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Home improvements are a great way to add value and enjoyment to your existing home, or to increase the listing price if you are thinking about selling. For those seeking to rehabilitate property, several home improvement loan options are available for projects large and small. A home improvement loan is similar to a home equity loan, except that the loan proceeds are used specifically for making capital improvements to your home.
FHA Home Improvement Loans
FHA home improvement loans are a bit of a misnomer. The loans are not actually made by the Federal Housing Administration (FHA), bur are made by local and national commercial banks and then insured against default by the FHA. Sometimes these loans are also called FHA insured loans. They are popular loan programs, which offer standardized application guidelines, and a streamlined approval process. Usually, FHA insured loans can be funded in 30 days or less with a complete application and documentation package.
There are several FHA insured loan programs specifically tailored to an owner rehabilitating or improving her home. Most of these programs are only available for work done to a primary residence, but a few allow work to investment properties as well. The more popular FHA insured rehab loans are listed below.
FHA Rehabilitation Loan 203K
The FHA rehabilitation loan, also known as the 203k loan, provides money for borrowers to rehabilitate an existing home, or to purchase a home and immediately make improvements to it.
Improvements are considered additions or things done to increase the property value, while repairs are considered things done to bring the property back to habitable conditions, or up to local code.
Under the 203k program, you can get funds to improve or repair a residential property (one to four units in size), or to the residential portion of a mixed use property, like a retail establishment with residential units above the shop.
A borrower could use the 203k rehab loan to make repairs to their home including, but not limited to:
- Modernizing a home and eliminating functional obsolescence
- Making the home compliant with Americans with Disability Act (ADA)
- Eliminating safety hazards and bringing the home back to local building codes
- Work on the roof, gutters, and downspouts
- Major landscaping projects
- Adding energy efficient appliances and building features
- Structural alterations to the foundation or building frame
Disaster Recovery Loans 203H
The FHA also makes available a loan program for property owners to obtain funds to renovate a property that has been significantly damaged due to a natural disaster. The 203H disaster recovery loan program allows borrowers to receive a loan renovate or completely replace a home if it has been damaged beyond repair.
Under the 203h program, borrowers can receive up to 100% of the cost of improvements or replacement, but to be approved for the program the property must be located within a federally designated disaster area. Currently designated disaster areas can be found in the resource list below.
Community and Portfolio Lenders
Community lenders are lenders in your local market, and are not larger chain retail banks. A portfolio lender is usually a smaller bank, like a community bank, which holds all its loans on the books, rather than selling them on the secondary mortgage market. Both community and portfolio lenders use conventional underwriting standards, but commonly offer higher interest rates and associated loan costs.
Some community and portfolio lenders offer FHA insured loan programs, while other simply offer their own version of a rehab and construction loan. To be approved for these loans you’ll likely have to submit construction cost estimates from a licensed and bonded contractor in your area, and submit to a specialized appraisal which analyzes the current value of your property and estimates the value of the property with the planned renovations complete.
Once a construction loan is approved, you receive money in stages, called draws. When it is time to complete a portion of the work on your home, the contractor submits to the bank a draw request. After the work is complete and installed, a bank representative inspects the property to make sure the requested work was done correctly, and then approves the draw request and transfers the funds to your account or to the contractor directly. This process continues on a regular basis until the project is complete or until you have reached your draw or loan limit.
Home Equity Lines of Credit Make Great Rehab Loans
Home equity lines of credit are a great way to make improvements to your property without obtaining or refinancing other liens on your home. For smaller projects, a HELOC can be an inexpensive and effective way to make improvements.
Most HELOCs are made as second position loans, subordinate to a senior lien from your first lien lender. HELOCs can also be a stand alone lien on properties currently free and clear, owned outright by the borrower.
A home equity line of credit works like a credit card in that you are approved for a maximum amount of credit and are allowed to charge up to that limit, but not above it. Some banks attach your home equity line of credit to a checking account and allow you to deposit funds from the line into the account to draw down on by writing checks. Other banks simply give you a credit or debit card and allow you to draw down on the line by making charges on the card. Usually, home equity lines of credit require a monthly payment like a credit card, and may have a minimum monthly amount that you must pay to keep the account in good standing.
HELOCs usually stay open as long as the account is being paid and is in good standing, as opposed to other term loans, which expire after they are paid off or the term ends. The downside of a HELOC is that a bank can reduce your line at any time, and usually without warning.
Tax Implications of Home Improvements
Some renovations you make to your primary residence can be considered to tax deductions. Other improvements, like installing energy efficient upgrades, can earn you valuable tax credits, which are a dollar for dollar reduction in your tax liability. Most improvements made to investment property will be deductible, and some tax credits are also available for these purposes. To determine tax implications specific to your situation, contact a qualified and licensed CPA or tax attorney.
Where to Get Them?
Home improvement loans are available at most savings and loan associations, mortgage banks, and commercial banks. Interest rates and terms may vary considerably from lender to lender. Typically, interest rates are adjustable, but some fixed rates are available. We recommend that you talk to several lenders, compare interest rates, and certainly ask about obtaining a fixed rate.
If You Have Bad Credit?
FHA home improvement loans (discussed earlier) may be available to you even if you have poor credit and no equity in your home. You may be able to borrow as much as $25,000 to make improvements on your home. This is a big help for homeowners who have credit problems or have seen the market value of their real estate plunge below their mortgage balance. These borrowers would probably not qualify for a home equity loan or second mortgage.
Under the FHA home improvement loan program (discussed previously) funding can be obtained within 7 to 10 days. A second mortgage or home equity line could take 30 to 45 days. This could make a big difference to you if your home improvement loan is funding repair of a leaking roof or septic system.
What if you don’t have any equity?
You may be able to get a home improvement loan even if you do not have any equity in your home. The Federal Housing Authority (FHA), a federally sponsored agency, manages a government insured home improvement loan program. No appraisal is required, and you can borrow under the FHA program whether or not you have any equity. Other benefits of the plan include fixed interest rates, up to 20-year terms and quick funding (7 to 10 days). Ask your lender about FHA Title 1 Home Improvement Loans. Typically, the bank will require an appraisal of your home to determine the value of your equity. Most lenders will loan you more than the value of the equity in your home on the assumption that the capital improvements will increase the value of your home.
Interest on home improvement loans secured by your primary or secondary residence is generally deductible as long as the total of all mortgage and home improvement loans secured by your primary or secondary residences does not exceed $1 million ($500,000 if you are married and filing a separate return).