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Found your dream home, but it’s in need of some serious rehab? Don’t worry. Careful planning can make financing a fixer-upper a lot more bearable and easier. The right loan options will help you cover both a down payment and home renovation cost without much hassles.
Challenges of financing a fixer-upper
The fact is homebuyers looking for financing a fixer-upper, have it tough. There are various obstacles along the way.
The first quandary is that they can’t easily borrow the money. Ironically, the bank won’t approve the loan until all the repairs are done, and the repairs can’t be done until the house has been bought.
Moreover, a mortgage lender isn’t going to give you a $300,000 loan to buy a house that’s worth only $250,000. A mortgage company is more critical of your decision as the fixer-upper might not even meet its minimum standards for a loan.
However, don’t let all these factors deter you from buying your dream house. Fortunately, today, there are renovation mortgages through loan programs that can make financing a fixer-upper a lot easier.
In this article, we endeavor to make your dream a reality by listing out all these loan options. If you want to buy a fixer-upper with a lot of potentials — read on.
When it comes to financing a fixer-upper, you have a good amount of choices, some government-sponsored and others private. We’ll first explore the former and then venture into the private loan options.
Government-backed home loans
The Department of Housing and Urban Development (HUD) offer loan programs to make rehabbing a fixer-upper hassle-free. They are Federal Housing Administration aka FHA 203(k) mortgage, Fannie Mae HomeStyle renovation mortgage, and the recently launched Freddie Mac renovation mortgage. Plus, there’s a special loan for veterans too.
How do these loans work?
Once the mortgage closes, one part pays for the house while the other is deposited into an escrow account. When the work complete, the lender sends an inspector to check the work. If it’s completed to the scope of the project and to state as well as local codes — the money is released to pay the contractor.
They allow borrowers to purchase a fixer-upper and finance all the renovation with one loan. Let’s look at all three.
1. FHA 203(k) program
Financing a fixer-upper is easy with the FHA 203k loan program. It insures the loans by approved lenders and offers loans to homebuyers who want to buy a home and renovate it with a single mortgage.
This single, long-term, fixed- or adjustable-rate mortgage helps save on interest payments and closing costs too.
Moreover, since the mortgages are federally insured, lenders are more willing to provide the loans. This can be helpful when the value of your property is not high.
In this program, the buyer must work with a licensed contractor for a detailed listing of the costs associated with the repair work. In case it’s a DIY project, the buyer will have to provide details of the project. A complete list of materials along with local permits, and other essential supporting documentation.
Types of renovations qualifying for FHA 203(k) loan:
- Structural reconstruction.
- Modernization or improving the house’s function.
- Removing health and safety hazards.
- Improving the house’s appearance, painting, or landscaping.
- Replacing plumbing or electrical system.
- Adding/replacing roofing, gutters, and downspouts.
- Adding/replacing floor treatments.
- Improving accessibility for the disabled.
- Remodeling kitchen; buying new appliances.
- Finishing the basement.
- Adding insulation or weather-stripping.
- Improving energy conservation.
There are two types of FHA 203(k) loans: limited and standard.
A limited 203(k) loan is a good choice for smaller renovations. Basically, any repair that costs $35,000 or less and doesn’t require structural changes. A standard loan, on the other hand, is for more costly renovations.
To qualify for a standard FHA, the house must be at least one year old, and the renovation cost must be upward of $5,000. Typically, the maximum you can borrow is the lesser of your purchase price plus rehabilitation costs. Or, 110% of the value of your house once the repairs are complete.
Keep in mind that the value can’t exceed the FHA loan limit.
- The minimum credit score of the buyer should be 580.
- Minimum 3.5% down payment.
- Valid only for primary residence; investment properties aren’t eligible.
FHA 203(k) loans are flexible with 15-, 20-, 25- and 30-year fixed-rate mortgages as well as 1/1, 3/1, 5/1 and 7/1 Adjustable-Rate Mortgages (ARMs).
2. Fannie Mae HomeStyle Renovation Mortgage
Fannie Mae’s HomeStyle Renovation mortgage is a convenient and flexible way for borrowers to finance renovations with a first mortgage instead of a second mortgage, home equity line of credit, or other expensive types of financing.
This mortgage can be used to buy:
- One to four units of principal residences.
- One-unit second home or mother-in-law suite, or granny units.
- Single-unit investment such as co-ops or condos.
Typically, the loan’s minimum down payment is around 5%. However, there is no specific minimum down payment stipulation. Interestingly, HomeStyle lenders use factors such as the house’s equity and borrower’s credit rating to determine the cost of the loan.
Fortunately, Fannie Mae HomeStyle is based on the completed value of the house — after making all the upgrades. As a result, all costs of renovations are covered by the mortgage.
A HomeStyle mortgage does not allow for any do-it-yourself repairs.
Fannie Mae inclusions:
- Architect or designer fees.
- Engineering as well as design updates.
- Energy-efficiency assessments.
- Other required inspections.
- Permit fees.
Remember that your lender-approved, licensed contractor must complete the work promptly. Also, all renovations must be permanently affixed to the property.
This mortgage includes 15- and 30-year fixed-rate mortgages and ARMs.
3. Freddie Mac renovation mortgage
Similar to Fannie Mae HomeStyle, this mortgage program is for homebuyers and owners looking to restore or renovate an existing home through a purchase or refinancing.
when it comes to the minimum down payment, borrowers must contribute 5% for a single-family home, 15% for a two-unit home, and 20% for three- or four-unit homes.
If you’re putting down less than 25% on a single-family home, you’ll need a credit score of at least 660. For buyers putting down 25% or more, the score is 620.
The maximum loan-to-value (LTV) ratio is whichever value is lesser: the purchase plus renovation costs or the appraised value of the house after the renovations are done.
Interestingly, this mortgage has a unique feature that addresses the danger of natural disasters and flooding. It allows homeowners to use the funds to repair a damaged property after a natural disaster. It even caters for storm surge barriers, foundation retrofitting, or retaining walls.
Eligibility guidelines include:
- Primary, investment, and second homes.
- Cash-out and traditional refinances.
Keep in mind that manufactured homes are not eligible. Also, homebuyers can’t be affiliated with or related to the builder, developer, or home seller. Especially for the purchase of an investment property or second home.
This type of mortgage is a flexible solution for financing a fixer-upper — available for fixed-rate mortgages with 15-, 20- or 30-year terms and most types of adjustable-rate mortgages.
4. VA home improvement loan
United States Veterans Administration offers a special loan for those who are veterans or active duty service members (or even a surviving spouse of someone who’s served in the U.S. military).
If they have a credit score of 620 or higher, they can qualify for a VA home improvement loan. Generally, private lenders and banks offer this loan to cover the cost of purchase as well as the cost of renovations.
Typically, the payments are disbursed to a VA-approved builder to improve the property. The advantage is that buyers have little or no down payment requirements, and there are limits on closing costs.
Other financing options: private loans
Apart from government-sponsored loan options, there are private home renovation loans that are available, albeit at higher interest rates. Let’s talk about some of them.
A home equity loan, also known as a second mortgage, lets you finance your home renovation. Since it’s a one-time loan, it doesn’t have fluctuating interest rates. And, monthly payments remain the same for the loan term.
A home equity line of credit, aka HELOC, on the other hand, has a revolving balance. It’s a good choice for someone who has several large payments due in time. For instance, after a big home improvement project.
In both cases, you pledge your house as collateral. Keep in mind that if you fail to make your payments, the lender will end up owning your house!
Credit score requirement: 620 or higher. It varies according to home equity, debt-to-income ratio, etc.
2. Cash-out mortgage refinance
Through this, homeowners can refinance their mortgage. The second mortgage will be for a higher amount than the first one. And, the homeowner gets the difference in cash — keeping the home as collateral.
But, if you have a considerable amount of home equity, you could find lower interest rates — benefitting you more in the long run.
Keep in mind that you’ll need at least 20% equity in your home to qualify for cash-out refinancing. The total loan amount depends on the available equity in your home.
Credit score requirement: Generally it starts at 640. But, may vary depending upon the loan amount and value of your home.
3. Personal loan
Those who don’t want to (or can’t) tap their home equity, apply for a personal loan. Generally, from a bank, credit union, or an online lender. They don’t put up their house as collateral. As a result, there’s no need for a home appraisal. Also, funds for your renovation are quickly available. It’s a lot similar to using a credit card!
Here, loan eligibility depends on your credit score, income, and financial history. Therefore, homeowners with excellent credit scores of 720 or higher get the best interest rates — averaging below 10% annual percentage rate or APR.
The lower the credit scores, the higher the interest rates. Those with credit scores between 630 and 719, can expect to pay interest rates ranging between 15% and 21.3%.
4. Construction to permanent loan (C2P)
A C2P loan lets a borrower finance the cost of building a new home or renovations for a fixer-upper — with a single mortgage. A good choice for a borrower who’s arranging two separate loans to build or renovate a house. A short-term construction loan to finance significant repair work and a second (permanent) mortgage to replace the construction loan once the renovation is complete.
Therefore, a borrower has one mortgage closing instead of two, thereby reducing closing costs.
More often than not, lenders for construction loans include regional banks, credit unions, and banks where you hold an account.
5. Hard money mortgage
Finding arranging a mortgage for a fixer-upper through a traditional lender difficult? You may be able to get one through a hard money lender or a private lender.
You can use this short-term hard money loan to finance the purchase and renovation of a property. Borrowers can then refinance the loan with a traditional mortgage with a lower interest rate — after the remodeling of the house is complete.
Typically, you can expect an interest rate that’s 4.0% – 7.0% higher than a traditional mortgage. Add the lender fees to this amount. Also, the borrower will need to make a higher down payment or equity contribution.
Whichever home renovation loan you choose, be sure to get an unbiased home inspection. Also, list out a remodeling estimate before looking to finance your fixer-upper. It’s best if you work with a home mortgage consultant or a real estate agent.
They will navigate the complexities of financing a fixer-upper for you. So, if you’re eyeing that run-down property, don’t worry! You have a host of financing options out there that can make it yours.
Read more: Pros and Cons of Fixer Upper Houses