How to get a construction loan


Americans spend more than $ 400 billion on home improvement and repairs every year. That number has increased by more than 50% since the end of the Great Recession, in large part due to the fact that four in ten homes, or about 55 million, were built in this country before 1970.

As living preferences change with the pandemic and more baby boomers choose to stay in their long-standing homes after their kids have left the stables, the popularity of home improvement projects is sure to increase in the years to come – and with it the cost of their completion.

According to the Harvard Joint Center for Housing Studies, the average cost of a home improvement project in 2017 was $ 1,200. Most people covered repairs with cash, but replacing an outdated HVAC system or improving accessibility usually cost a lot more, which means that homeowners are increasingly taking out home finance loans.

“Expanding the ability of owners to pay for improvement projects over time – whether through home loans or credit lines, cash-out refinances, or contractor-arranged financing – would not only result in significant growth in the remodeling industry, but also help the maintain and modernize the country’s aging housing stock, ”wrote the authors of Harvard’s semi-annual report on home improvement spending.

Here we outline the steps to funding your next home improvement project – and how to qualify for a home improvement loan.

Home finance loan: Develop your home equity with a home equity loan, home equity line of credit, or cash out refinancing

Owners’ equity in their homes has been increasing for a decade. Equity grew even faster during the real estate purchase boom triggered by the coronavirus pandemic.

Homeowners typically spend the most on home improvement in the markets where home prices have risen the most. Since the Great Recession, which included areas like Boston, Dallas, San Antonio, San Jose, San Francisco, and Seattle. According to the Harvard report, “Rising prices mean growing home equity, offering owners both the incentive and the means to do more and bigger projects.”

Leveraging the equity you’ve built up in your home is one of the most common ways to fund a home renovation project. You can do this by taking out a second mortgage in the form of a home equity loan or line of credit, or by refinancing your current mortgage and making a withdrawal.

Step 1 for Construction Loans: Gather Your Information

All three options require good credit (i.e., a FICO score of 670 or higher). A good first step is to do your credit report (you are eligible for a free annual report) and check your credit history (you can do this at your bank or through an app like Credit Karma). Just like when applying for your purchase mortgage, the next thing you should do is gather documents that prove your income, such as: B. Your W-2 and pay slips. As with your original mortgage, on a home equity loan or refi, lenders want to see your debt-to-income ratio (DTI) – the percentage of your income that you spend on debt each month (mortgages, student loans, auto loans, etc.) – stay below 43 %. Because there are fewer state guidelines on HELOCs, you may be able to qualify with a higher DTI.

Lenders also typically require that you keep around 20% equity in your home in order to receive any of these mortgage payments. Remember that the bulk of your monthly mortgage payment is used for interest initially.

Step 2 for Home Improvement Loans: Research How Much Home Loans, HELOCs, or Cash Out Refis Cost

These loans have higher interest rates than your original mortgage, but lower interest rates than an unsecured personal loan. For example, when the average interest rate on a 30-year fixed-rate mortgage was below 3% in October, the average interest rate on a HELOC was around 4.5% and on a home equity loan around 5%. The closing costs, such as agency and valuation fees, are usually 2 to 5% of the mortgage lending value.

If you use the funds received from a home loan or line of credit to make meaningful improvements to your home, you may be able to deduct interest payments from your taxes. However, like a first mortgage, these loans are backed by your home, which means your lender can force you to sell your home if you don’t pay.

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Step 3 for building loans: decide which one is right for you

A Home Equity Line of Credit works like a credit card with your credit line ranging from 60% to 85% of the value of your home. (However, in poor economic conditions, lenders sometimes limit the amount borrowers can borrow to 75% or 80%.)

HELOCs have adjustable prices, which means your price may be low to begin with but may change depending on market conditions. That said, you should only go this route if you can pay off the debt quickly. In addition, some HELOCs only charge interest payments for five to ten years, which means you can work that long without wiping your bankroll. However, if you are sure that you can pay on time, a HELOC can be a flexible and relatively inexpensive way to fund an ongoing home improvement project. Debt is revolving, which means you can borrow more as you settle your balances.

A Home loan, on the other hand, is an installment loan that you pay back over five to 30 years. This means you will get the money upfront, which makes this a solid option if you know exactly how much you are spending. A home equity loan, just like a plain vanilla mortgage, has repayment terms – with a fixed rate and a monthly repayment schedule – which makes it easy to understand if you are already paying off a home loan. That is why these loans are sometimes referred to simply as second mortgages.

Finally with a Cash-out refinancing You are replacing your current mortgage with a new, larger one. You refinance your existing mortgage and the lender will give you the rest in cash. The funds you receive from a cash-out refinancing are deducted from your equity. This could be a good way to go if you could also lower your interest rate by refinancing, or if you want to adjust your repayment term to pay off your mortgage faster (although a shorter loan combined with a higher balance could mean much higher monthly payments).

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Bad credit borrowers may have an easier time qualifying for a cash-out refinance. Refinance, however, puts the clock back on your mortgage, which means you’ll be paying longer. (This applies whether you are refinancing to withdraw cash or setting a lower interest rate – or both.) Unlike a home loan or a line of credit, with a withdrawal refinance, instead, you pay the closing costs for the entire loan amount just for the money that You need.

What are Unsecured Repair Loans?

According to the Harvard report, over 80% of home renovation spending in 2017 was on professionally executed projects, and 28% of professional projects were paid for with funding.

If you choose to hire a contractor for your project, it is possible that they will try to sell you the funding. Some remodeling professionals work with lenders to offer personal loans with only 0% interest. Think of it like a car dealer arranging the financing of your car, usually working with a bank and selling the loan on their behalf.

Contractors like these because people tend to spend more on funding. According to Harvard, owners who pay with savings or credit cards spend an average of $ 3,300. People who pay with contractor-arranged financing spend almost twice as much – an average of $ 6,500. (Owners who top up their equity spend even more: $ 7,500 if the source is refinance and $ 9,300 on a home loan or line of credit.)

Like any personal loan, this funding is unsecured. That means that you are not using your home as collateral, but it can also mean a much higher interest rate. Personal loan repayment times are also generally much shorter than mortgages – typically one to five years. But this type of financing is convenient and does not require you to forego equity. Personal loans – arranged by contractors or otherwise – can also be the only option for newer homeowners who do not already have a lot of equity but still want to undertake a home renovation project.

Home Improvement Mortgages and FHA 203 (k) Loans: What You Should Know

Loans such as the Federal Housing Administration 203 (k) Renovation Loan or the Fannie Mae HomeStyle Renovation Mortgage are intended for the purchase of a home that requires significant work – fixer uppers. Both provide funds for the acquisitions as well as a reserve for renovations, which is deposited in an escrow account.

FHA 203 (k) loans only require a 3.5% deposit. You can borrow up to the FHA loan limit in your area ($ 331,760 in most cases) and do certain repairs yourself. Homestyle loans require a minimum of 5% down. You can borrow up to Fannie Mae’s credit limit ($ 510,400 for most of the country) and finance renovations up to 50% of the completed appraisal of your home. No DIY allowed.

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