HELOC v Renovation Loans: What Every Lender Needs To Know

America’s homes are aging, and it’s no surprise that many homeowners are deciding to renovate. Having underbuilt for over a decade, 50% of the existing homes in the U.S. are now over 40 years old, and possibly in need of renovations, particularly structural repairs affixed to real property. Not only do homes over 40 years old likely need foundation, plumbing, or roof repairs, but non-structural items like counters, flooring, or cabinets could be at end of life and need to be replaced, not only for usability or environmental hazards but style, too. Thus said, the U.S. home flipping rate reached a nine-year high in Q1 of 2019 and remodeling activity during the first three months of 2019 exceeded the growth of the previous quarter. Additionally, 48% of homeowners plan to renovate their homes in the next two years, and a third of those homeowners expect to spend more than $50,000 on their renovations.

In all, Americans spent $322 billion on remodeling and home repairs during the 12 months ending in June, a 6.8% jump from a year earlier, according to Harvard University’s Joint Center for Housing Studies. For all of 2019, remodeling spending will probably total a record $331 billion, according to the index. By the end of 2020’s second quarter, the furthest projection in the index, spending over the prior 12 months will probably total $323 billion.

How Are Homeowners Paying For Renovations?

There are many paths homeowners could use to fund their renovation such as through savings, credit card, Home Equity Line of Credit (HELOC), personal loans, or renovation loans. Various studies report different findings, but in general, American homeowners are paying for/plan to pay for home renovations with savings. In the chart below, we see a downward trend with savings and and an upword trend with HELOCs.

2017 2018 2019
Cash/Savings 85% 62% 48%
Credit Card 33% 30% 24%
Secured loan 11% X X
HELOC X 13% 25%
Home improvement loan X 9% X
Liquidate or use investments X 5% X
Personal loan X X 18%

X= not reported | 2017 Source: Statisa | 2018 Source: LightStream Home Improvement Survey | 2019 Source: TD Bank’s Home Equity Trend Watch

Fewer and fewer homeowners are using savings to pay for their renovations, and more and more are tapping into their HELOC. We would suggest two things: 1) more homeowners need to renovate than have enough savings to do so, and 2) homeowners simply don’t know what their options are for renovations.

For the purpose of this blog we will look at HELOCs and renovation loans.

Home Equity Line of Credit

A HELOC, or Home Equity Line Of Credit, is an increasingly popular way for borrowers to finance any number of expenses, including home improvements. However, it appears the HELOC is shrouded in mystery for the borrower. In a recent study by TD Bank, it was discovered that

  • A quarter (23 percent) of homeowners said they could not define a HELOC
  • Almost a third (32 percent) of homeowners did not know the current equity in their home
  • One in six (16 percent) of homeowners did not understand the impact of fixed versus variable rates on monthly payments

Despite a lack of education on the part of the borrower, using home equity can be an easy -and increasingly popular- way to finance home improvements or repairs. However, HELOCS being used for renovations can cause issues for borrowers and lenders alike, which is outlined in detail later on. Another option to fund a renovation project that homeowners are far less aware of and fewer lenders offer is renovation loans.

Renovation Loans

The differences between HELOCs and renovation loans is that renovation loans can be used on purchases or current homes, and the potential loan amount is based on the future value of the home after the improvements have been completed. Rehabilitation funds are held in an escrow account and will be managed by a program specialist with the lender.

Loan Programs for Renovation Include:

• Fannie Mae HomeStyle
• Freddie Mac CHOICERenovation
• FHA 203K Standard or Limited
• VA Renovation 

Fannie Mae Homestyle Renovation Loan
The HomeStyle Renovation (HSR) is a single-close loan that enables borrowers to purchase a home that needs repairs, or refinance the mortgage on their existing home and includes the necessary funds for renovation in the loan balance. The loan amount is based on the “as-completed” value of the home rather than the present value.

    • Conventional Program
    • Eligible properties
    • 1- to 4-Unit Primary Residence
    • 1-unit second home
    • 1-unit Investment Property
    • Manufactured Home
    • Condominiums, planned unit developments, and eligible co-ops
    • Requires lenders get pre-approval to sell loans

Freddie Mac CHOICERenovation
The Freddie Mac CHOICERenovation loan is a single-close loan that allows borrowers to use mortgage proceeds to pay for repairs and/or improvements. It allows borrowers to buy a fixer-upper or for existing homeowners to renovate their homes. The loan can also be used to renovate or repair a property that has been damaged in a disaster or for renovations that will protect the home in case of a future disaster. The loan amount is based on the “as-completed” value of the home rather than the present value.

  • Conventional Program
  • Eligible Properties
  • 1- to 4-Unit Primary Residence
  • Second home
  • 1-unit Investment Property
  • Manufactured Home
  • Condominium Unit, a unit in a Planned Unit Development (PUD), or a Cooperative Unit if permitted under the Seller’s Purchase Documents
  • Requires lenders get pre-approval to sell loans

FHA 203K Loan
The 203K loan is a specialized renovation loan, backed by the Federal Housing Administration. It is available to both buyers and refinancing households, and combines the traditional “home improvement” loan with a standard FHA mortgage, allowing homeowners to borrow their renovation costs. A HUD Consultant is needed to help manage FHA 203K. The FHA 203K comes as Standard or Limited.

Standard 203K

  • FHA program
  • Low down payment purchase no cash out refi
  • Bigger credit bucket — good for large projects
  • Primary residence use only
  • Must use HUD consultant
  • $5K minimum, no max

Limited 203K

  • FHA Program
  • Low down payment
  • Good for facelifts or cosmetic repairs
  • No structural repairs permitted
  • Max loan: Up to $35K includes reno costs not just repairs

VA Renovation
The VA Renovation loan provides no money down financing as long as the VA loan is under the VA loan limit for that county. It covers the current value of the property and the cost of remodeling and repairs. It is intended for minor or major repairs with no minimum or maximum renovation cost requirement. Purchase and refinance options.

  • Used to finance minor remodeling or structural repairs
  • There is no renovation consultant requirement
  • Fully Amortizing Fixed Rate
  • 10-year, 15-year, 20-year, 25-year, and 30-year term options
  • One or two-unit homes
  • Primary residence only


What Are The Considerations with HELOCs V Renovation Loans For Borrowers?

If a borrower is considering using a HELOC for renovations, make sure they understand that the amount of the HELOC is based on the amount of existing or “as is” equity in a home. Renovation loans, on the other hand, take into consideration the proposed renovations when determining the loan amount. Borrowers need to know they will be responsible for managing the entire project themselves, a task not every borrower is ready for. This includes vetting their contractor (builder), managing payment schedule for work completed, and managing payback on the HELOC. On the other hand, renovation loans at a minimum have baked in protection in the form of draws, and at a maximum when using a 203K, a HUD consultant will guide the project through to completion.

Trouble occurs when borrowers don’t understand their adjustable (or variable) rate HELOC. Either they don’t actually understand the premise of an adjustable rate, or they don’t pay enough attention to the market, or the terms they agreed to, to notice when interest rates change and what that means for them. Consequently, they may be completely blindsided by their monthly payment. If the borrower is not prepared for the terms of paypack, they may get underwater quickly and will be unable to make their payments.

You, the lender, has sole discretion to freeze a HELOC or review HELOCS at any time, likely when the market has changed. Consumers get into trouble when they don’t understand what rights the lender has with their HELOC.

What Are The Considerations with HELOCs V Renovation Loans For Lenders?

Lenders run the very great risk that a borrower may default on the HELOC and the home would go into foreclosure. HELOCs overlook one safety net that lenders usually have with renovation loans: contractor  (or builder) acceptance. While the borrower should always be selecting their own contractor, if the lender has no power of veto, risk is higher that the borrower may select a contractor who will not act with the utmost of professionalism.

The borrower may not follow best practices to protect their own assets. Many HELOC borrowers are inexperienced in renovations and in managing the funds, project, and paying back a HELOC. They don’t know industry standards for mitigating risk. They may not understand the importance of paying contractors only after services received or the importance of creating a contingency fund into their budget. This inexperience may position borrowers to default on their loan.

Renovation loans are more hands-on and require effort from the lender. There are more steps involved before the loan closes, such as contractor acceptance. But that also eliminates some risk. And post-close draw-management is another set of activities to which the lender is responsible, but again this helps to eliminate risk. This is where Land Gorilla comes in. Our software and professional services allow lenders to take control of their loan pipeline while mitigating risk.


As you can see, renovation loans are a better option for both parties. HELOCs have their place in your loan product mix, but they shouldn’t take the place of a renovation loan product. For more information on renovation loans, watch this webinar:

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