construction-loan-guide): Which Is Better for Home Renovations?

You're planning a renovation — maybe a kitchen gut, an addition, or a full remodel. The question isn't whether to finance it (most people do). The question is how.

Two of the most common options are a HELOC and a construction loan. They work very differently, cost different amounts, and suit different projects. This guide breaks down both so you can pick the right tool for your renovation.

The Quick Comparison

Before diving deep, here's the high-level difference:

HELOC: A revolving line of credit secured by your home equity. You draw funds as needed, pay interest only on what you borrow, and manage the project yourself.
Construction loan: A short-term loan specifically designed for building or major renovation projects. Funds are disbursed in stages based on project milestones, and a lender-approved inspector verifies progress before each draw.

Think of a HELOC as a credit card secured by your house. A construction loan is more like a project-managed funding vehicle with built-in oversight.

How a HELOC Works for Renovations

With a HELOC, you get approved for a credit limit based on your home's current value and existing mortgage balance. Most lenders allow you to borrow up to 80-85% of your home's value minus what you owe.

Example: Your home is worth $600,000 and you owe $350,000. At 80% LTV, you could qualify for a HELOC up to $130,000 ($600,000 × 0.80 − $350,000).

Once approved, you draw funds whenever you need them during the draw period (typically 5-10 years). Pay your contractor, buy materials, handle surprises — all on your timeline.

HELOC Costs for Renovations

Interest rates: Variable, typically prime + 0.5% to prime + 2%. As of early 2026, that puts most HELOCs between 8% and 10.5%.
Closing costs: Often minimal — many lenders offer HELOCs with no closing costs or fees under $500.
Annual fee: Some lenders charge $50-$100/year.
[Interest-only payments](/blog/heloc-draw-period-vs-repayment) during draw period: On a $100,000 balance at 9%, that's $750/month.

Pros of Using a HELOC

Flexibility. Draw what you need, when you need it. No disbursement schedules or inspections.
Lower upfront costs. Closing costs are minimal compared to construction loans.
You control the project. No lender oversight on how you spend the money or which contractor you hire.
Only pay interest on what you use. If your $130,000 HELOC only has a $40,000 balance, you pay interest on $40,000.
Reusable. After paying it down, the credit is available again for future projects.

Cons of Using a HELOC

Variable rate risk. If rates climb 2% during your renovation, your interest cost jumps significantly.
Based on current home value. Lenders don't consider the post-[renovation value](/blog/renovation-roi-by-project), so you might not qualify for enough.
No project oversight. That's a pro if you're experienced, but a con if you're not. There's no third party making sure your contractor is hitting milestones before getting paid.
You bear all the risk. If the project goes sideways, the lender doesn't care — you still owe the balance.

How a Construction Loan Works for Renovations

Construction loans are purpose-built for building and major renovation projects. They're short-term (usually 12-18 months) and convert to a permanent mortgage or get paid off when the project is complete.

For renovations specifically, you'll typically encounter two types:

Renovation Construction Loan

A standalone construction loan where the lender finances the renovation based on the after-renovation value (ARV) of the home. This is the key advantage — you can borrow against what the home will be worth, not just what it's worth today.

[Construction-to-Permanent Loan](/blog/construction-loan-types)

This combines the construction phase and the permanent mortgage into one loan. You close once, the lender disburses funds during construction, and the loan automatically converts to a standard mortgage when the project is complete.

FHA 203(k) Loan

A government-backed option that lets you finance both the home purchase (or refinance) and renovation costs in one loan. There are two versions:

Standard 203(k): For renovations over $35,000. Requires a HUD consultant.
Limited 203(k): For renovations under $35,000. Less paperwork, no consultant required.

Construction Loan Costs

Interest rates: Typically 1-2% higher than standard mortgage rates. Expect 7.5-9.5% in the current environment.
Closing costs: Significant — usually 2-5% of the loan amount. On a $200,000 construction loan, that's $4,000-$10,000.
Inspection fees: $100-$500 per draw inspection, and you might have 4-6 inspections.
Origination fees: 1-1.5% of the loan amount.
Interest reserve: Some lenders build an interest reserve into the loan so you don't make payments during construction.

The Draw Schedule

This is the defining feature of construction loans. Instead of getting all the money upfront, funds are released in stages:

Foundation/framing: 20-30% of funds released after inspection
Rough-in (plumbing, electrical, HVAC): Next 20-30%
Drywall/interior: Next 20%
Finish work: Next 15-20%
Completion/final inspection: Remaining funds

The lender sends an inspector before each disbursement to verify the work is done. This protects you (the contractor can't take the money and disappear) but also slows things down.

Pros of a Construction Loan

Borrow against after-renovation value. If your home is worth $400,000 now but will be worth $600,000 after renovation, you can potentially borrow more.
Built-in project oversight. The draw inspection process keeps contractors accountable.
Can convert to permanent financing. With a construction-to-perm loan, you avoid refinancing when the project is done.
May allow larger renovation budgets. Because you're borrowing against ARV, the numbers often support bigger projects.

Cons of a Construction Loan

Higher costs. More fees, higher rates, inspection costs — construction loans are expensive.
Rigid process. You need detailed plans, contractor bids, and a construction timeline before approval. Changes mid-project require lender approval.
Slower disbursements. Waiting for inspections and draw approvals can delay your contractor, which can delay the project.
Harder to qualify. Lenders scrutinize construction loans more heavily. Expect more paperwork, longer processing times, and stricter requirements.
Contractor requirements. Most lenders require licensed, insured contractors with a track record. DIY work is usually not allowed.

Side-by-Side Cost Comparison

Let's compare a $100,000 renovation financed both ways:

HELOC Scenario

Credit limit: $130,000 (you use $100,000)
Rate: 9% variable
Closing costs: $300
Monthly interest-only payment: $750
12-month interest cost: $9,000
Total cost for 12-month project: ~$9,300

Construction Loan Scenario

Loan amount: $100,000
Rate: 8.5% (may be slightly lower since it's secured against ARV)
Closing costs: $4,000
Origination fee (1%): $1,000
Inspection fees (5 draws): $1,500
Average balance during construction (funds drawn gradually): ~$60,000
12-month interest cost on average balance: $5,100
Total cost for 12-month project: ~$11,600

In this scenario, the HELOC is actually cheaper despite the higher rate, because you avoid the heavy upfront fees. But the construction loan let you borrow against the future value of the home — which might be the only way to get $100,000 if your current equity is limited.

Decision Framework: Which One Should You Choose?

Choose a HELOC When:

Your renovation is under $75,000. The flexibility and low costs of a HELOC outweigh the structure of a construction loan for smaller projects.
You have sufficient equity already. If your current home value supports the HELOC amount you need, there's no reason to pay construction loan fees.
You're experienced with renovations. You know how to manage contractors, handle change orders, and stay on budget.
The project is relatively simple. Kitchen remodel, bathroom update, new roof, landscaping — these don't need construction loan oversight.
You want speed. HELOCs can be approved in 2-4 weeks. Construction loans take 45-90 days.

Choose a Construction Loan When:

The renovation is major ($100,000+). Additions, full gut renovations, structural changes — these benefit from the oversight and larger borrowing capacity.
You need to borrow against the after-renovation value. If your current equity doesn't support a large enough HELOC, a construction loan based on ARV is the way to go.
You want project oversight. If this is your first big renovation, having a lender-required inspector verify milestones provides a safety net.
The project changes your home's footprint. Adding square footage, converting a garage, building an ADU — these are construction loan territory.
You want fixed-rate permanent financing built in. A construction-to-perm loan gives you a known rate for the long term.

Consider Both (Hybrid Approach)

Some homeowners use a HELOC for the initial phase (design, permits, demolition) and a construction loan for the major work. Others use a construction loan for the big stuff and a HELOC for overages and finishing touches.

This can work, but watch your total debt load and make sure both lenders are aware of each other.

Real-World Renovation Scenarios

Scenario 1: $40,000 Kitchen Remodel

Best option: HELOC

A kitchen remodel is straightforward — demolition, plumbing, electrical, cabinets, countertops, appliances. The timeline is 6-10 weeks. A HELOC gives you flexibility to pay contractors as milestones are hit without waiting for draw inspections.

Cost of HELOC financing: approximately $1,800 in interest over 6 months + $300 in fees = $2,100.

Scenario 2: $180,000 Second-Story Addition

Best option: Construction loan

Adding a second story involves structural engineering, significant permitting, and 6-12 months of construction. A construction loan provides the oversight this complexity demands, and borrowing against the ARV lets you finance the full project even if your current equity is limited.

Scenario 3: $85,000 Basement Finishing + Bathroom Addition

Best option: Could go either way

This is the gray zone. If you have the equity for a HELOC and experience managing contractors, go HELOC. If you want guardrails and your equity is tight, go construction loan.

What About Other Options?

Home Equity Loan (HEL)

A fixed-rate lump sum secured by your home. Good for renovations with a clear, fixed budget. Rates are typically 0.5-1% higher than HELOCs, but the rate is locked. Closing costs are $2,000-$5,000.

Personal Loan

Unsecured, so no risk to your home. But rates are 8-15% and limits are usually $50,000 max. Only makes sense for smaller projects if you don't want to touch your equity.

Credit Cards (0% APR Promotional)

For very small projects ($5,000-$15,000), a 0% APR promotional credit card can be genuinely free financing if you pay it off before the promotional period ends. Not suitable for larger renovations.

Fannie Mae HomeStyle Renovation Loan

Similar to an FHA 203(k) but with conventional loan guidelines. Allows up to 75% LTV for investment properties and 97% for primary residences. One close, one loan, renovation funds included.

Tips for Financing Your Renovation Successfully

Get detailed bids before choosing your financing. You need to know the real cost before you can pick the right product.
Add 15-20% contingency. Renovations almost always cost more than estimated. Make sure your financing covers overruns.
Don't drain your HELOC to zero available credit. Keep a buffer for surprises.
Check if your HELOC has a minimum draw requirement. Some require $500+ per draw.
For construction loans, vet your contractor thoroughly. The lender will too, but do your own due diligence.
Get permits. Unpermitted work can create problems when you sell or refinance. It can also void your homeowner's insurance.

Frequently Asked Questions

Can I use a HELOC for a major renovation like an addition?

Yes, there's no restriction on what you use HELOC funds for. The question is whether you have enough equity and whether you're comfortable managing a major project without lender oversight.

Do I need a contractor for a construction loan?

Almost always yes. Construction loan lenders require licensed, bonded, and insured contractors. DIY renovations typically don't qualify for construction loan financing.

Can I get a construction loan if I already have a HELOC?

Yes, but the HELOC balance counts against your equity and DTI. Some construction lenders may require you to close or subordinate the HELOC.

Which has lower interest rates — HELOC or construction loan?

It depends on market conditions. Construction loan rates are typically slightly lower than HELOC rates (because they're secured against a higher ARV), but the total cost is usually higher due to fees, inspections, and origination charges.

How long does it take to get approved for each?

HELOCs typically take 2-4 weeks. Construction loans take 45-90 days due to the appraisal, plan review, and additional underwriting.

Can I refinance a HELOC into a construction loan mid-project?

This would be unusual and complicated. It's better to choose the right product upfront. If you're unsure, consult with a loan officer who offers both products.

Bottom Line

For most homeowners doing a renovation under $100,000, a HELOC is simpler, cheaper, and faster. For major projects that exceed your current equity or require structural changes, a construction loan provides both the funding and the project guardrails you need.

The worst choice is picking a financing product that doesn't fit the scope of your project. A HELOC on a $300,000 gut renovation leaves you exposed. A construction loan for a $20,000 bathroom update is overkill.

Match the tool to the job, build in contingency, and start with conservative numbers. Your renovation should add value to your home — not stress to your life.

[[Home [Equity Explained](/blog/home-equity-explained)](/blog/what-is-home-equity): What It Is and How to Build It](/blog/home-equity-explained)
Blended Family Home Planning: Merging Households and Managing Home Equity
[How to [[Build Home Equity](/blog/equity-building-strategies) Faster](/blog/build-home-equity-faster): 8 Proven Strategies](/blog/build-home-equity-faster)

Heloc Vs Construction Loan

Key Takeaways