Real Estate Tips: How Does a Home Construction Loan Work?

Whether it’s to renovate a kitchen, tear out a wall or two to expand a room, or add on to the property, when deciding on a home upgrade the next statement typically is, “How are we going to pay for it?”

One of the most common ways to secure funds for upgrading a home is to tap into its equity, or accumulated market value. Refinancing your mortgage or securing a home equity line of credit are excellent ways to turn your home into what’s often called your “personal piggybank.”

Below are a few ideas for getting your hands on the funds you need to get the ball rolling.

1. Cash-out refinance

A cash-out refinance helps you tap into some of your home’s equity. Lenders will generally let you borrow enough to pay off your current mortgage and take out more cash, usually up to 80 percent of your home’s value. But proceed carefully before agreeing to this type of refinance. You’ll be using your home as collateral for a bigger loan, and you’ll be financing short-term costs with long-term debt, which adds interest and other fees to the price of the renovations. In most cases, a cash-out refinance is appropriate only if you’re improving your home in ways that will increase its value.

 Photo by  rawpixel  on  Unsplash

Photo by rawpixel on Unsplash

2. Unsecured loans

What if you can’t qualify for a loan because your credit score isn’t high enough or some other mitigating factor? Don’t worry too much. First, get some advice from a lending institution officer or an experienced real estate professional. Then think about an unsecured personal loan. This is a common type of loan that isn’t backed by collateral, such as your home or car. It’s riskier for lenders, though, who might charge higher annual percentage rates than a secured loan. Approval and the rate you receive are still primarily based on your credit score, but with some caveats. You probably won’t get funded for a major renovation, but for general sprucing up–maybe adding a new front door or a few windows–an unsecured personal loan could be just the ticket. Rates typically range from 5 percent to 36 percent, and repayment terms range from one to seven years.

3. 203k rehab loan

A popular loan for someone buying a home that needs work, the 203k rehab loan allows a buyer to finance the purchase price of the property and the cost of needed or desired repairs–all folded into a single loan. If you don’t have the money to renovate, this type of loan can be a real benefit to creating your ideal home. No scrambling around before closing, trying to repair the home so the bank will lend on it. No shopping around for a second mortgage to finance repairs. No living with a leaky roof while you save up the funds to fix it. A 203k loan can take care of these repairs and more with one loan transaction.

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4. Good old cash

Of course, paying for renovations with cash is the best way to avoid finance and other charges, and stay within your budget. Saving up takes time and patience, but is bound to cause fewer headaches along the way to completing your reimagined dream home.