How to Finance a Home Addition to Achieve Your Dream Remodel

There are plenty of reasons you might want to finance your next home remodeling project. Favorable financing options at a home improvement store, emergencies that require more than your pocketbook can afford, and even a surprise new addition to your family can have you looking to make changes around your home. While there is no one-size-fits-all home improvement loan, there are plenty of options for people looking to borrow their way to a renovation or home addition. In this guide, we’ll explain how to know what you can borrow, some creative financing options, what to look for in a lender, and more.

What Is Your Borrowing Power?

Before you figure out the best way to finance a home addition or renovation project and hire a home addition company near you, it’s worth taking some time to figure out how much you can comfortably borrow. Your borrowing power depends on a few things.

Debt-to-Income Ratio

One of the first things a lender is going to look at to determine your borrowing power is your debt-to-income ratio, commonly referred to as DTI. Your loan officer will calculate your DTI by comparing your monthly debts to your gross monthly income.

The ratio tells the officer how much money you’re expected to have left after paying credit card bills, your mortgage, property taxes, car payments, and any other debt listed on your credit report.

Generally speaking, lenders are willing to lend more money—and you’ll have more buying power—as your DTI decreases. Some lenders may stop lending if your DTI surpasses 50%.

Credit Score

Your credit score will also play a role in your borrowing power, in part because if will affect the interest rate on a new loan. The higher your credit score, the more money lenders will be willing to lend you for your home addition or renovation.

Loan-to-Value Ratio

In some cases, you’ll use the value added by your new home addition as collateral for the loan itself. Securing the loan with the value added by a home addition may require a specific loan-to-value (LTV) ratio. In other words, the more value your addition will add to your property, the more a lender might be willing to lend, and the more borrowing power you’ll have.

We recommend speaking with a lender to figure out your buying power. This can help you determine which financing option is right for your home addition.

HELOC and Home Equity Loans

If you already have a bit of equity in your home—the difference between how much money you owe on your mortgage and the value of your home—you can consider using a home equity line of credit (HELOC) or a home equity loan to finance your home addition or remodel. Both of these loans work by borrowing against that value. These types of loans normally have more favorable terms and interest rates because they’re secured against your property, which means the lender can take possession of your home if you are unable to pay back the money you borrow.

HELOC and home equity loans are often processed faster than a traditional home loan. The fast turnaround time can make all the difference in the world if the reason you’re borrowing money is due to an unexpected or emergency home repair.

One thing to note: Unlike a home equity loan, which gives you one lump sum payment upfront, you can draw from a HELOC slowly over time. Like a credit card, you can pay down your balance and use it again the next time the need arises. 

Credit Cards

Using your plastic to pay for smaller remodeling needs—like updating your kitchen sink, replacing a toilet, or even installing new wall-to-wall carpeting—can be a good option for those who don’t need to borrow a lot of money for a long time. Since credit cards often come with smaller lending limits than their secured counterparts, they’re normally not ideal for more expensive projects, but they might be suitable for small additions, like building a mudroom or another small bump out.

Additionally, credit cards come with significantly higher interest rates because they're unsecured. Rates typically sit around 24.99%, but there is no federal limit to how high the interest rate can go. That means your small improvements can end up with a big price tag if you don’t pay them off quickly.

Cash-Out Refinances

If you have a lot of equity in your home and you’re looking to borrow a large chunk of money and pay it back over time, a cash-out refinance might be an option to consider. However, interest rates are generally a little higher than they would be with a traditional mortgage, but if your equity is significant, you could end up with a lower rate.

Conventional lenders have certain appraisal requirements for cash-out refinances, which means significant repairs—like financing a damaged roof or fixing a flooded basement—might be difficult to get approved. That does, however, mean that they can be great for financing home additions, which are expected to add value to your home.

Refinancing can also demand that you pay closing costs again, which can cut into the amount you’ll be able to use to finance a home addition or renovation project.

Personal Loans

A personal loan is another option for people looking to borrow a smaller amount of money that they plan to pay off quickly. These unsecured loans don’t have appraisal requirements, so they’re a good fit for covering surprise costs for a renovation that’s already in progress or unexpected issues that caught you financially off guard. They can also be ideal for covering all of your home addition ideas and not just the ones that add value to your property.

However, personal loans can have higher interest rates and smaller available funds. If you want to go this route, your local bank or credit union might be a great place to start. 

Angi also offers payment options through Affirm*—a simple, straightforward way for homeowners to pay for a project over time through monthly installments. Affirm plans are flexible based on your budget and available for pre-priced projects, as well as managed projects.

*Subject to eligibility. Payment options through Affirm are provided by these lending partners: affirm.com/lenders.

Home Rehab Loans

Many home lending institutions offer loans that are designed to accommodate repairs on top of the home’s purchase price, which makes them ideal for financing a home addition or remodel on a property you’re in the process of purchasing. There are two main kinds of rehab loans:

• FHA 203k loans: FHA 203k loans are backed by the Federal Housing Administration (FHA) and provide funds for the purchase and renovation of a home. These loans come with lower down payment requirements (as low as 3.5%) and less stringent credit score requirements. Interest rates are also often lower than traditional mortgages.

• Conventional rehab loans: Conventional rehab loans are similar to 203k loans, but they aren’t backed by the FHA. These loans have low down payment requirements as well, although they’re stricter when it comes to the amount above the purchase price you can borrow for the addition or remodel. Two examples of these loans are the HomeStyle Loan from Fannie Mae and the CHOICERenovation Loan from Freddie Mac.

Another thing to note is that, since these loans are designed to cover things like remodels and home additions, you can often cover the cost of home addition permits, construction clean-up costs, and other related items that other loans might not.

Choosing the Right Financing for Your Home Addition

With so many options for financing a home addition, it can be intimidating choosing the one that suits you and your home addition project best. There are a few things you should consider to decide which options will work for you.

• Consider your project cost. Different home renovations and additions will demand different costs, which might rule out certain financing options. The cost to finish an attic, for example, probably wouldn’t make sense to take out a renovation loan or a home equity loan, but it might be the perfect amount to cover with a personal loan, a credit card, or a HELOC. You can eliminate some options based solely on the cost and what financing options make sense for that amount.

• Think about your repayment timeline. If you’re financing a moderately sized project, like the cost to finish a basement, then you’ll probably be able to repay the loan in a relatively short amount of time. That means something like a HELOC, a personal loan, or even a credit card might make sense. If you’re instead looking to finance the cost to add a second story or some other major home addition, a loan with a longer repayment timeline—like a home equity loan or cash-out refi—might be more appropriate.

• Value added by your home addition. If you’re financing an emergency repair, chances are you won’t qualify for larger loan options like 203k loans that use the value added to your home as collateral. If you’re using the loan to cover the cost of a home addition that will add significant value to your property, then reno loans and home equity loans might be ideal.

• Your project timeline. Similarly, if you need the funds quickly for an emergency renovation or repair, the fastest option is to pay with a credit card. However, doing so might not make sense for projects that will take some time, as credit cards have some of the highest interest rates. More intensive repairs might be better suited with a HELOC, reno loan, or even a personal loan.

• Your DTI and credit score. These factors can sometimes preclude you from taking out certain loans, or they might make borrowing money more difficult. Financing a small home addition is likely possible with credit cards regardless of these factors, but something like an unsecured personal loan might not be an option.

What to Look for In a Lender or Loan

Once you’ve decided which type of financing to use for your home addition or remodel, there are a handful of things you’ll want to look for in a lender to make sure you get a good deal and avoid scams.

Low Interest Rates

Your interest rate is going to determine what you pay for the line of credit you’re opening. Finding a lender that offers a low interest rate will keep your all-in cost of adding onto your home as low as possible.

Mortgage Lender vs. Mortgage Broker

A mortgage lender is the actual company that lends you money via a loan, which means speaking with one will give you one set of financing terms. A mortgage broker is an intermediary that negotiates with multiple lenders to find you the best deal possible. However, mortgage brokers are typically paid through a percentage of your purchase price, which gets tacked onto your interest rate.

Neither option is exclusively better than the other, but it’s important to understand the difference.

The Right Loan Term

The term of the loan that your lender offers is a crucial detail to get right. Too short, and you might not be able to pay for the entire home addition before it’s completed. Too long, and you could unnecessarily pay additional interest and increase the total cost of your project.

Avoid Predatory Lenders

Finally, when it comes to personal loans, it’s important to avoid predatory lenders that charge hidden fees or use unusually high interest rates to profit from your home addition project. We recommend researching any company you’re considering and getting multiple quotes from different lenders to spot predatory lending practices.

Know the Common Terms

When you’re reaching out to lenders and working on getting your loan in order, it’s helpful to understand some of the financing terms you’ll likely hear.

• Adjustable-rate mortgage: A mortgage in which your rate changes over time, usually based on the performance of a specific index.

• Annual percentage rate (APR): The interest rate you’ll pay on your principal.

• Broker: Someone who negotiates for the best loan terms possible from a variety of lenders on your behalf. Cash-out refinance: A new mortgage on your home that provides the difference between the value and your equity in cash to you.

• Closing costs: The fees you’ll pay at closing (i.e. to your lawyer, to your mortgage broker, for prepaid taxes, etc)

• Collateral: Some item of value—usually your home or a portion of it—to back a loan. You’ll lose the collateral if you default on the loan.

• Debt-to-income ratio: A comparison of your monthly debts vs. your gross monthly income.

• Equity: The difference between the value of your home and the amount you owe on your mortgage.

• Fixed-rate mortgage: A mortgage with an APR that stays constant for the entire loan term.

• Home equity line of credit: A line of credit using the equity you have in your home as collateral.

• Loan-to-value ratio: A comparison of the value of the item you’re financing—sometimes included in your remodeling contract—to the amount you’re borrowing.

• Principal balance: The amount you owe on a loan, excluding interest and other fees.

• Rehabilitation loan: A loan for more than a property is worth, with the additional funds to go toward renovations or a property addition.

• Secured loans: Loans that are backed by collateral.

• Term: The length of a loan in months or years.