There are several financing options for home additions or large renovation projects, and they vary from lender to lender. Most people choose either a home equity line of credit (HELOC) or a construction loan.
Home equity lines of credit are based on your property’s current equity, and construction loans are based on the future value of your home (when construction is complete). These loans have different qualification requirements and different costs for the loans themselves.
The product you choose will depend on the home equity you have, how much you need to finance your renovation, and the interest type you prefer.
Home Equity Line of Credit vs. Construction Loan
Home Equity Line of Credit
A home equity line of credit (HELOC) is based on your current house’s value minus the amount you owe on your mortgage. The bank will typically lend a percentage of this difference. A home equity line of credit places the funds in the homeowner’s control during construction. The bank releases the funds—or credit line, and the homeowner releases the funds during construction to the builder they hire. Home equity lines of credit are standard, and most banks offer them.
Other features of this loan product include:
- There are fewer closing costs, and the lender may cover some of them.
- Lenders may design a HELOC for up to 90% of your home equity. There is an upper limit on how much you can borrow if you are currently paying off your first mortgage.
- If you haven’t built up substantial equity yet, a HELOC isn’t an option for your renovation or addition.
- It’s up to the homeowner to apply the funds when a HELOC product is chosen.
Construction or Renovation Loan
A construction or renovation loan is a little different than a HELOC in that it is based on the proposed value of the home after the addition or renovation project is completed. The lender will lend a percentage of that proposed value minus what is owed on your existing mortgage.
A construction loan keeps the funds in the bank’s control. During construction, there is an inspector that your builder calls when each progress payment is due to confirm that the work is done. Once the work is confirmed, the funds are released to your builder.
A construction loan is more of a niche market. At Action Builders, we are very familiar with construction loans, and many of the projects we do for homeowners are done with this type of loan.
Other features of this loan product include:
- Like a home mortgage, closing costs are included in this product.
- This loan type works well for those who want to undertake an addition or major renovation but don’t have enough (or any) home equity yet.
- The current home plus the addition or renovation creates the secured value for the project’s cost.
- Lenders assess the plan and budget for the building project and decide how likely the finished product is to offer the value needed to secure the loan.
- Banks will either extend the loan with various interest rates (based on perceived risk) or if necessary, deny it.
4 Steps to Help You Decide Which Option Is Best for You
- Determine whether you have enough home equity to qualify for the size of HELOC you need for your home addition or major renovation.
- If you don’t have the equity you need yet for a HELOC, then a construction loan will likely work best.
- If you qualify for both loan types, compare them side-by-side to see which will be the best overall fit for your circumstances.
- Shop around to find the best terms for the loan type you have decided on.
Finance Your Addition or Major Renovation with Ease
Now that you’ve explored the difference between these two primary financing options, allow the best one for your situation to emerge, and know we are here to help. We have worked with numerous construction loans and highly recommend them.
To assist you in finding suitable financing options, we advise you to work with smaller banks. At Action Builders, we recommend local banks in the Pittsburgh market and can provide you with a list of options to simplify the process. Rest at ease that your financing will work out smoothly. And in the meantime, learn more about how our home remodeling and addition services can bring your vision to life.