How do renovation loans work and which one is right for you?

Key takeaways

• Renovation loans combine the cost of a home purchase and repairs into a single mortgage, giving buyers access to properties that standard loan programs will not finance. This structure offers lower borrowing costs than personal loans or credit cards and reduces competition by opening up fixer-uppers that other buyers pass over.
• Government-sponsored programs serve different borrower profiles and include the following: FHA 203(k); Fannie Mae's HomeStyle and Freddie Mac's CHOICERenovation; VA renovation; and the USDA Section 504 program.
• Eligibility rules, renovation limits and completion deadlines vary significantly across programs. Matching the right program to your credit profile, property type and project scope is the most important step before applying.

Buying a fixer-upper can be one of the more affordable paths to homeownership, but most standard mortgage programs will not finance a home that needs significant work. Renovation loans solve that problem by combining the cost of the home and repairs into a single mortgage.

Several government-backed and government-sponsored programs offer this option, each with different eligibility rules, renovation limits and trade-offs. This guide compares five of them to help you determine which one fits your financial profile, your property and the scope of work you have in mind.

Instead of buying a home with one loan and then taking out a second loan or using savings to pay for repairs, a renovation loan lets you borrow the total amount needed for both. The lender holds the renovation funds in escrow and releases them in stages as work is completed and inspected.

This structure offers two main advantages. First, mortgage rates are typically lower than personal loan or credit card rates, which reduces your total borrowing costs. Second, properties that do not meet standard appraisal requirements may qualify under renovation loan programs, giving you access to homes that other buyers pass over and reducing competition.

The home is appraised based on its projected value after the renovations are completed, sometimes called the "as-completed" value. The loan amount is calculated from that figure, not the home's current condition.

The FHA 203(k) program is a government-backed mortgage administered by the U.S. Department of Housing and Urban Development. It lets owner-occupants finance both the purchase and renovation of a home in a single loan.

The program comes in two versions, according to the FHA. The Standard 203(k) is designed for major renovations, including structural work, and requires a minimum repair cost of $5,000. The maximum loan amount is subject to FHA loan limits for the county where the property is located. A HUD-approved 203(k) consultant must evaluate the proposed work, review contractor bids and approve fund releases, and a contingency reserve of 10% to 20% is held in escrow for unexpected costs.

The Limited 203(k) is for nonstructural repairs and cosmetic updates. It allows up to $75,000 in renovation financing, according to HUD, with no minimum repair cost. A HUD consultant is not required, though a contractor familiar with the 203(k) process is recommended. A 15% contingency reserve is required.

To qualify, borrowers need a minimum credit score of 580 for a 3.5% down payment, or 500 to 579 with a 10% down payment. The debt-to-income ratio is typically capped at 43%. The loan is available for primary residences only, with no investment properties or second homes. Borrowers must apply through an FHA-approved lender, and two types of mortgage insurance are required: an upfront premium of 1.75% of the loan amount plus a monthly premium that typically remains for the life of the loan.

Eligible improvements include kitchen and bathroom remodels, roof, siding and gutter replacement, plumbing, electrical and heating, ventilation and air-conditioning system (HVAC) repairs or replacement, flooring, painting and appliance upgrades, accessibility modifications and energy-efficient upgrades. Structural repairs and room additions are allowed under the Standard version only. The program does not cover swimming pools, hot tubs or outdoor kitchens.

Related content:

• FHA 203(k) loan: Buy and renovate fixer-uppers with one mortgage

Fannie Mae's HomeStyle Renovation mortgage lets buyers and homeowners add renovation costs directly to their mortgage. Because it is a conventional loan rather than a government-insured one, it has some advantages over the FHA 203(k) for borrowers with stronger credit profiles.

The program requires a minimum down payment of 3% for a one-unit primary residence with a fixed rate and a minimum credit score of 620. Renovation financing can cover up to 75% of the home's as-completed appraised value, with a contingency fund of up to 15% of the cost of repairs and renovations. All renovations must be completed within 15 months of closing. The loan is eligible for primary residences, second homes and investment properties.

HomeStyle covers nearly any improvement as long as it is permanently affixed to the property, including accessory dwelling units and energy-efficient upgrades. Kitchen appliances are an exception to the permanent-affixation requirement. The program does not cover teardowns and full rebuilds where the existing foundation is removed, or improvements that are not affixed to the property.

CHOICERenovation is Freddie Mac's conventional renovation mortgage and closely mirrors the HomeStyle program. Like HomeStyle, it lets borrowers finance home improvements as part of a purchase or no-cash-out refinance, according to Freddie Mac.

The program requires a minimum down payment of 3% and a minimum credit score of 620. Renovation financing covers up to 75% of the finished value, and private mortgage insurance can be canceled at 20% equity. The loan is eligible for primary residences, second homes and investment properties. Eligible property types include one- to four-unit homes, condos and manufactured homes. DIY work is allowed on a limited basis, and accessory dwelling units are eligible.

The program offers three tiers depending on the scope of the project. CHOICERenovation is for larger projects and requires prior written approval from Freddie Mac when the loan is sold before renovations are complete. CHOICERenovation eXPress is for smaller projects and does not require prior written approval or recourse when sold before completion. Renovation Mortgages are for projects where interim construction financing is structured separately from permanent financing, and improvements must be completed before conversion to permanent financing.

Department of Veterans Affairs home loans can be used not only for buying a home but also for renovations and repairs, according to the VA.

The loan requires no down payment and no mortgage insurance. There is no formal minimum credit score, though individual lenders may impose their own requirements. Borrowers must have a valid Certificate of Eligibility, and the property must be the borrower's intended primary residence. Contractors must meet state and local licensing requirements, and a VA appraiser determines the as-completed value.

Eligible improvements must be "ordinarily found on similar property or comparable value in the community," according to the VA. They must also fund renovations that improve the livability, safety or structural integrity of the home, including work on the roof, foundation, floors, plumbing, electrical systems, water heaters and heating, ventilation and air-conditioning system. The program does not cover luxury or cosmetic-only improvements.

Important limitation: Few lenders offer VA renovation loans. Borrowers may need to search specifically for lenders experienced with this product.

Related content:

• How to get a VA loan

The USDA's Section 504 program provides low-interest loans and grants to very low-income homeowners in rural areas for repairs and safety improvements. Unlike the other programs on this list, the USDA Section 504 is not a purchase loan. It is designed for homeowners who already own and occupy a home in an eligible rural area and need help paying for repairs.

According to the USDA:

• The loan option provides up to $40,000 at a fixed interest rate of 1% for the life of the loan, repayable over 20 years, and must be used to repair, improve or modernize the home. The grant option provides up to $10,000, or $15,000 in presidentially declared disaster areas. Grant applicants must be 62 or older, and the funds must be used to remove health and safety hazards only. The grant must be repaid if the property is sold within three years. Loans and grants can be combined for up to $50,000 in assistance, or $55,000 in disaster areas.
• To qualify, homeowners must own and occupy the home as a primary residence in a USDA-eligible rural area, generally towns with populations under 35,000. Household income must be at or below 50% of the area median income and the applicant must be unable to obtain affordable credit elsewhere. Liquid assets are limited to $15,000, or $20,000 for applicants 62 or older.
• Eligible repairs include roof and foundation work, electrical rewiring and lead plumbing replacement, accessibility modifications such as ramps, grab bars and walk-in tubs, energy-efficient windows and doors and heating and air-conditioning system repairs when related to health and safety. The program does not cover cosmetic work, luxury items, repairs to rental or income properties or personal electronics and furniture.

Related content:

• What is a USDA loan and how does it work?

The following table highlights the key differences across all five programs:

Sources: FHA, Fannie Mae, Freddie Mac, VA, USDA

The standard FHA 203(k) requires a contingency reserve of 10% to 20% to cover overruns. HomeStyle includes a contingency reserve as well. If costs exceed the contingency, the borrower is typically responsible for the difference out of pocket. This is one reason accurate contractor bids and realistic project scoping are important before closing.

No. Not all FHA-approved lenders handle 203(k) loans, and VA renovation loans in particular are offered by very few lenders. Before applying, verify that the lender regularly underwrites the specific renovation loan program you are considering.