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Construction vs. Renovation Loans - What's The Difference?

When we think about mortgage loans, we often think of the traditional longer-term financial commitment to purchase a home. But many people don't realize that there are specific loans for new construction builds and renovating homes. Below are ways to utilize these loans and how they can benefit you.


Construction Loans

A Construction Loan is a short-term loan used to finance the building of a new home. Once the construction of the new home is completed, the borrower then must refinance and convert the loan into a permanent traditional mortgage. Often a construction loan has a one-year term before they need to be converted to a conventional mortgage. A construction loan is used for costs associated with a home building like land purchase, building materials, labor permits, landscaping, even appliances.

Renovation Loans

A renovation loan is used to finance a home renovation, home repairs, and remodels. Renovations loans are a great option if a home needs significant overhauls, whether updating or a major facelift. There are a couple of options for renovation loans. The two most common areFHA 203 (k) loans and FNMA Homestyle loans.The Federal Housing Administration offers the FHA 203(k).The loan will finance the needed repairs in a single mortgage on a primary residence and will require a minimum down payment of 3.5%. There are two types of renovation loans of 203(k) loans:Standard FHA203(K) loans that will permit borrowers to finance the repair or rehab costs starting at $5,000 and will not have a maximum. Streamline FHA 203(k) loans will allow renovation and repair financing for up to $35,000. The alternative is the FNMA Homestyle loan which is offered by Fannie Mae. It will enable you to renovate and purchase a primary home, second home, or investment property with a minimum down payment of 3% in one mortgage up to the lending limit.


Is a Construction or Renovation Loan Right for You?

Choosing a construction loan vs. a renovation loan will vary greatly dependant on your situation. Before you decide, there are a few questions you need to ask yourself. When considering a renovation, you need first to weigh the notion of timing. Is this the right time to be renovating? Is a renovation going to increase the value of the home and your quality of life? How much will this renovation cost, and can I really afford it?


If you are thinking about a construction loan you need to consider what you can really afford in the long term. You will need to consider needs vs. wants. Does new construction make more sense than purchasing an existing property? What timeline are you considering for moving into your new home? Discussing your goals with your mortgage lender is always the best way to start any project that you are considering.


How to Get a Construction or Renovation Loan

Now that you have decided on the type of loan you will need, it's essential to evaluate your current financial capabilities. Have you checked your credit score with your mortgage company? If your credit score isn't great, you will need to work on improving it, which can take time, so planning is key to getting a yes to your construction or renovation loan. A key component to getting any loan is a good credit score. Other things that you will need to consider are financial obligations. Do you have money for a sufficient down payment? The amount that you will be required to put down may vary based on your loan type. Making sure you have a sufficient amount is key to closing. Monitoring your debt is also an important factor. Having a debt-to-income ratio of under 36% is ideal for getting approved for a mortgage loan. If you are looking for a construction loan, finding a licensed builder is an important first step. Any mortgage lender will want to know that you have a qualified, experienced, licensed, insured builder working on your project.


Getting prequalified is the key to making your renovation or new build a go. The prequalification will give you a reasonable estimate of how much you can afford to borrow and can help with expectations. Now that you've got your finances in order, let the project begin!


Are you ready to build the home of your dreams? Are you ready to get started on a big renovation? Call The Wood Team at Hometown Lenders today to get started. 406.220.0077

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