Can You Add Remodel or Repair Costs to Your Initial Mortgage Loan?

So you’ve just found your dream home, but it’s a bit of a fixer-upper. Now what?

If you’re like many homebuyers in today’s high-priced market, you’re probably stretching your budget just to secure the property, and might not have much cash left over. But that doesn’t mean you can’t do any renovations; there are a number of loan options that actually allow you to add renovation costs to your initial mortgage.

Each type of renovation loan works for a different type of buyer, and they each have their own benefits, drawbacks, and limitations. Here’s how to choose the best option for you. 

How to Estimate Costs for Remodels or Repairs

Before you even start talking to lenders about renovation loans, you’ll need to take one important step: Accurately estimating how much the remodel is going to cost.

That can be challenging, especially during this pandemic era renovation boom. Contractors are hard to come by, and supply shortages only drive up costs.

“Material can get really, really expensive,” says Tabitha Mazzara, director of operations at MBANC, a mortgage lending company headquartered in California.

One way to secure an estimate of renovation costs is working with an inspector that’s certified with the Department of Housing and Urban Development, known as HUD. These HUD-certified inspectors will give you a detailed rundown of what needs to be done and how much it should cost.

Sometimes, the inspector may tell you that a home isn’t worth the amount of money it would take to repair, and that’s okay. But investing in that inspection — which might cost between $300 and $500, according to HUD — gives you crucial information, and will be an important step in pursuing any of the government-backed renovation loan options.

Adding the Cost to Your Mortgage Loan

Once you have a budget for renovations, you can start to consider your options for adding that cost to your mortgage. In doing so, the remodeling costs would be tacked onto your initial loan amount (the money needed to purchase the home), creating a new combined total balance for your mortgage.

That single loan would cover both the home purchase and renovations, and you’d pay it off with a single monthly payment. The renovation money, however, is not simply a lump sum of cash you can use as you wish. Each loan type has different requirements for how and when you can use the renovation money. 

Consider working with a HUD-certified housing counselor in your area, who can help you decide which loan is best for you. These are some of the most common options, and how they work:

FHA 203(k) Loan

The FHA 203(k) loan is a government-backed mortgage, which means there are a few more rules and requirements than with a conventional mortgage, but it has some unique benefits, too.

When a buyer takes out a 203(k) loan, the large majority of the loan is used to purchase the home, and the remaining balance is held in an escrow account that releases funds as you complete the renovation.

This option is ideal for a home that needs a lot of work before you can move in, and is meant for first-time home buyers. The renovation money can be used for a wide range of projects, from plumbing to roofing to energy efficiency to structural improvements. Projects under $35,000 are considered limited 203(k) loans, while projects in excess of $35,000 are deemed standard 203(k) loans. But regardless of the amount, the total loan must fall within government-set FHA mortgage limits in your area. 

“The 203(k) product can be a really good product for someone who fits within the confines and constraints of what’s allowable,” Mazzara says.

But there is some red tape involved: You’ll need to work with your lender and with HUD to get the renovations approved, and your contractor will need to submit a detailed cost breakdown. “It’s going to take a little bit of patience to coordinate,” says Haider Garzon, a HUD-certified housing counselor and an advisor with the Troy Rehabilitation and Improvement Program.

Plus, because it’s a government-backed loan, interest rates may be higher than those of a conventional mortgage, and you’ll be required to pay private mortgage insurance.

Fannie Mae Homestyle Loan

The Fannie Mae Homestyle loan is another type of government-backed lending option. The basic structure of the loan is similar to 203(k), but the requirements are slightly different.

“[A Homestyle loan] would be more accommodating than 203(k),” Mazzara says, because it’s more flexible in the type of improvements it can be used for.

Homestyle loans are available for investment and vacation properties, whereas a 203(k) is meant only for primary residences. Plus, Homestyle loans can be used for certain types of upgrades — like pools or hot tubs — that are not eligible under a 203(k) loan.

Some other notable differences: Homestyle loans require a higher credit score and down payment than a 203(k) loan, but give you 12 months to complete the renovation, compared to 6 months with a 203(k). The maximum cost of renovations that can be financed with a Homestyle loan is 75% of either the purchase price plus renovation costs, or the “as-completed” appraised value of the home, whichever is lesser. For refinances, the maximum is 75% of the “as-completed” appraised value. 

You can secure a Homestyle loan by working with a Fannie Mae-approved lender. 

Freddie Mac Renovation Mortgage (CHOICERenovation loan and CHOICEReno eXPress)

A Freddie Mac Renovation Mortgage is very similar to a Fannie Mae Homestyle Loan. Freddie Mac, which is also a government-backed enterprise, offers two versions of the loan: CHOICERenovation loan and CHOICEReno eXPress.

The CHOICERenovation loan is a relatively new option and, like Homestyle loans, it offers more flexibility than an FHA 203(k) loan and possibly lower interest rates, depending on your financial situation. 

With a CHOICERenovation loan, the total cost of the financed renovations on purchase transactions cannot exceed 75% of either the purchase price of the property plus the estimated total renovation costs, or the completed value of the property, whichever is lesser. For refinance transactions, the limit is 75% of the completed value. All renovations must also be completed within 365 days of the note date, regardless if you are purchasing a new property or refinancing. 

The CHOICEReno eXPress loan is meant for smaller-scale renovations where a smaller amount of money is needed, and the renovations will be done in a shorter period of time. Renovations must be completed within 180 days and the total cost of renovations cannot exceed 15% of the value for properties located in designated Duty to Serve high-needs areas, or 10% for properties not in Duty to Serve high-needs areas.

Both types of loans are available from Freddie Mac-approved lenders. 

How Does a Remodel Affect Your Home Value?

All of these renovation loan options are based on the assumption that remodels almost always increase the value of your home. 

Just how much any one renovation will improve your home value can be harder to predict, but there are certain types of renovations that typically provide more value than others.

The tried and true remodels are kitchens and bathrooms, two places in your home where improvements are highly sought after from homebuyers. Especially now, when materials and appliances are hard to come buy, completing those types of renovations will likely be well worth it when it comes time to sell.

“If, in fact, you’re going to remodel and you’re making sure to source new appliances, and it’s not the headache of the person who’s purchasing, that’s brilliant,” Mazzara says.

There’s also a lot of value in additional square footage. Especially in the age of changing lifestyles and remote work, when families might want that extra room to double as an office or a bedroom for visitors, creating more space in your home can be a smart move.

“If you can add square footage that doesn’t significantly impact a hike in your real estate taxes, it’s a home run all the time,” Mazzara says.

But be careful not to “over-improve” any one space, Mazzara advises. Splurging on expensive tile, for example, isn’t likely to pay off. Make sure that whatever you’re spending on aligns with the average price per square foot in your area, Mazzara says.

And don’t forget: Even if a renovation can improve your home’s value, it still might not be the best decision for your current financial situation. You don’t want to stretch yourself if you truly can’t afford it. And if you have the money, it might be better used paying off high interest debt or building an emergency fund.

Other Options for Financing Your Remodel or Repairs

If you’re set on tackling that home renovation, adding the costs to your initial mortgage might be your best bet. But keep in mind, there are a few other options out there for financing your project.

Cash-Out Refinance

A cash-out refinance is exactly what it sounds like: By refinancing your existing mortgage to one

with a larger loan amount, you are able to extract equity in the form of cash. 

Assuming you can secure a good interest rate, this can be a low-cost option for accessing funds. It can be an especially good choice if you need a large lump sum of cash all at once to jumpstart your renovation. There are typically no restrictions on what the money from a cash-out refinance can be used for, so it can be a good option if you want to use some of the money for other expenses besides renovations, or you don’t want to jump through the hoops of a government-backed home renovation loan. 

But be aware that cash-out refinancing can mean higher monthly loan payments (because your loan amount increased) and a longer repayment period (if you reset the clock on the loan). Rising mortgage rates might also make a refinance less attractive, especially if you’ve recently refinanced already and don’t want to lose your current rate. 

Home Equity Lending

If you don’t want to mess with your primary mortgage, you can also pursue a second mortgage — also known as home equity lending. 

There are two types of home equity lending: A home equity loan is a lump sum of cash that you borrow upfront and pay back over a set term, like an installment loan. A home equity line of credit is more like a credit card: it allows you to continuously draw from a line of credit for as much or as little as you need (up to the credit limit) for a set period of time, therefore only paying interest on the amount you use. 

Home equity lending may have higher interest rates than a cash-out refinance, but they usually have fewer closing costs. They can be a good option for renovations if you need more flexibility, especially in the form of a HELOC. Be aware that like a primary mortgage or cash-out refinance, a home equity loan or HELOC is secured by your home, meaning you risk foreclosure if you default on the loan. 

Personal Loans

If you don’t have any home equity to work with, a personal loan can also be an option to fund home renovations. 

Personal loans are given out based on your personal credit history, but because they’re usually not secured by a physical asset (like a home), the interest rates are typically significantly higher. That said, if you’re doing a minor renovation of less than $10,000, they can still be a good choice for quick cash with few strings attached.