New type of home equity loan caters to major renovation projects

Brandon Segal was set to make a substantial addition to his historic house in a Philadelphia suburb, but he wasn’t sure how to pay for it.

He didn’t have enough equity to cover the six-figure renovation bill with a home equity line of credit or a cash-out refinance. A construction loan struck Segal as complicated and cumbersome.

Segal settled on a home equity loan through RenoFi, a financial technology company that connects homeowners with credit unions willing to loan based on how much a house will be worth after upgrades are completed.

“I like the ability to borrow based on what my appraised value is going to be,” Segal says.

RenoFi served as a matchmaker, directing Segal to Ardent Credit Union, a Philadelphia lender. He took a 20-year, fixed-rate loan to pay for a two-story addition to his 1920s home.

Home improvement takes off during the pandemic

The coronavirus pandemic has turned home improvement into a national pastime. In one illustration of that trend, the National Association of Home Builders’ remodeling index soared during the pandemic. Home-improvement retailers and remodeling contractors reported spikes in business.

With many Americans working from their home offices, more homeowners have developed a hankering for upgrades to their spaces. Meanwhile, a spike in home prices and a shortage of homes for sale limits the choices available to those who’d traditionally be move-up buyers.

The national median price of homes sold by Realtors spiked 12.9 percent from December 2019 to December 2020. Housing inventory fell to a record low, according to the National Association of Realtors.

Segal, for his part, loves the house he shares with his wife and their three daughters, but the quarters were getting cramped. He found a contractor to add a master bedroom and other living space to the house.

Paying for home improvements can pose a challenge, however. A home equity line of credit (HELOC) is one tried-and-true source of renovation funds. But HELOCs work only for homeowners with significant equity. If you owe $300,000 on your $400,000 property, a bank is unlikely to lend $100,000 through a HELOC. To keep your loan-to-equity level at 80 percent, or $320,000, you’d be able to borrow just $20,000.

RenoFi offers a different approach: Homeowners can borrow up to 90 percent of their home’s after-renovation value.

The company has partnered with credit unions throughout the country to offer the loans, says Justin Goldman, founder and chief executive of RenoFi. Goldman launched the company after experiencing firsthand the challenges of paying for renovations on an older home.

He created RenoFi to fill what he sees as a gap in the market. Goldman found most lenders didn’t offer after-renovation loans, so he began persuading credit unions to add RenoFi home equity loans to their offerings.

How RenoFi loans work

RenoFi loans are second mortgages. In one example, Ardent Credit Union offers 20-year loans at a fixed rate of 4.25 percent, Goldman says. That’s higher than the rate on a primary mortgage, but it includes the flexibility of allowing homeowners to borrow against yet-to-be-created value.

Borrowers pay for an appraisal that establishes the home’s value after renovation. The appraiser looks at the proposed construction plan and determines by how much the work will boost the property’s market value.

The typical RenoFi customer borrows $150,000, Goldman says. At that amount, a 20-year loan with a 4.25 percent interest rate carries a monthly payment of $929.

Goldman says RenoFi’s loans also appeal to homeowners who recently locked in loans at rock-bottom levels and don’t want to do a cash-out refinance to pay for improvements.

“If you’ve taken advantage of a low rate and refinanced, you’re going to have to pay all those closing costs again,” Goldman says.

That situation applied to Segal, the Philadelphia-area homeowner. He had recently refinanced and didn’t want to do so again.

“We have a great rate on our current mortgage, and we didn’t want to touch that,” he says.

To land a RenoFi loan, the borrower pays for the after-renovation appraisal, which typically costs $100 to $200 more than a standard appraisal, Goldman says. Beyond that, closing costs typically range between $95 and $500.

“Credit unions’ closing costs are typically lower than a traditional bank, so in the end, it’s still cheaper for the homeowner,” Goldman says.

Other ways to pay for home improvements

RenoFi’s loans are one of several options for homeowners looking to renovate. Among the others:

  • Home equity lines of credit. HELOCs come with one significant caveat: To borrow against your house, you must have plenty of home equity. Before considering a HELOC, make sure the value of your home is significantly higher than the amount you still owe on your mortgage. HELOCs usually close quickly and carry variable interest rates.
  • Home equity loans. Essentially a second mortgage, a home equity loan comes with a fixed interest rate. As with a HELOC, you’ll need sufficient equity.
  • FHA 203(k) loans. This type of loan lets you borrow against the value of the home after improvements. FHA loans are lenient about down payments and credit scores, but they charge higher mortgage insurance fees than other types of loans.
  • Cash-out refinance. In this scenario, you borrow more than you owe on your existing mortgage and apply the proceeds to renovations. This requires equity in your home.
  • Construction loan. A home construction loan is a short-term, higher-interest loan that provides the cash to pay the contractors. The property owner typically needs a longer-term mortgage after the work is completed.
  • Selling a stake in your home. A new breed of financial technology firms is pitching American homeowners on a different way of tapping into home equity. If you’re sitting on a pile of it, these companies — including Haus, Hometap, Noah, Point and Unison — will buy a piece of your house. You repay the “co-investment” when you sell. One downside: This money comes at a higher cost than a mortgage or HELOC.

3 Reasons to Consider a Renovation Refinance Right Now

Is using your kitchen table as an office-slash-kids’-classroom making you long to upgrade your home? You’re not alone.

Sixty-one percent of American homeowners have taken on home improvement projects since March 1, 2020, according to NerdWallet’s 2020 Home Improvement Report. But before you can join them, you’ll have to decide how to finance your project.

Refinancing with a renovation loan is a way to borrow money for home improvements at a lower interest rate than personal loans or credit cards. And instead of paying back a separate loan, the costs of your updates are rolled into your new mortgage payment.

Intrigued? Here are three reasons to consider refinancing with a renovation loan.

Reason 1: You can take advantage of low interest rates

With mortgage rates falling throughout 2020, the number of mortgage refinances has skyrocketed.

Americans took out over 2.3 million refinance loans in the second quarter of 2020, according to mortgage industry analytics company Black Knight. Even with all that refinance activity, Black Knight estimates that almost 18 million homeowners could still benefit from refinancing.

With a renovation refinance, improvement costs become part of your new mortgage amount. Because rates are at or near record lows, this could mean borrowing more without drastically changing your monthly mortgage payment.  While it may not compare to a credit card with a 0% introductory APR, a renovation refinance gives you a higher borrowing limit. And you’ll pay much less interest than you would on a personal loan for the same amount of money.

Reason 2: Remodeling is an accessible alternative to buying

Though the spring homebuying season got off to a slow start due to the coronavirus pandemic, real estate markets throughout the country have since heated up. According to the National Association of Realtors, 69% of homes sold in August were on the market for less than a month and the inventory of unsold homes was down almost 19% when compared with a year prior.

“Multiple offers and bidding wars have just led some people to stay where they are and customize the home to their liking,” comments Jamie Zeitz, a Jacksonville, Florida-based sales manager with Homebridge, which offers renovation loans.

More than 1 in 5 (21%) of those who have tackled home improvement projects since March opted to do so instead of looking to move, according to NerdWallet’s 2020 Home Improvement Report.

Though concerns about the spread of COVID-19 initially caused contractors’ workloads to drop, “by the end of the second quarter, people had found workarounds,” says Paul Emrath, vice president of surveys and housing policy research at the National Association of Home Builders.

And they seem to be working. The NAHB’s Market Index for the third quarter of 2020 found that remodeling professionals were quite confident about the current market and the outlook for the rest of the year.

Reason 3: You may add value to your home

A smart renovation can boost your property’s value — and it isn’t all about curb appeal or gourmet kitchens, either.

A 2019 joint report from the NAR and the National Association of the Remodeling Industry found that replacing outdated heating and cooling systems or upgrading insulation offered some of the best returns on investment when it came time to sell, for example. In the meantime, such updates could result in a more comfortable home and lower utility bills.

And, unlike a cash-out refinance, a renovation loan may expand your budget by allowing you to borrow against the home’s expected value after improvements are complete, rather than its current value. Similarly, you may be able to take advantage of a renovation refinance even if you haven’t owned your home long, since these loans require less equity than a cash-out refinance, home equity line of credit or home equity loan.

Tips for using a renovation refinance

Think a renovation refinance might be for you? Here’s what’s next:

Research the right loan product: Renovation loan options include Freddie Mac’s CHOICERenovation loan, Fannie Mae’s Home Style renovation loan and FHA 203(k) refinance loans from the Federal Housing Administration.

Your credit score and the improvements you plan to tackle determine which renovation loan is right for you, Zeitz says.

FHA 203(k) loans typically have more lenient credit requirements, but place limits on the types of renovations you can do. If you wanted to, for example, put in a pool, you’d need to qualify for a conventional renovation refinance like the Fannie Mae Home Style.

Get familiar with refinance requirements: In addition to available home equity, your lender will examine your credit score, debt-to-income ratio and employment history to determine if you qualify for the renovation refinance loan you’re seeking. If you’re considering a 203(k), bear in mind that even though the FHA’s credit score minimums are typically low, lenders can impose their own higher numbers.

Find an experienced contractor: In order to know how much you’ll need to borrow — or how much your home may be worth once the remodeling’s done — you’ll need accurate cost estimates from a licensed contractor. It’s also important to have a contractor who’s willing to take on the extra paperwork and planning involved with a renovation loan.

Compare lenders: Though rates are low, comparing interest rate quotes from at least three lenders will ensure you get the best deal. Your research may be a bit tougher since not all lenders offer renovation loans. Even lenders that offer FHA loans may not necessarily offer FHA 203(k) loans. But once you find the right fit and get approved, you’ll be on track to create the home you need from the house you already have.