a savings account, large reconstruction projects take far more time and money, often requiring home renovation loans to cover the cost.

There are several different ways to finance your major home renovations. For starters, you could opt for what is called cash-out mortgage refinancing. This is where you refinance your existing mortgage for more than what you currently owe. For example, if you owe $250,000 on your mortgage, you could refinance for $400,000. This would leave you with $150,000 to put toward renovations.

The amount of money you can access using this option depends on how much equity you have in the home – this is the difference between the value of your home and the amount you owe on your mortgage. Typically, the amount of money you can free up is positively correlated to how long you have owned your home. You will usually be able to refinance to about 80 per cent of the home’s value. In the example above, your home would need to be worth $500,000 or more in today’s market.

This option is advantageous because it will carry a lower interest rate and you’re using an asset you already have in order to pay for your renovations. The other benefit is that you are leveraging the current value of the home to further increase its value through the renovations.

A second option is a home improvement loan. Making home improvements is one of the quickest ways to add to your home’s value, while also increasing your enjoyment of it.

Home improvement loans are ideal because lenders can customize your loan, including your repayment plan, with an affordable interest rate. This is based on the borrower demonstrating that they can repay the loan and that their home carries a value worth funding.

Another name for a home improvement loan is a renovation mortgage. With renovation mortgage financing, some of the funds will go toward paying for the home or the balance on your existing mortgage, and the rest can be allocated towards making improvements to your home. Sometimes lenders will add specific instructions to these loan agreements. For example, you may be required to have a construction company on-hand to immediately receive the funds from the bank – this is done to ensure that the funds are used for their intended purpose.

When applying for one of these loans or mortgages, it is ideal to have your renovations planned out and have contractors and materials ready to go upon approval. This demonstrates to the lender that you will be using the funds appropriately.

Lenders will examine your employment history to ensure that you have a steady income and present a low risk of defaulting on your loan. Your debt-to-income ratio will also be taken into account; this is the amount of debt you carry in relation to the income you make each month.

Other Factors to Consider

When looking to get a mortgage renovation loan or a home improvement loan, there are a few factors that come into play. The first is how much money you require. The second is the amount of time it will take you to repay the loan. The third is the interest rate. The greater the number associated with any of these factors, the more you will spend paying back the loan. This makes each of them a key aspect to consider when comparing the full cost of the renovations versus your home’s increased value once they are completed.

As with any loan, it is important to remember that interest starts accruing from the day the renovation funds get deposited to your bank account, whether you use them to cover your renovation costs or not. Therefore, it is prudent to have everything pre-planned and coordinated, to allow you to begin as soon as you receive the funds.

Before making any financial decisions, consult with a professional to hear about all the available options that you qualify for and to make sure you are matched with a loan that adequately covers your needs.

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