How to Finance Your First Home Renovation

People looking to finance a home renovation can be both short-term or long-term investors. Short-term investors are known as “fix-and-flippers” and typically purchase, renovate, and sell a property within 12 months. Long-term investors usually purchase and renovate a property before acting as a landlord. Below we discuss the best financing options for fix and flippers as well as buy-and-hold investors.

Hard Money Loan

Hard money loans are short-term loans secured by real estate, often used by fix-and-flippers to finance the purchase and renovation of a property, usually selling it within 1 year. This is because the typical loan term is between 1 – 3 years. Hard money loans usually require interest-only monthly payments and the full loan amount repaid at the end of the term.

Hard money loan amounts are usually based on either the loan-to-value (LTV) or the after-repair-value (ARV) ratio. The LTV ratio measures the loan amount as a percentage of a property’s purchase price while the ARV ratio measures the loan amount as a portion of  a property’s expected fair market value after renovations.

Hard money loan qualifications are easier to meet when compared to other financing options, and the approval and funding turnaround time can take as little as 15-days. Hard money loans are best for novice and experienced short-term investors alike. This is because hard money lenders usually look at the value of the property more than the experience of the borrower.

Cash Out Refinance

A cash out refinance occurs when an investor takes out a new loan against an existing personal or investment property. Cash received from the new mortgage is used to pay off any existing liens and the remaining cash can be used to finance an investment property. This gives investors the opportunity tap into any existing equity without needing to take out 2 liens (as may be the case with HELOCs).

A cash out refinance is best for investors who own existing personal or investment properties with at least 30% – 40% equity. This is because the amount of a cash out refinance is based on a percentage of the existing property’s loan-to-value (LTV) ratio, typically around 75% – 80%.

Since they’re usually issued by traditional lenders like banks, the qualification requirements can be more stringent than with hard money loans. However, a cash out refinance can be used by short-term investors and long-term investors alike. Once the new mortgage is issued and the old one paid off, there are no restrictions on how you use your excess capital.

Home Equity Line of Credit (HELOC)

A home equity line of credit (HELOC) is a credit line based on the equity of an investor’s existing primary residence. Like a credit card, investors may use the credit line only when they need it and interest rates are charged only on the amount used. This is best for investors with no specific project in mind, but who have equity in an owner-occupied primary residence.

The total amount of a HELOC is based on a property’s combined loan-to-value (CLTV) ratio, which takes into account any existing liens. Lenders will issue HELOCs based on CLTV because there is usually already a first mortgage and the HELOC serves as a second mortgage.

Qualification requirements are relatively higher compared to hard money loans. Further, HELOCs often have variable interest rates that can increase during the term of HELOC. A HELOC can be used by short-term fix-and-flippers as well as long-term investors. However, a home equity line of credit requires that you have an existing owner-occupied primary residence.

Permanent Mortgage

Permanent mortgages are long-term conforming loans provided by FHA lenders. They are used to purchase long-term investment properties that are in good condition. Because rehabilitation is not allowed with permanent mortgages, fix-and-flippers typically don’t use a permanent mortgage. However, these mortgages are great for buy-and-hold investors looking for a permanent investment property.

The application process for a permanent mortgage is similar to a cash out refinance but may take longer when compared to a hard money loan. The qualification requirements are much stricter compared to other financing options and the rates and fees are therefore lower. Permanent mortgages are recommended for investors who plan to buy long-term rental properties in good condition.

Personal Credit Card or Personal Loan

Another good option to cover small expenses and incidental costs regarding home renovation is the use of credit cards and/or personal loans. Credit cards may be used normally to buy renovation materials. Repayment term is usually monthly, however, you are allowed to float rehab expenses and incur interest charges if needed.

Personal loans are consumer loans provided by conventional lenders for various consumer-related purposes. Typically, loan amounts available are relatively small and often have a maximum loan amount around $150k. You may use personal loans to pay for materials and labor costs as well as other incidental expenses. Personal credit cards and loans can be used by both short-term investors as well as long-term investors.

Bottom Line

Whether you’re planning to purchase a rental property or fix-and-flip a short-term investment, the underlying costs involved might be quite expensive. If your personal savings and/or small loans from family and friends are still not sufficient to cover such costs, the next best option is to find the proper financing for your investment strategy.

There are a large number of financing options available to short-term and long-term real estate investors alike. If you’re thinking about investing in a property, it’s important to know the various home renovation financing options available. If you can understand the different loan amounts, terms, costs, and qualification requirements, you’ll be able to find a loan product that works for your specific needs.

Evan Tarver is a small business and investments writer for Fit Small Business, fiction author, and screenwriter with experience in finance and technology. When he isn’t busy scheming his next business idea, you’ll find Evan holed up in a coffee shop working on the next great American fiction story.

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