Renovation loans: What they are, and how both buyers and sellers can take advantage

Key insights

• Renovation loans can be the perfect fit for buyers who are ready to create their dream home, or homeowners who hope to fix up the property before listing it on the market.
• The most important part of the renovation process is the appraisal, where the appraiser will assess the value of the home after the renovations are made.
• Homeowners may wonder if it’s worth making renovations on their home when the market favors sellers. Experts say that even in today’s low-inventory market, buyers expect turnkey homes, so the repairs may help a seller generate more interest in their property.

What are renovation loans, anyway?

Renovation loans are a type of financing vehicle that covers the cost of the home, as well as its planned upgrades and repairs.

Either buyers or current homeowners can secure a renovation loan but:

• Buyers will secure a new loan that covers the acquisition and remodeling of their property
• Homeowners will refinance their existing mortgage so that it includes the funds for the planned and approved renovations.

How do renovation loans work?

Renovation loans typically follow these six steps:

1. Determine the repairs or improvements

Whether it’s a buyer looking at homes that need renovations, or a homeowner who wants to update their existing house, the first step is to make a list of the repairs you’d like to make to a specific property.

2. Get in touch with a renovation specialist

Once you’ve decided you want to pursue renovations on a property you wish to purchase or already own, you’ll want to talk to your lender’s renovation specialist, who will help you

• Run the numbers on potential repairs
• Work with your chosen contractor, who will provide a cost estimate analysis for the home improvements
• Complete all the necessary paperwork to secure the loan

3. Finalize the plans with the contractor

Before you submit the final paperwork for your loan application, you’ll need to hire a contractor who can create a bid for the planned renovations. You may also need to finalize drawings or blueprints for any larger renovations or additions you have planned.

Pro tip: Like most markets, Minnesota and western Wisconsin have a shortage of licensed contractors. To ensure you don’t have to delay your dream home, work to secure a contractor as soon as you can.

4. Submit your loan or refinance application

Once all the paperwork has been signed and the contractor has completed their bid, your renovation specialist will help you apply for a new or refinanced loan.

5. Get the property appraised

It’s important to understand that in a renovation loan, the appraisal is based on the improved, or post-renovation, value of the home.

Let’s say that the property in question has a bad furnace and an aging roof. In a traditional appraisal, the appraiser would deduct value due to these issues. But with a renovation loan appraisal, the appraiser would base their assessment on the final product of the property — the same house, with a gleaming new furnace and roof.

To determine the appraised value, appraisers will compare your property to other similar local properties that will match your home’s improved, or post-renovation, condition.

6. Finalizing the loan

The final step is the one that varies the most between buyers securing a new loan and current homeowners refinancing their existing mortgage.

For buyers, their lender will:

• Pay the home seller the contract price of the home at closing.
• Assign the remainder of the funds to an escrow account that will be used to pay the contractor for the planned and approved work.

For current homeowners, the lender will:

• Pay off their first loan.
• Assign the remainder of the funds to an escrow account that will be used to pay the contractor for the planned and approved work.

How do renovation loans benefit buyers?

Buyers can benefit from renovation loans in a variety of ways. Here are some of the most common scenarios:

A chance at a different set of houses

Some homes that are listed as-is and in need of major repairs may be aimed at investors who plan to flip the property — and buyers who need financing may not qualify to purchase the property under a traditional loan structure. By taking out a renovation loan, buyers can open themselves up to a new pool of properties that were previously off-limits.

A chance to create their dream home

Another common scenario for buyers is that their down payment will cash out their savings, so they need to find a house that meets all their needs. That means that a house requiring a bit of work — whether it’s a historic property that needs to be updated to today’s standards or trends, or a suburban house that just needs a finished basement — isn’t in the cards. With a renovation loan, buyers can purchase the rough version of their dream house and make it a reality.

A chance to plan your renovations in advance (and guarantee they happen)

 If you’re going to tear down that wall or replace that roof anyway, why not make a clear plan — that includes hiring a licensed contractor — to help ensure it happens on time and within budget?

How do renovation loans benefit homeowners who wish to stay in place?

Homeowners who plan to stay in the house can benefit from renovation loans because the loan allows them to create the house they want or need now.

“Most homes in our market are at least 20 years old,” said Brian Peterson, a renovation specialist from HomeServices Lending, LLC, “With that kind of aging housing stock, a lot of current homeowners are living in outdated properties — and their taste or lifestyle may have changed since they first bought the home. They may want to take down some walls to create an open floor plan or they may hope to finally refinish the attic into a luxury master suite.”

Why would sellers take on a renovation loan?

In today’s low-inventory market, homeowners may wonder if it’s worth updating their home well in advance of putting the home on the market. The surprising answer is, yes.

“I always tell homeowners with questions about renovation loans that they have two options: sell their home later without updating and take their chances on getting a lower price offer, or to renovate the home so they can enjoy it now. Then when they are ready to sell it down the road, it will be a hot property that generates a lot of immediate interest,” said Peterson. “Because we’re seeing such low inventory today, any home that’s move-in ready is extra appealing to today’s buyers — so renovating can pay off.”

Ready to get started?

When you make the call to pursue a renovation loan, you’ll want to get moving fast to get a contractor signed on and the loan in process.

For help finding a mortgage renovation specialist, reach out to Edina Realty customer care. They can help match you with an expert seven days a week.

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