Pros and Cons of Renovation Loans

A renovation loan is a loan where you buy a home that needs to be remodeled or repaired. The bank allows you to borrow money for the repairs as part of your first mortgage on the home. In this manner, you are able to begin construction on the new house immediately after closing on a loan and you do not need to take a second mortgage or come up with the additional capital to improve the house. It is also possible to take a renovation loan once you have already purchased a house or for your existing home, in order to remodel or renovate, but these are generally qualified for and approved differently. If you are considering taking a renovation loan for a home you are planning on purchasing, there are several pros and cons to consider. 

Pros of a Renovation Loan

Overall, taking a renovation loan out when you wish to buy a fixer upper can be a way to simplify the process. You will only have one application and one mortgage to qualify for and to pay each month. A renovation loan provides you with a number of benefits including:

  • The ability to borrow more money: A renovation loan will allow you to borrow based on the expected value of the upgraded home.
  • The opportunity to restore an old home: Old homes often have charm and features that new homes don't.
  • A lower cost: Since you are taking out one first mortgage for the home and renovation, your interest rate is usually going to be lower and you are usually going to have a longer period of time to repay the loan. 
  • A larger tax deduction: Since you are taking out only one first mortgage, the interest, including the cost for renovation, will be tax deductible.

Cons of a Renovation Loan

When you take on a renovation loan, it is important to be aware that you are taking a risk. You are taking the risk that the home's renovations will increase the value enough to justify the cost of the purchase and renovation. You are also taking on the challenge and expense of renovating a house. There are also some downsides to a renovation loan that you should consider before deciding this is the right choice for you:

  • Not all banks offer special "renovation loan" programs and this can limit your choices when looking for a lender.
  • More preparation is usually required. You'll need to be able to prove to the bank or mortgage lender that the home, when completed, will have a high enough value to justify the cost.
  • It takes longer to qualify for the loan: Since there are more people involved in the approval and since you need to have a contractor, the approval process takes longer than for a traditional mortgage.