Can You Add Renovation Costs to a Conventional Mortgage?

You can add renovation costs to a conventional mortgage, but only when you’re using a conventional cash-out refinance. 

If you’re doing a cash-out refinance on an existing home, you can withdraw additional funds on top of your existing mortgage balance. This will give you a new conventional mortgage that replaces your existing one and allows you to access funds from your equity that can be used for renovations. 

While you can add renovation costs to a conventional mortgage with a cash-out refinance, there are other options to consider that may be better suited to your needs.

Conventional Mortgages vs Renovation Mortgages

If you’re curious about conventional mortgages vs. renovation mortgages, let’s take a look at the differences between the two. 

Conventional mortgages 

Conventional mortgages are available through private lenders, banks, and credit unions. In most cases, they cannot exceed the appraised value of a home. 

Most conventional loans require decent credit scores and a low debt-to-income ratio to qualify. Conventional loans can include cash-back refinance options, which allow you to borrow additional funds on top of the balance needed to purchase the home. 

Your cash-out refinance conventional mortgage will replace your original mortgage. That means that any existing terms—including length of the loan, your interest rate, and any points you previously purchased—will no longer apply. 

These are some things to consider:

• You lose any existing terms regarding interest rate and points previously purchased, which can be a pro or a con, depending on market conditions.
• Conventional mortgages only cover the appraised value of a home in its current state— not what it will be worth after a renovation, which may prevent you from getting the funds you need.
• You can only get a cash-out refinance if you have at least 20% equity in the home.
• Refinancing is only an option if you have already purchased the home. 

Renovation mortgages 

Renovation mortgages, on the other hand, are a specialized type of mortgage that includes funding for renovations, including home repairs and improvements. 

There are different types of renovation mortgages available, and they each work a little differently. In general, though, they typically work in one of the following ways:

• Single-close loans that include the cost of renovations in the initial loan balance
• Loans that can be added alongside conventional mortgages to cover renovations
• Loans specific to making upgrades needed for the health and safety of residents of a home

You can also look into additional, non-mortgage loans or lines of credit after securing a mortgage to purchase your home. 

You’ll want to keep the following in mind when considering renovation mortgages:

• They account for the added value that can come with renovations during the approval process.
• You can use them to cover repairs required by lenders to purchase the home (like repairing a roof or replacing pipes); many also come with the option to make structural or cosmetic changes to the home.
• They may have higher interest rates than conventional loans.
• There’s often more paperwork involved, as you have to document the changes you want to make and estimated costs.

Options for Financing Renovations

If you want to finance renovations, you can choose renovation mortgages or other financing options that will allow you to access the funds you need. Let’s look at each. 

FHA 203(k) loan

FHA 203(k) loans are backed by the Federal Housing Administration (FHA). They allow homebuyers to borrow the funds needed to make proposed repairs, in addition to the cost of the property. 

These loans can be 15- or 30-year mortgages and can either be fixed-rate or adjustable-rate (ARM) mortgages. They may be more flexible with qualification terms compared to other mortgages because they’re backed by the government, making them an option for some borrowers who are working on building their credit scores up. 

Eligibility and requirements include:

• Minimum credit score of 500
• Minimum down payment of 3.5% with a 580-plus credit score, or 10% down payment for those with a score under 580
• You must use the loan if the property will be your primary residence
• Financed renovations must be performed by a licensed contractor, not a borrower
• Work with an FHA-approved lender
• Provide documentation for planned home repairs 

Fannie Mae HomeStyle loan

Fannie Mae HomeStyle loans allow home buyers to add renovation costs to their mortgage. Before closing on the loan, however, approved contractors must submit work plans to the bank for a “draw”; after inspections, the bank distributes payment. 

Fannie Mae HomeStyle loans are flexible. You can use them to cover multiple costs, including permits and license fees, the cost of the renovations, and living costs for rentals. You can also account for project contingency reserves. 

Eligibility and requirements include:

• Available for multiple home types, including for investment properties or second homes
• Down payment based on home and property type, ranging from 3% to 25%
• Minimum credit score of 620
• Debt-to-income ratio under 50%
• Documentation from an approved contractor prior to loan acceptance

Construction loan

If you want to build a new custom home, construction loans are an option to consider. Most construction mortgages are “construction-to-permanent” loans.

These loans allow you to withdraw funds from your mortgage reserves at set milestones during construction. The final payment is delivered when the certificate of occupancy is issued. The first year involves interest-only payments; after that, the loan converts to a permanent mortgage. 

Construction loans typically have the following requirements:

• Strong credit scores required; often at least 680, but may be as high as 720, depending on the lender
• Down payments of 20% or more are typically required
• Detailed contracts and work proposals submitted before the underwriting process begins

Cash-out refinance

We’ve already discussed cash-out refinancing as an option. This is the best way to lump renovation costs into a conventional mortgage, if you have the equity on hand.

These are the typical eligibility requirements to consider, though specific requirements depends on your lender and the loan type you’re using:

• Typically can cash out up to 80% of your home equity
• Minimum credit scores for each loan type must be met; if your credit score is lower than when you first obtained the property, this could prevent a refinance
• Debt-to-income ratio must be able to account for the extra cash-out refinance
• Cash-out refinances may incur slightly higher rates than traditional mortgages  

Freddie Mac Renovation loans

Freddie Mac CHOICERenovation loans allow you to add renovation and construction costs to Freddie Mac mortgages, which typically offer benefits like low down payments. 

It’s another flexible mortgage option, allowing buyers to combine homebuying balances and renovation costs into a single loan. Borrowers can finance renovations that cost up to 75% of the home’s post-renovation value. 

Eligibility requirements typically include the following:

• Down payments ranging from 3% to 20% 
• Most lenders require credit scores of at least 620.
• Multiple home types included, including primary residences, one-unit investment homes, and manufactured homes 

Jumbo renovation loans 

Jumbo renovation loans are designed for renovations that go beyond conventional or FHA limits, so they’re often used for higher-priced homes. These loans do typically cover nonstructural and cosmetic repairs. 

The maximum cost of repair is $150,000, or 20% of the renovation’s completed value (whichever is lower). They can be used for buying homes that need renovations, or refinancing for renovations. 

Eligibility requirements include:

• High income
• Strong credit scores, often 680 or above 
• A minimum of a 10% down payment, depending on the lender and property type
• Debt-to-income ratio requirements lower than conventional mortgages; often 43% or below

Hard money loan

Hard money loans are also called bridge loans. These are short-term loans designed to help you get the funds you need to purchase (or, in some cases, renovate) a property. They require collateral; for many investors, another property may be used, and conventional buyers may use the existing home they plan to sell for collateral.

Hard money loans are not permanent mortgages, so these are only meant for short-term and transitional transactions ranging from 12 to 24 months. They typically have higher interest rates as a result. 

These loans typically have the following eligibility requirements:

• Loan-to-value ratio of 50% to 70%, depending on the lender
• Good credit scores, often at least 680 or above
• Down payments of 20% typically required 

Equity-based lines of credit 

Equity-based lines of credit for your properties are a good choice for renovations, with home equity lines of credit (HELOCs) the most common option. These are always available for primary residences, and some lenders offer HELOCs for investment properties. 

HELOCs allow you to leverage your equity to take out a second loan (sometimes called a second mortgage) on your home, which has its own unique terms. HELOCs typically have draw periods of around 10 years, during which time you can repeatedly draw funds as needed up to your loan limit. You’ll only pay interest on what you’re using, and after the 10 years, you’ll have an extended repayment period (often around another 10 years). 

It may be more difficult to qualify for a HELOC for an investment property, but these are the general eligibility requirements:

• Debt-to-income ratio that can accommodate the full loan balance (43% is typically the max)
• Own a certain percentage of equity, often at least 15% 
• Good credit score, with most lenders requiring around a 620-680 credit score minimum

The Process of Adding Renovation Costs

When you’re using financing to cover renovation costs for a new home purchase, the process will vary based on the type of loan you’re using. 

In general, the process typically involves the following:

• Getting quotes from contractors about the estimated costs for renovations; always try to account for unexpected costs (including increases of material or labor costs)
• Choosing the type of loan that you want to use
• Have your property appraised to determine its current value
• Submitting paperwork, including contractor information, contracts, and detailed plans for renovations and costs 
• An appraiser may consider the estimated value of the property after proposed renovations are complete
• Lenders will consider renovation costs as you move through the underwriting process 
• Have renovations inspected by the lender for final payment 

Some loans have much more flexibility than others. Only some loans, for example, require inspections on completed work. Others, like HELOCs, don’t require contracts, proposals, or inspections.

All loan types have limitations and will consider the loan-to-value ratio to determine how much money they’re willing to lend you based on the appraised value of the home itself. Some loans will consider the appraised value of the home as it is now; others may consider the estimated appraised value of the home after renovations are complete. 

Pros & Cons of Adding Renovation Costs to a Mortgage

There are pros and cons that come with adding renovation costs to a mortgage, and you’ll want to weigh them carefully.

These are the pros:

• You can get the funds you need to renovate a property upfront, allowing you to enjoy it (and potentially even live in it) from the beginning.
• You may need financing in order to make structural or safety changes needed in order to secure a mortgage.
• Investors can renovate a property quickly so they can charge more upfront without needing downtime for renovations later. 
• You only have one loan to worry about, and an extra $10,000 to $30,000 on a loan doesn’t make a huge impact on a monthly payment that’s spread out over a 30-year loan.

These are the cons:

• You’ll be paying interest on the cost of renovations for the entirety of a mortgage, which can add up significantly over time.
• The process for adding renovation costs to a mortgage is often extensive.
• Some renovation mortgages can have restrictions on how you use the funds, or how much funding you’re able to receive.
• Interest rates may be higher on renovation mortgages. 

Weigh out both long-term and short-term benefits against the disadvantages.

Adding $10,000 to a $300,000 30-year mortgage with a 7% interest rate, for example, adds less than $100 per month to your total monthly payment (using BiggerPockets mortgage calculator). For many, this is a low cost that’s accessible now.

It’s important to consider the long-term interest, though. Those same numbers take your total interest for the lifetime of the loan from $418,527 to $432,478.

You’ll also want to consider what rates are available with different types of mortgages. You may benefit from a conventional or FHA mortgage without renovation costs at a lower rate for the home balance, and then a secondary loan like a HELOC that you can pay down faster. 

A trusted loan officer can help you decide what’s right for you. 

Tips for a Successful Renovation Mortgage

Follow these steps to increase your odds of getting a successful renovation mortgage:

• Do your research first: Consider which repairs and renovations are needed. Get quotes from contractors to come prepared.
• Account for unexpected costs: Renovations almost always cost more than expected, whether it’s because there’s an increase in material or labor costs, hidden damage is revealed, or you make changes part of the way through. Account for this in your quote.
• Have a short-term and long-term plan: How will these renovations impact the appraised value of the home? And for investors, how will it impact your bottom line? 
• Consider different options: Talk to a loan officer experienced with real estate investors to discuss which financing and mortgage options are best for your goals. 

Final Thoughts

Real estate investors are particularly skilled at spotting a diamond in the rough, whether it’s to flip a home or to create a rental property that will yield profit for years to come. Different renovation loans and renovation mortgages can help you take advantage of those opportunities.

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.