Recently, in Los Angeles and Southern California, there has been a spike in home renovation and remodeling activity. With people spending more time at home, they are deciding to make improvements to their existing space, expanding their homes, or adding an ADU or garage conversion.
Although hope improvements can be a great way to improve your space and add long-term value, the cost of remodeling can be significant. Some homeowners choose to use savings to pay for a renovation project, while others prefer to find a way to finance the construction with a loan that works for them.
Here at GreatBuildz, a free service that connects homeowners with reliable general contractors in Los Angeles, Orange County, Ventura & San Diego, we get inquiries every day about home improvement financing options for their renovation projects – here are some key points you need to know.
Renovation and construction projects will vary greatly in cost based on the scope, size, and options you choose, but you can be certain it’s a sizeable expense. Most renovations are major construction projects requiring costly materials, knowledgeable workers, and competent management in the form of a licensed general contractor.
The costs of renovating in Los Angeles and Southern California can vary significantly depending on the type of project. For a detailed breakdown of the costs of various projects, check out my blog on home remodeling costs.
In summary, a minor remodeling project like flooring/paint or a small bathroom remodel might cost $20,000-$30,000. A medium-sized project might be a full kitchen remodel, a garage conversion, or several bathrooms and will likely cost $50,000-$100,000. Larger projects that cost over $100,000 include a whole home remodel, ADU, or master bedroom addition.
Because the costs to renovate are significant, many homeowners will need to consider financing and loan options for their project. There are a number of options worth considering based on your specific situation, and fortunately, more and more lenders are offering home improvement loan products. Let’s explore the most common home improvement financing in Los Angeles and even a few ‘untraditional’ options:
Home Equity Line of Credit (HELOC)
Assuming you have an existing mortgage on your home, but you’ve also built up some equity in your home as prices have gone up, a HELOC loan may be a good option for you to finance your home improvement loan. With a Home Equity Line of Credit, you keep your original mortgage just as it is, but the bank essentially gives you a second mortgage in the form of a credit line. The lender will likely be willing to loan you an amount based on the following calculation: 80-90% of the appraised value of your home minus what you owe on your existing mortgage.
The HELOC is a revolving credit line structured similar to a credit card: you can withdraw as much or little of the loan at any time and pay it back anytime, and you only pay interest based on the amount you have withdrawn. Usually, a HELOC loan is relatively quick and cheap to accomplish with minimal closing costs. However, this loan may come with a higher interest rate than other loans and with a variable interest rate that may go up over time, so make sure to compare your options. Also, depending on your lender, the term of this loan can range from 10-30 years, either interest-only or fully amortized.
Home Equity Loan
A Home Equity Loan is a good financing option for renovation financing and is sometimes known as a second mortgage. It’s somewhat similar to a HELOC in that the homeowner is tapping the equity in their home above what is owed on their first mortgage. The difference with a Home Equity Loan is that you receive the entire amount of the loan right away in a lump sum. The downside to this is having to pay interest on the full amount of the loan (unlike the HELOC). The upside is the interest rate can be fixed rather than variable.
Home Equity Loans will always have a higher interest rate than your primary, first mortgage and will have a payback period that typically ranges 5-15 years. Also, this loan will usually require a similar underwriting process to a standard mortgage with appraisal, credit checks, etc. And just like a HELOC, the amount of financing you qualify for will be based on a calculation of how much equity you have in your home.
The cash-out refi is another good remodeling loan option. A cash-out refi replaces the first mortgage you originally got on your home purchase with a new mortgage and extracts some of your equity in the home as cash that can be used to pay for construction. The process is very similar to a traditional mortgage refinance, but instead of refinancing for the exact amount of your current mortgage, you would refinance for a higher amount which will both pay off your existing loan and provide you additional cash for renovations or construction.
Like other types of home improvement financing options discussed above, a cash-out refi requires that you’ve built up some equity in the value of your home. So the maximum amount of your refinance will usually be about 80% of the value of your home based on the appraisal.
A cash-out refi is considered one of the best options for renovation financing for several reasons. Because it’s very similar to a traditional refinance, you are likely to get the best possible interest rate. If your current mortgage interest rate is higher than today’s current rates, this loan is an opportunity to reduce your rate. Also, a refinance comes with a traditional loan term of 30 years (with other available options like 15 or 20 years) so it’s likely your monthly payment can stay within your budget.
A few other things to consider with this home improvement loan option. You can expect to pay the standard types of fees with a refinance like appraisal, title, closing fees, etc. Also, you’ll have to go through a full ‘underwriting’ process where the lender will check your credit, taxes, income, etc.
Another way of financing your remodel or construction project is by using a renovation loan. These loans are personal loans that are not secured by your property. They are quicker and easier to secure than more traditional loans and are based on your income qualifications and not property value/equity. Usually, the amount of the loan will be limited to about $100,000.
Also, because the loan is not secured by the property, it will come with a higher interest rate and shorter payback period. This form of home improvement loan is good for those looking for speed and simplicity. A few lenders that offer this type of program are Sofi and Lightstream (links), but you can also ask your local bank or lender if they have similar options.
Another loan option for larger construction projects such as an ADU or garage conversion is a construction loan. This loan is a bit more complicated than the traditional products above and will require more work on your part.
A lender will provide you a construction loan in an amount that is a percentage (80-95%) of the “completed value” of your ADU. Your lender will have their own underwriter determine the value of your completed project and lend based on that. This loan is usually a short-term loan (approx. one year) and may come with a somewhat higher interest rate than a conventional loan.
In order to qualify for this type of loan, you will need to provide the lender items like your completed plans, schedule, and budget created by a licensed, insured general contractor. Usually, the lender will not fund the loan until you also have a building permit in hand. Once the loan is approved/funded, the lender will only release the money to the contractor in chunks (called “draws”) based on their progress, which will be verified in person by an inspector working for the bank.
You can expect this type of construction financing to take longer to process and cost more in various lenders and closing fees because of the additional work required of the lender.
During the term of this loan, you will likely just pay interest on the amount outstanding each month. At the end of the one-year construction loan period, this loan should automatically convert to a long-term, permanent loan of 30 years, which may be at a fixed or variable interest rate.
FHA & Fannie Mae Loans
FHA and Fannie Mae have some unique offerings for renovation loans. FHA has a financing program called the 203k loan and Fannie Mae’s program is called a HomeStyle loan. Not every lender offers these programs, so it may take a bit of searching to find the right lender if one of these programs is a fit for your situation. The 203k loan is only available for a primary residence.
The 203k and Homestyle loans are unique as they allow you to finance both the purchase of a home and the costs of remodeling in one single loan. This is a potentially good option for someone that intends on purchasing a home and immediately undertaking some construction or remodeling.
Because these loans are guaranteed by government agencies (FHA or Fannie Mae), the loan amounts can be generous. Specifically, they may allow you to borrow up to 97% of the value of the home and up to 75% of the value of the ‘additional’ value coming from the renovations or new construction. But there are loan limits that depend on where you live, so make sure to check on these maximums.
These types of loans are most like construction loans discussed above. The interest rate is likely to be slightly higher than average and there will be additional closing costs relative to a conventional loan. Also, the lender will require you to provide them information on your chosen contractor, architectural plans, budgets, etc.
Generally, you will have to start the project within 30 days of closing, beginning with submitting plans and getting your building permit. These loans usually allow 6 months for completion of work, but extensions are available if there are delays. Your monthly payments will begin right away on your new loan. However, if you can’t live in your home during the project, you can finance a few months of payments into the mortgage to defer the start of payments. The draw process to pay the contractor is the same as a construction loan.
Less Traditional Forms of Financing
Family and Friends loan: If you have close relationships with people who are willing to loan you some or all the money to renovate, this is a potential financing option. If you plan to rent the home you’re remodeling, you might commit to repaying the loan from your rental income every month. Also, you and your lender have total flexibility to decide on the term of the loan, the interest rate, and repayment schedule, etc.
Credit Card or Personal Loan: These types of financing options should be used carefully because they come with high-interest rates and the potential to hurt your credit score if not paid back diligently. This might be a good option if you just need some temporary cash to start or finish out a project and plan to pay this back in a reasonably short timeframe.
Retirement Accounts: If you are old enough to take distributions, you might consider whether taking a lump sum is a viable alternative. You’ll want to consult with a CPA or tax expert to understand any tax liability. Another option may be to borrow from your retirement account. Some retirement accounts allow you to borrow up to 50% of the total funds in the account, but with certain maximums. You will have to pay back the loan to prevent any tax penalties, so plan out how you’ll make these repayments upfront.
With so many forms of home improvement financing available, most people will find that one of these programs is a good fit for them. Please check out my various blogs If you want to learn more about renovation costs, kitchen remodels, bathroom remodels, ADU projects, or how to find a great contractor.
When it comes to planning and financing a remodel for your home, you shouldn’t have to go it alone – Greatbuildz can help simplify your renovation experience. GreatBuildz is a free service that connects homeowners with reliable, thoroughly screened general contractors in Los Angeles, Orange County, Ventura & San Diego and provides project support from start to finish.
Call now (818.317.3567) to chat with a real person about financing your renovation project or visit our website for more information: www.greatbuildz.com