The median age of US owner-occupied homes is 40 years. This middle-aged housing stock may seem a bit “meh” to homebuyers at first—often leaving it to be picked over by fix-and-flip investors. But savvy buyers and agents can turn to renovation programs to unlock hidden inventory and find themselves a great deal.
With a renovation loan (sometimes called a rehab loan), Tomo uses the after renovation value (ARV) of the property. Our appraiser will take a look at the property as well as the plans prepared by a contractor and make their best estimate of what the home will be worth after the work is completed. Another major advantage of the renovation program is that our minimum downpayment is 5% of the ARV, meaning that nearly all of the renovation cost can be financed.
Renovation loans are essentially a way to buy a home and fund its repairs or improvements with a single loan. For example, if you find a charming but outdated house listed at $200,000 and estimate that you’ll need an additional $50,000 to renovate the kitchen, update the plumbing, and repair the roof, a renovation loan can cover both the purchase and renovation costs, all rolled into one neat package.
How do renovation loans (or “rehab loans”) work?
Here’s how it plays out: you get approved for a loan based on the estimated value of the home after renovations. For instance, if the house you want to buy is worth $200,000 now but could be worth $300,000 after you make $50,000 in renovations, the lender might approve a loan amount that covers both the purchase price and the renovation costs, with funds released in stages as the work progresses.
What types of renovations can be financed?
You can finance a variety of renovations, from major structural changes to aesthetic upgrades. For example, you might use a renovation loan to fix a cracked foundation, install new energy-efficient windows, or renovate an outdated bathroom. Some common examples include:
- Install a pool
- Create an in-law apartment
- Build an ensuite bathroom off the primary bedroom
- Install central air conditioning on an older house with wall units
- Finish a basement
How do they compare to other financing options?
The other options for renovation financing are:
- Taking out a second mortgage, like a HELOC
- Unsecured lending, like a personal loan
A second mortgage is seen as riskier and the rates tend to be higher and adjustable. Tomo’s renovation program is a 30yr fixed mortgage. These products also typically won’t allow borrowing against the after renovation value which means larger projects won’t be able to be financed.
Home value isn’t a factor in unsecured lending, but that means these loans have higher interest rates and shorter payback periods. For example, a personal loan used to fund home improvement will be around 5% higher in rate than a 30yr fixed mortgage and you need to pay it back in 5 to 10 years. The monthly cost of these loans is far higher than using a home improvement loan through Tomo.
This table summarized the monthly costs of each loan program for a $100,000 renovation:
| Renovation Loan | HELOC | Personal Loan | |
| Rate | 6.75% | 8.13% | 13% |
| Payback Period | 30 Years | 30 Years | 10 Years |
| Monthly Payment | $518.88 | $594.00 | $1,194.49 |
Rates as of 1/15/2024
How much can I borrow?
The borrowing limit depends on factors like the future value of the home, your credit score, and your income. Suppose you’re buying a home for $150,000 that could be worth $250,000 after $75,000 worth of renovations. If the lender determines the home’s post-renovation value, they’ll set a loan amount that covers both the purchase price and renovation costs up to that estimated value.
How to get the best return on renovation dollars?
Here are some of the renovation projects that are most additive to after renovation value (if you’re looking to flip)
- Mid-range kitchen and bathroom renovations. This means semi-custom wood cabinets, modest backsplash tile work, and stone countertops. Higher end renovations with extensive custom work won’t return the same value for your renovation dollars.
- Adding living area, like finishing a basement.
- Paint and flooring. These are relatively inexpensive changes and make a big difference in the look and feel of the house.
- Buying a home that is eligible for “renovation financing only” in the listing. These are typically distressed properties and available at a discount relative to after renovation value. A buyer who wants to undertake future renovations themselves can buy the home with a renovation loan, do the minimum amount of work to get the home to a livable condition, then complete the renovation over the course of years using vendors of their choosing.
Who are renovation loans a good option for?
If you’re a first-time buyer who spots a 1950s fixer-upper with good bones but outdated interiors, a renovation loan lets you purchase the home and fund necessary updates like modernizing the kitchen and installing new HVAC systems without having to save a separate pile of cash for renovations.
They’re especially useful if you’re eyeing a house in a desirable neighborhood but can’t afford a move-in-ready home. With a renovation loan, you can buy a fixer-upper in a great area, make the necessary improvements, and build equity in a sought-after location. This strategy can pay off when you sell, as homes in good neighborhoods often appreciate more, giving you significant gains.
Are there downsides of a renovation loan?
Yes, there are some potential drawbacks. For instance, interest rates on renovation loans can be higher than traditional mortgages. Plus, if your renovation costs run over budget, you’ll need to cover the extra costs yourself. If your renovation timeline stretches out, it can delay your move-in date. So, if you’re planning to move into your new home by summer but face unexpected delays in renovations, it might push your timeline to fall or even later.
What are the interest rates and terms for renovation loans?
Interest rates can be slightly higher compared to traditional mortgages. For instance, if a regular mortgage might have an interest rate of 5.5%, a renovation loan might come with a rate of 6% or higher. Terms usually range from 15 to 30 years, depending on the lender and the specifics of the loan. Make sure to compare rates and terms from different lenders to find the best deal.
What are the costs involved?
Beyond the standard mortgage costs like closing fees and appraisal charges, renovation loans involve additional expenses. For example, you might face costs for contractor fees, permits, and inspections. If your renovation budget includes hiring a contractor to redo the plumbing, you’ll need to account for their fees and any associated permits, which can add to your overall costs.
How is the renovation process managed?
The renovation process is managed through a series of inspections and disbursements. For example, you might get an initial draw of funds to start work, followed by additional disbursements as milestones are completed, like finishing the kitchen or installing new windows. Your lender will require updates and inspections to ensure the work is progressing as planned.
What happens if the renovation costs exceed the budget?
If your renovation costs exceed the budget, you’ll likely need to cover the extra expenses out of pocket. For example, if unforeseen issues arise during the renovation and you need an extra $10,000 to fix a problem with the electrical system, you’ll have to find that extra money yourself unless your lender agrees to adjust the loan amount.
Are there any tax implications?
There can be some tax implications. For instance, you might be able to deduct the interest on your renovation loan from your taxes. Additionally, certain energy-efficient upgrades might qualify for tax credits. However, tax benefits vary, so it’s smart to consult a tax professional to understand what deductions or credits you can claim.
What happens if I decide to sell the home before the renovations are completed?
If you decide to sell the home before finishing renovations, you’ll need to pay off the remaining loan balance. For example, if you sell the home halfway through renovations, you’ll need to ensure the remaining loan amount is settled, which could impact the sale price or negotiations with buyers.
What should I look for in a lender?
When choosing a lender, look for someone experienced with renovation loans and offering competitive rates. For instance, you might want a lender who’s known for smooth processing and good customer service. Read reviews and ask for recommendations to ensure you’re working with a reliable lender who can guide you through the renovation process seamlessly.
How do I start?
- Call or Text with a Tomo Mortgage loan advisor at (737) 510-2523 they will guide you through the process – the call is free and there is no obligation. You can always start a digital application at hellotomo.com.
- Get a Tomo Mortgage pre approval to learn your total budget, including renovations
- Use Tomo.com to search for a home to purchase or discuss with your real estate agent. We can recommend agents who are familiar with the Tomo renovation program.
Next Up: Check out our Tomo Mortgage Rates Monitor!