If you want to buy a home that needs some work, you may take out a home renovation loan. These loans help you buy the property, but also give you money to renovate it. They are one of the only ways to purchase a fixer-upper, especially if the home won’t pass an appraisal.
But will you pay more interest for the home renovation loan? Let’s take a look below.
What Drives the Interest Rate?
You might think all interest rates are created equal on loans, but they aren’t. Lenders determine your interest rate based on the risk that your loan creates. For example, a borrower with a conventional loan that has great credit, a low debt ratio, and a large down payment will probably get one of the best interest rates available because they are a low risk of default. A borrower with bad credit, a high debt ratio, and low down payment, on the other hand, will get a much higher interest rate because of the risk he/she poses.
Now, looking at the home renovation loan, it makes sense that you would pay a higher interest rate for this type of loan. Not only is the lender giving you money to buy the home, but they are investing their money into the home to fix it up too. They are taking a big risk assuming that you will be able to properly renovate the home and increase its value.
Other Factors That Drive the Interest Rate
Now that we know that you’ll pay a higher interest rate for a home renovation loan, you should know that you also play a role in just how high that interest rate gets.
Some of your factors will determine what interest rate a lender will give you:
- Your credit score – As we discussed above, your credit score plays an integral role in your interest rate. Your credit score is the first impression lenders have of your level of financial responsibility. If you have a high credit score, you are a low risk of default. If you have a low credit score, though, you are a higher risk of default and will likely get a higher interest rate.
- Debt ratio – Your debt ratio plays a role in your level of riskiness as well. The more debt you have outstanding aside from your mortgage, the higher your risk of default becomes. If you have to split your money up between multiple debts, it could become difficult to pay your mortgage on time. The lower your debt ratio (housing and total) becomes, the lower the interest rate a lender can provide.
- LTV – The amount you put down on a home also plays a role in the interest rate that you get. The less money you put down on the home, the riskier you become. The lender has to give you more money for you to buy/renovate the home. This higher loan amount puts the lender at risk of default, which means you usually get charged a higher interest rate.
Buying Down the Rate
It’s important to know that you always have the option to buy the internet rate down at the closing. Lenders call them discount points. You pay a point or 1% of your loan amount to lower your interest rate around 0.25% – 0.5%, depending on what the lender allows. You may be able to pay several points to get your interest rate down as far as you want.
When you pay discount points, you prepay the interest. In other words, lenders get the interest at the closing rather than with your monthly mortgage payments. When you pay the interest upfront, lenders are often willing to give you that lower interest rate.
It probably won’t be the lowest interest rate on the market just because of the riskiness that a home renovation loan creates, but it will be lower than the rate that the lender originally quoted you. If you maximize your qualifying factors and pay a discount point or two, you stand to get a decent interest rate on your home renovation loan.Click to See the Latest Mortgage Rates»