Learn about the different types of loans available for financing home renovations

Education page intended to provide brief description of general loan types along with pro's and Con's for each

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Conventional FinancingA conventional mortgage, or conventional loan, refers to any mortgage or home loan that is “not guaranteed or insured by the Federal Government”, and is commonly available in the market through Banks, Mortgage Companies, Savings and Loans, Credit Unions, etc,. Conventional mortgages are used in about 65% of all home mortgages nationally. Generally, conventional mortgages fall into two categories: “Conforming” which means the loan guidelines and loan amounts, conform to the standards established by Fannie Mae and/or Freddie Mac. “Non-Conforming” refers to loans that do not conform to these standards, most commonly due to the loan amount being higher than Fannie Mae limits such as with Jumbo Loans. Conventional loans can be fixed rate, adjustable rate, or a hybrid of both fixed and adjustable. The loan term, or length of the loan, is typically 15 years, 20 years, or 30 years. The 30-year “Fixed Rate” mortgage has historically been the most popular.

With this fixed rate loan the interest rate and payments are fixed over the 30-year life the loan. Each month the borrower makes the same principal and interest payment amount so that by the end of the loan term, the loan is paid off in full. The advantage of fixed rate loan is that the payments are set and do not change over time. Adjustable Rate Mortgages (ARM’s) are 30-year loans, but have interest rates and payments that adjust periodically. The interest rate is tied to a specific interest rate index, such as the 1-Year T-Bill or LIBOR. Most common is a 1-year ARM which has a low starting rate the first year, then the rate and payment adjusts annually based upon the movement of the underlying index. The advantage of an ARM is that the initial starting payments are often less than fixed rate loans thus making the loan initially more affordable.

A Hybrid ARM has an initial fixed rate period then rolls into a 1-year adjustable. For example, a 5/1 Hybrid is fixed for the first 5 years, and changes to a 1-year adjustable over the remaining 25 years. The advantage of Hybrid ARM’s is that the initial fixed period has rates and payments that is lower than a 30-year fixed rate, thus making the loan more affordable than a 30-year fixed but with less interest rate movement risk than a 1-year ARM.

Fixed Rate

Conventional
“Fixed Rate”
Mortgage

Fixed Rate mortgages have interest rates that are fixed, and do not change over the life of the loan. Since the interest rate is fixed, the monthly principal and interest payment is the same each month, and the loan pays off in full by the end of the term. The most common loan terms (length of loan) are for 15, 20 or 30 years long.

A “Conventional” Fixed Rate mortgage means any commonly available fixed rate mortgage that is not issued or guaranteed by the federal government.

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Adjustable Rate

Conventional
“Adjustable Rate”
Mortgage

Adjustable Rate Mortgages (ARM’s) are 30-years loans that have interest rates and payments that change periodically (i.e. monthly, semi-annually or annually). Adjustable rate mortgages have low starting interest rates and payments, usually lower than current fixed rate loans, and then adjust based upon the movement of the underlying interest rate index. A “Conventional” Adjustable Rate mortgage means any commonly available adjustable rate mortgage that is not issued or guaranteed by the federal government.

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Hybrid

Conventional
“Hybrid ARM”

A Hybrid ARM is a loan that is fixed for an initial period of time, and then converts to an adjustable rate mortgage. One of the most common is a 5/1 Hybrid ARM which is fixed for the first 5 years and then converts to 1-year adjustable rate mortgage for the remaining 25 years. Also Available are 7/1 and 10/1 Hybrid ARM’s.

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FHA 203K
Rehabilitation Loan

Rehabilitation Loan

Government guaranteed loan designed to provide consumers with financing to purchase (or refinance) a property in need of renovations and to simultaneously finance the cost of the improvements in the loan. The amount of the loan is based upon the increased value of the property after the improvements are completed. FHA 203K loans have easier qualification requirements and lower down payments / loan-to-value requirements. FHA 203K are available as Fixed Rate or 5/1 Hybrid ARMs. The types of eligible renovations or improvements range from the relatively minor repairs and improvements, such as new paint or kitchen cabinets, to more extensive improvements or structural renovations such as adding rooms to near complete remodeling.

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Fannie Mae HomeStyle Renovation Loan

HomeStyle renovation loan

Similar to FHA 203K this loan allows borrowers to purchase, or refinance, a property in need of repairs or improvements, and to finance the cost of the renovations into the loan. The amount of loan is based upon the “after improved value”. This loan is considered less restrictive than FHA 203K loans on allowable and required repairs and improvements. It is available for owner-occupied, second homes and investment properties. It is available as a fixed rate, adjustable rate or hybrid arm.

The Fannie Mae Homestyle mortgage is a single close loan that allows borrowers to purchase, or refinance, a property in need of repairs or improvements, and to finance the cost of the renovations into the loan.

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Home Equity Line of Credit – HELOC

HELOC

A revolving line of credit, secured by residential property, and used to access the existing equity in residential property. Borrowers are approved for a specific credit limit based upon their qualifications and amount of equity within the property. Borrower can draw funds (borrow) as needed up, usually via check writing, can repay funds as desire, and only pay interest on amount of funds borrowed during draw period. After the draw period, borrower can no longer borrow funds and must make monthly principal and interest payments. The terms vary between 10 years and 30 years with the draw period about half the term. HELOC’s have variable rates of interest most commonly tied to the Prime Rate.

A Home Equity Line of Credit, usually referred to as a HELOC, is a revolving line of credit that is secured by residential property and used to access the existing equity in the property. It is usually a 2nd mortgage as it is obtained in addition to an existing mortgage when the borrower does not want to refinance or payoff an existing mortgage.

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Home Equity Loan

Home Equity Loan

A fixed loan amount and term, secured by residential property, that is used to access the existing equity in the property. Most commonly with a fixed interest rate and fixed monthly principal & interest payments. It is a 2nd mortgage used in addition to an existing mortgage when the borrower does not want to refinance or payoff the existing mortgage.

A home equity loan is a fixed loan amount, secured by residential property, and is used to access the existing equity in the property. The loan amount (less any fees) is paid out to the approved borrower at time of closing, and interest charges begin accruing on the full loan amount.

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Personal – Unsecured Loan

Personal – Unsecured Loan

A Personal loan is lumpsum fixed loan amount given to a qualified borrower that is not secured by residential property or collateral. The amount of the loan varies between $2,500 and $100,000, and is highly dependent upon the borrower’s credit score, qualifications and ability to repay the loan. The term, or length of the loan, varies between 24 month and 72 months. The primary benefit of this type of loan is ease of application and speed. In most cases qualified borrowers can obtain the funds within a few days. The interest rate and monthly payments are fixed. Interest rates are higher than conventional secured financing, but less than revolving credit cards. The interest depends upon the borrower’s qualification, the loan amount, and the length of the loan.

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