Brandon Segal was about to make a substantial addition to his historic home in a Philadelphia suburb, but he didn’t know how to pay for it.
He didn’t have enough equity to cover the six-figure renovation bill with a home equity line of credit or cash refinance. A construction loan seemed complicated and cumbersome to Segal.
Segal opted for a home equity loan through RenoFi, a fintech company that connects homeowners with credit unions willing to lend based on a home’s value after renovations are complete.
“I like the ability to borrow based on my appraised worth,” Segal said.
RenoFi served as matchmaker, directing Segal to Ardent Credit Union, a Philadelphia lender. He took out a 20-year fixed-rate loan to pay for a two-story addition to his 1920s home.
Pandemic spurs improvement boom
The coronavirus pandemic has turned home improvement into a national pastime. In an illustration of this trend, the National Association of Home Builders’ remodeling index has soared during the pandemic. Home improvement retailers and renovation contractors reported spikes in activity.
With many Americans working from their home office, more and more homeowners have developed a desire to modernize their spaces. Meanwhile, a spike in home prices and a shortage of homes for sale are limiting the choices available to those who would traditionally be upper-tier buyers.
The national median price of homes sold by real estate agents climbed 12.9% from December 2019 to December 2020. Home inventory fell to a record high, according to the National Association of Realtors.
Segal, on the other hand, loves the home he shares with his wife and three daughters, but the quarters were getting cramped. He found a contractor to add a master bedroom and another living space to the house.
However, paying for home renovations can be a challenge. A home equity line of credit, or HELOC, is a proven source of home improvement funds.
But HELOCs only work for owners with significant capital. If you owe $300,000 on your $400,000 property, a bank is unlikely to lend $100,000 through a HELOC. To maintain your loan to equity ratio at 80%, or $320,000, you can only borrow $20,000.
RenoFi offers a different approach: homeowners can borrow up to 90% of the post-renovation value of their home.
The company has partnered with credit unions across the country to offer the loans, said Justin Goldman, founder and chief executive of RenoFi. Goldman started the business after experiencing first-hand the challenges of paying for renovations to an older home.
He created RenoFi to fill what he sees as a gap in the market. Goldman found that most lenders didn’t offer post-renovation loans, so it began persuading credit unions to add RenoFi home equity loans to their offerings.
How Loans Work
RenoFi loans are second mortgages. In one example, Ardent Credit Union offers 20-year loans at a fixed rate of 4.25%, Goldman said. This is higher than the rate for a prime mortgage, but includes the flexibility to allow homeowners to borrow against value yet to be created.
Borrowers pay for an appraisal that establishes the value of the home after renovation. The expert examines the proposed construction plan and determines how much the work will increase the market value of the property.
The typical RenoFi customer borrows $150,000, Goldman said. At this amount, a 20-year loan with an interest rate of 4.25% has a monthly payment of $929.
Goldman said RenoFi loans are also appealing to homeowners who have recently locked in loans at very low levels and don’t want to refinance in cash to pay for upgrades.
“If you took advantage of a low rate and refinanced, you’ll have to pay all those closing costs again,” Goldman said.
This situation applied to Segal, the owner of the Philadelphia area. He had recently refinanced and didn’t want to do it again.
“We have a great rate on our current mortgage, and we didn’t want to touch it,” he said.
To get a RenoFi loan, the borrower pays for the post-renovation appraisal, which typically costs $100 to $200 more than a standard appraisal, Goldman said. Beyond that, closing costs typically range between $95 and $500.
“Closing costs for credit unions are generally lower than for a traditional bank, so at the end of the day, it’s always cheaper for the owner,” Goldman said.
Other ways to finance home renovations
RenoFi loans are one of many options for homeowners looking to renovate. Amongst others :
• Home equity lines of credit. HELOCs come with an important caveat: to borrow against your home, you must have sufficient equity. Before considering a HELOC, make sure the value of your home is significantly higher than the amount you still owe on your mortgage. HELOCs usually close quickly and carry variable interest rates.
• Home equity loans. Essentially a second mortgage, a home equity loan comes with a fixed interest rate. As with a HELOC, you will need sufficient capital.
• FHA 203(k) loans. This type of loan allows you to borrow against the value of the home after improvements. FHA loans are lenient on down payments and credit scores, but they charge higher mortgage insurance fees than other types of loans.
• Refinancing by collection. In this scenario, you borrow more than you owe on your existing mortgage and apply the proceeds to renovations. This requires the equity in your home.
• Ready to build. A home construction loan is a short-term, higher-interest loan that provides the cash needed to pay contractors. The owner usually needs a longer term mortgage once the work is complete.
• Sell an interest in your home. A new generation of fintech companies is giving American homeowners a different way to tap into their home equity. If you’re sitting on a pile, these companies — including Haus, Hometap, Noah, Point and Unison — will buy a portion of your home. You repay the “co-investment” when you sell. One downside: This money has a higher cost than a mortgage or HELOC.