Comparing Loans: Renovation Loans vs Construction Loans
Renovating your current home or building a new home can be life-changing. Home projects of any scale are both incredibly exciting and question-provoking — especially when determining how to pay for them.
Every project is unique and has different nuances to think about when setting up financing. If you are feeling lost when it comes to all the different types of loans, Great Midwest Bank will help you navigate your options.
We’ll go over the basics of Home Renovation Loans versus New Home Construction Loans, different types of loans in each category, and use case considerations. However, if you have a unique situation, our knowledgeable loan officers are happy to answer your individual questions.
Home Renovation Loans
When you have a home update project in mind that requires more than just a bucket of paint or some spackle, you may be in the market for a Home Renovation Loan. Home renovations can involve smaller-scale updates (refinishing floors, updating lighting, replacing the hardware on cabinetry) and large-scale updates (reconfiguring a room’s layout, knocking down walls). Home renovations can even include major renovations like new additions to a home, like adding entire new rooms or building a deck in the backyard.
The different types of home renovation projects out there vary extensively in scope, effort to complete, and total cost. That’s why Great Midwest Bank offers several flexible Home Renovation Loan options. We’ll go over these in a bit.
The most important thing to remember is that Home Renovation Loans are not one-size-fits-all. If you are not sure which type of loan you should get, there is no need to worry. Great Midwest Bank’s experienced loan officers will work with you to determine the best fit for your specific project’s needs and go from there.
New Home Construction Loans
If you are planning on building your own house from the ground up — first of all, congratulations! Secondly, you will need a New Home Construction Loan. These loans cover the cost of building your home. The loan amount is based on the projected value of the home once the work is complete.
To establish a Home Construction Loan, you will need to come prepared with a builder’s contract, architectural plans, a clear budget and a schedule for the project phases.
Construction Loans get paid out in installments throughout the duration of the home build project. As a borrower you won’t have to worry about handling the builder payments yourself. The lender pays the contractor directly as different parts of the building process wrap up. After your home is completely built, the full cost is then transferred to you.
Payment installments from the bank are referred to as “draws.” Every draw pays the contractor the costs associated with the building phase they have completed. The lender will also have inspections performed at different intervals of the project to ensure things are on track and staying within the agreed-upon scope.
Great Midwest Bank has two main types of Home Construction Loans: construction-to-permanent loans with a one-time close and construction-only loans. Later on, we will cover the differences between each option. If you are interested in getting started on a Home Construction Loan, a loan officer at Great Midwest Bank will sit down with you and help figure out the best loan for your needs.
Loan Options for Home Renovation
Whether you have grand or modest home renovation plans, Great Midwest Bank has a loan option to cover your needs.
Home Equity Loan (HELOAN)
f you have equity built up in your current home, a Home Equity Loan (HELOAN) is a simple and often less-costly option to fund smaller renovation projects. This type of loan is technically a second mortgage loan. HELOANs allow you to borrow against the existing equity in your home and provide you with a lump sum of money. Rather than basing the loan amount on the value of the home after the renovation project has been completed, the loan officers at Great Midwest Bank will either use a new appraisal value or a tax bill to assess the current fair market value of your home.
Home equity loans are flexible in the expenses they can cover. HELOANs can be a good choice if you have a strong understanding of what your home renovation project will cost. You can then borrow a set amount of money at a fixed rate and term. Another advantage is that you will know upfront how long it will take to pay off the loan and how much those monthly payments will be.
Home Equity Line of Credit (HELOC)
A Home Equity Line of Credit (HELOC) is like a credit card, but with a HELOC your home is used as collateral. A HELOC has a credit limit and a pre-determined borrowing period — commonly about ten years. You can withdraw funds from your line of credit up to your credit limit. Like HELOANs, when you take out a HELOC it is considered a second mortgage.
With HELOCs, you only use funds when you need to — and you will only pay interest on the funds you use. Therefore, HELOCs can be a good option for a home renovation if you are less sure about the amount of funds that will be required for your project. You can continue to use the money as you repay the line of credit, just like a credit card. Unlike a HELOAN, though, a home equity line of credit has an adjustable rate, meaning your interest payments will likely fluctuate over time.
A cash-out refinance of your current mortgage can free up existing equity in your home. For many homeowners, there is plenty of equity available to apply to home renovations. It may even have a bonus advantage of lowering your monthly mortgage payments.
When you do a cash-out refinance you can utilize the equity you have already established in your home to borrow funds. You liquidate part of your home’s equity and actually form a new mortgage loan that consists of your prior mortgage amount plus the money you are taking out.
Then, you can use this as an opportunity to reinvest the cash-out back into your home by making home renovations or repairs that boost your home’s value. It’s a win-win!
Major Renovation Loan
Maybe you are looking to do a serious overhaul of your house — perhaps even build out a room addition. Major home revisions like that tend to call for a Major Renovation Loan.
Major Renovation Loans are essentially somewhere between a standard Home Renovation Loan and a Home Construction Loan. In fact, the loan process and structure for major renovations are similar to that of a loan to build a new home, including the need for a contract, plans and specifications from a qualified contractor.
Great Midwest Bank offers local loan servicing and flexible underwriting using our own funds. That makes our Major Renovation Loans a terrific financing option for larger renovation projects and home additions.
Our Major Renovation Loans often include a minimal down payment requirement and a “one-time close” feature with permanent financing. These loans also have interest-only payments during construction followed by regular monthly payments upon completion of the project.
Loan Options for New Home Construction
The two New Home Construction Loan options available are construction-to-permanent and construction-only. Let’s build the framework, shall we?
One-Time Close (Construction-to-Permanent)
Construction-to-permanent construction loans are commonly referred to as our “one-time close” option. This allows you to lock in the interest rate during closing, which means you have steady interest-only payments throughout the construction process. The lender will pay the contractor as phases of the build are completed. Once the house is built, the cost is converted into a mortgage at closing.
We call it a one-time close because you only submit your documentation (credit report, financial information, etc.) once, and the closing only happens once as well. This option can save you lots of time and money.
Two-Time Close (Construction-Only)
Construction-only loans are a bit less common. These loans require borrowers to fully pay the balance off once the build has concluded. You might go with this if you expect the funds from your current home’s sale to cover the new construction costs — or if you have enough money available to pay off the balance. Keep in mind that if you need a mortgage to cover the cost to pay the initial mortgage off you will need to be approved again and pay another set of closing costs.
Key Comparisons Between Major Renovation and Home Construction Loans
Now we have laid out the foundation of what renovation and construction loans are and their general functions. Typically, Home Renovation Loans cover updates to your existing home, whereas Home Construction Loans fund a new home build. There are differences between each loan product, along with some overlaps in processes and functions to consider.
Application and Approval Process
Applying for a Home Renovation Loan is a simple process. You can start by filling out a guided online application, give us a call, or stop by a local Great Midwest Bank branch. Some of the financial documentation you will need to provide includes tax returns, employment income records, revolving credit balances, and bank account statements. From there, our loan officers will help find the best loan product to suit your needs.
The application and approval process for a Home Construction Loan involves more preparation. Great Midwest Bank will need to look over a number of documents for your loan. This includes the same types of financial documentation needed for renovation loans, but you’ll also need to provide some additional paperwork connected directly with the project.
Some of the required documents for Home Construction Loans include:
- Builder contract
- Detailed architectural plans and schedule
- Builder’s budget and specification sheet and records of past construction of similar homes
As mentioned, Major Renovation Loans will require much of the same documentation needed for a Home Construction Loan. The specific requirement and details surrounding the loan will vary depending on the size of the project, timeline and other factors. Our loan officers will look at your project parameters and needs, then discuss your loan options with you.
So, if you are not quite sure which type of loan you require or where to start, no worries! We are happy to help determine the best loan fit for your project.
If you use a HELOAN, HELOC or cash-out refinance to pay for your home renovation, you are borrowing against the equity you’ve built in your home. The requirements to establish these loans include the borrower having:
- A certain amount of equity established in their home (usually around 20% or more)
- Reliable past payment history
- Verified and sufficient income
- Good credit score
- Low debt-to-income ratio (DTI)
Since Home Construction Loans and Major Renovation Loans tend to be for a larger sum of money than standard Home Renovation Loans, they often come with higher qualifying standards in terms of credit and down payment. Generally, the credit score standard will be higher than needed for a mortgage loan. You will also need to be able to pay a higher down payment percentage than that of a mortgage loan.
While we cannot guarantee everyone will be approved for a Home Construction Loan, our loan officers always use a common sense approach to explore your financing options.
There are some different rate considerations between these loan options and rates will vary based on various factors. Here is a basic breakdown:
HELOANS: When you establish a HELOAN you borrow a lump sum of money, which you then pay off at a fixed interest rate.
HELOCS: With HELOCs, you take out cash as needed during the draw period (usually about ten years). Afterward, you will pay back what you borrowed during the repayment period. HELOCs have an adjustable interest rate, unlike HELOANs.
Mortgage Refinances: Interest rates for cash-out mortgage refinances are commonly lower than that of HELOANs or HELOCs.
Major Renovation Loans and Home Construction Loans: Typically, Major Renovation Loans and Home Construction Loans will have higher interest rates than those of Home Renovation Loans. Construction loans have variable interest rates that correspond to a certain percentage over the prime rate. If the prime rate is 4% and your loan rate is prime plus 2%, you would pay 6%.
It can be a lot to process, but don’t worry — we won’t quiz you! In fact, we’ll help you figure it all out. Talk to our friendly loan officers. They will help sort through the best financing options out there for your project, and they aim to make it a stress-free experience!
Closing costs on a cash-out refinance are typically higher than closing costs for HELOANs or HELOCs. The reason for this is because refinances are a new, single mortgage, while home equity loans or lines of credit are often a smaller second mortgage amount.
Closing fees for Home Construction Loans will typically be higher than that of Home Renovation Loans, since the loan amount is typically higher for a major renovation or a full home build.
For construction-to-permanent loans, once your project wraps Great Midwest Bank will combine your construction loan and permanent mortgage into one loan so you only close once.
Construction-only loans tend to have higher fees. The borrower would need to close on the construction loan, then close on a new mortgage loan if they need another mortgage to cover the construction loan — paying two sets of closing fees.
Scenarios: Funding Different Levels of Projects
When it comes to home projects, there are levels. Every project is unique and your funding choice depends on a variety of factors. We’ll help you find the best option for your project. Here are some common choices for different levels of renovation and construction. Keep in mind that these are scenario examples; many different types of financing can be appropriate for a project.
Moderate Cosmetic Updates
Maybe you’re updating your half-bathroom to look like it’s part of this century. It might involve putting in new tiling, swapping in a more modern lighting fixture, and replacing the laminate countertop. This probably will not be too expensive and it is likely you can get a good idea of how much this project will cost. In this case, you may choose to go with a HELOAN to get a lump sum of cash at a fixed rate and term.
“Pull and Replace”
Let’s say you’re renovating your guest bathroom now. You want to yank out and replace a bunch of things — putting in a new toilet, installing updated cabinetry, and getting a brand new jacuzzi tub. Maybe some other things too… you’re not quite sure. A HELOC might be an appropriate choice here because it allows for more flexibility — you can take out money as you need it.
Full Gut and Reconfiguration
You are going all-in now and renovating your master bathroom. It’s always bothered you that your toilet is directly behind the door and that the wall of your shower features a clear window facing the neighbors. You’ve decided to gut and reconfigure the layout of your bathroom. It probably won’t be cheap.
You don’t know exactly how much it will set you back or if you’ll uncover hidden expenses when the project’s underway. So, you talk to a Great Midwest Bank loan officer about whether you should go with a HELOC or a cash-out mortgage refinance.
Perhaps your family is growing, or an aging parent plans to move in with you, and you want to make your house bigger by building new additions to your home. There will be a new bathroom, another bedroom, and you’re expanding out your living room. For this, you choose a Major Renovation Loan to cover the construction costs.
New Home Construction
You and your partner decide to finally build the dream home you’ve always wanted. To fund the construction, you go with a construction-to-permanent loan after discussing your options with a GMB loan officer.
Ready to Renovate or Build?
When you’re planning a home renovation or considering a home build, we know there’s a lot to think about. At Great Midwest Bank, we want the financing process to be as stress-free as possible. Unsure where to start? Our experienced and personable loan officers can answer your questions about Home Renovation Loans and Home Construction Loans. They’re happy to help find a loan option that fits your project’s needs.