New type of home equity loan caters to major renovation projects

Brandon Segal was set to make a substantial addition to his historic house in a Philadelphia suburb, but he wasn’t sure 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 a cash-out refinance. A construction loan struck Segal as complicated and cumbersome.

Segal settled on a home-equity loan through RenoFi, a financial technology company that connects homeowners with credit unions willing to lend based on how much a house will be worth after upgrades are completed.

“I like the ability to borrow based on what my appraised value is going to be,” Segal said.

RenoFi served as a matchmaker, directing Segal to Ardent Credit Union, a Philadelphia lender. He took a 20-year, fixed-rate loan to pay for a two-story addition to his 1920s home.

The coronavirus pandemic has turned home improvement into a national pastime. In one illustration of that trend, the National Association of Home Builders’ remodeling index soared during the pandemic. Home-improvement retailers and remodeling contractors reported spikes in business.

With many Americans working from their home offices, more homeowners have developed a hankering for upgrades to their spaces. Meanwhile, a spike in home prices and a shortage of homes for sale limits the choices available to those who would traditionally be move-up buyers.

The national median price of homes sold by Realtors spiked 12.9% from December 2019 to December 2020. Housing inventory fell to a record low, according to the National Association of Realtors.

Segal, for his part, loves the house he shares with his wife and their three daughters, but the quarters were getting cramped. He found a contractor to add a master bedroom and other living space to the house.

Paying for home improvements can pose a challenge, however. A home equity line of credit (HELOC) is one tried-and-true source of renovation funds. But HELOCs work only for homeowners with significant equity. If you owe $300,000 on your $400,000 property, a bank is unlikely to lend $100,000 through a HELOC. To keep your loan-to-equity level at 80%, or $320,000, you’d be able to borrow just $20,000.

RenoFi offers a different approach: Homeowners can borrow up to 90% of their home’s after-renovation value.

The company has partnered with credit unions throughout the country to offer the loans, says Justin Goldman, founder and chief executive of RenoFi. Goldman launched the company after experiencing firsthand the challenges of paying for renovations on an older home.

He created RenoFi to fill what he sees as a gap in the market. Goldman found most lenders didn’t offer after-renovation loans, so he began persuading credit unions to add RenoFi home equity loans to their offerings.

RenoFi loans are second mortgages. In one example, Ardent Credit Union offers 20-year loans at a fixed rate of 4.25%, Goldman says. That’s higher than the rate on a primary mortgage, but it includes the flexibility of allowing homeowners to borrow against yet-to-be-created value.

Borrowers pay for an appraisal that establishes the home’s value after renovation. The appraiser looks at the proposed construction plan and determines by how much the work will boost the property’s market value.

The typical RenoFi customer borrows $150,000, Goldman says. At that amount, a 20-year loan with a 4.25% interest rate carries a monthly payment of $929.

Goldman says RenoFi’s loans also appeal to homeowners who recently locked in loans at rock-bottom levels and don’t want to do a cash-out refinance to pay for improvements.

“If you’ve taken advantage of a low rate and refinanced, you’re going to have to pay all those closing costs again,” Goldman says.

That situation applied to Segal, the Philadelphia-area homeowner. He had recently refinanced and didn’t want to do so again.

“We have a great rate on our current mortgage, and we didn’t want to touch that,” he says.

To land a RenoFi loan, the borrower pays for the after-renovation appraisal, which typically costs $100 to $200 more than a standard appraisal, Goldman says. Beyond that, closing costs typically range between $95 and $500.

“Credit unions’ closing costs are typically lower than a traditional bank, so in the end, it’s still cheaper for the homeowner,” Goldman says.

RenoFi’s loans are one of several options for homeowners looking to renovate. Among the others:

Home equity lines of credit. HELOCs come with one significant caveat: To borrow against your house, you must have plenty of home 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’ll need sufficient equity.

FHA 203(k) loans. This type of loan lets you borrow against the value of the home after improvements. FHA loans are lenient about down payments and credit scores, but they charge higher mortgage insurance fees than other types of loans.

Cash-out refinance. In this scenario, you borrow more than you owe on your existing mortgage and apply the proceeds to renovations. This requires equity in your home.

Construction loan. A home construction loan is a short-term, higher-interest loan that provides the cash to pay the contractors. The property owner typically needs a longer-term mortgage after the work is completed.

Selling a stake in your home. A new breed of financial technology firms is pitching American homeowners on a different way of tapping into home equity. If you’re sitting on a pile of it, these companies — including Haus, Hometap, Noah, Point, and Unison — will buy a piece of your house. You repay the “co-investment” when you sell. One downside: This money comes at a higher cost than a mortgage or HELOC.