As home prices and interest rates continue to rise, many of today’s buyers struggle to keep their monthly mortgage payments affordable. But for those willing to buy a cheaper home that needs a little TLC, there’s a silver lining: New listings advertised as homes for renovation rose 10% a year in June , according to data from Realtor.com.
Yet buying a repairman isn’t always the transparent business shown on reality TV shows, especially when it comes to financing. Some mortgage programs have strict ownership requirements, which can be a problem for buyers who don’t have the cash to make urgent repairs ahead of time.
For homebuyers who don’t mind putting up some equity, there are several types of home repair mortgages that incorporate the cost of home improvements into your total loan amount. If you’ve decided to buy a diamond in the rough, a renovation mortgage may be the right financing option for your needs.
Types of mortgages for repairers
|FHA 203(k) loan||VA renovation loan||Conventional rehabilitation loans|
|Maximum renovation costs||Up to the purchase price plus rehabilitation costs or 110% of the home’s completion value, whichever is lower||Up to 100% of the home’s completion value, as determined by a VA appraiser||Up to 75% of the purchase price plus rehabilitation costs or 75% of the home’s completion value, whichever is lower|
|Building Restrictions||Funds can only be used for eligible projects||Funds can only be used for eligible projects||Funds can be used for any renovation or repair project|
|Contractor Requirements||Must use FHA approved contractors||Must use VA approved contractors||Contractors must be licensed only when required by state law|
|Minimum credit score||As low as 500, depending on down payment||Not specified by the VA, but some lenders have a minimum of 620||Usually around 620, depending on the lender|
|Loan fees||Origination fee, typically 1.5% of the loan amount, plus closing costs||VA financing fees between 1.4% and 3.6% of the total loan amount||Fees and closing costs vary by lender|
|Contingency reserve||Up to 20%||Up to 15%||Up to 15%|
|Mortgage insurance||FHA mortgage loan insurance is required until you sell, refinance or pay off the loan in full||Not required||Private mortgage insurance is required until your loan-to-value ratio drops below 80%|
FHA 203(k) Loans
The Federal Housing Administration’s 203(k) loan program gives mortgage borrowers a way to buy and renovate a repairman. Unlike a typical FHA home loan, it includes the purchase of the property as well as the cost of repairs and renovations in the mortgage amount. There are two types of FHA rehabilitation loans: limited 203(k) loans and standard 203(k) loans.
Limited 203(k) loans are for homes that need minor improvements, repairs and upgrades costing up to $35,000. Small projects can include kitchen remodeling, interior painting or new flooring. However, a limited 203(k) loan does not cover structural repairs such as room additions or basement conversions.
Standard 203(k) Loans are intended for major repair and rehabilitation projects and should be supervised by an FHA-certified consultant. With a standard 203(k) loan, you can tackle bigger improvements like structural repairs, roof replacement, and plumbing work. However, the FHA won’t let you use the financing for luxury projects, like building swimming pools.
The maximum improvement cost of a standard 203(k) loan is limited to the purchase price plus rehabilitation costs or 110% of the home’s value after repairs are complete, whichever is lower. Standard 203(k) loans can only be used for projects costing at least $5,000.
VA Rehab Loans
Active and retired military personnel who meet the service requirements for a Veterans Affairs loan may qualify for a VA home improvement loan. Like a standard VA purchase loan, a VA rehab loan allows you to purchase property with 0% down payment, no mortgage insurance, and competitive interest rates. And like an FHA 203(k) loan, this type of VA loan allows you to build the cost of necessary home improvements and repairs into the cost of the mortgage.
With a VA renovation loan, you can borrow up to 100% of the home’s appraised value after renovation. Funds can only be used for repairs and upgrades necessary to improve the security or livability of the property, such as replacing heating, ventilation, air conditioning, electrical or plumbing systems. VA rehabilitation loans cannot be used to make major structural repairs, such as teardowns and rebuilds.
Classic Renovation Loans
In addition to government-backed home improvement loans, there are a few conventional loan programs that include the cost of repairs in the mortgage amount: Fannie Mae HomeStyle and Freddie Mac CHOICERenovation. For both options, you will need to find a lender that participates in this mortgage program.
At Fannie Mae’s The HomeStyle Renovation Loan is a conventional mortgage that includes home renovation financing at the time of purchase or when refinancing. For homebuyers purchasing a property, the maximum renovation costs are 75% of the sum of the purchase price and rehabilitation costs, or 75% of the appraised value upon completion of the property, depending on the lowest value. Homeowners who refinance can borrow up to 75% of the property’s appraised value upon completion to pay for repairs.
Freddie Mac’s CHOICERenovation Mortgage is similar to Fannie Mae’s offering, with the same 75% renovation budget threshold. But Freddie Mac also offers a simplified version of this loan, the CHOICEReno eXPress, for buyers with smaller rehab budgets. With the eXPress option, you can borrow up to 15% of the home’s value for renovation costs.
Unlike a government-backed rehabilitation loan, Fannie Mae and Freddie Mac’s renovation mortgage improvement funds can be used for any project, including home additions and non-essential improvements. You can also use any licensed contractor as permitted by state law, without the need for a 203(k) licensed consultant.
Advantages and Disadvantages of Fixer-Upper Mortgages
- There is generally less competition among homebuyers for a home that needs urgent repairs.
- You gain capital once the work is complete, even after factoring in the cost of renovations.
- You can choose the fixtures and finishes that suit your tastes.
- The process can be complicated, from completing mortgage paperwork to hiring contractors.
- You may need to set aside a contingency reserve to use in case something goes wrong with the repair work.
- You risk taking on a more complicated project that exceeds your original budget and construction schedule.
- Interest rates tend to be higher on home improvement loans than on traditional mortgages.
- Costs for permits, inspections, contractors and appraisers can add up quickly.
- Not all lenders offer rehab mortgages, and they can be hard to find.
How to choose the best renovation financing option
There is no one-size-fits-all financing solution for mortgage borrowers buying from a repairer. Here are some things to consider when choosing a loan to repair:
- Consider the scope of your work. Someone buying a home that only needs minor cosmetic upgrades will have very different financing needs than someone planning to buy a home that needs major repairs.
- Determine if you meet the eligibility requirements. For example, you will need a Certificate of Eligibility, or COE, to qualify for a VA home improvement loan. If you have a lower credit score, you might have the best luck with the FHA’s 203(k) loan program.
- Get some quotes for the necessary work. Contact the appropriate contractors, such as plumbers, electricians, and HVAC technicians, to find out how much each project will cost. Once you have a better idea of your total renovation budget, you should be able to narrow down your borrowing options.
- Compare borrowing costs for each product. Interest rates vary considerably from one type of mortgage loan to another. It is therefore important to consider the long-term cost of a renovation loan. You can find the mortgage rate, monthly payment and closing costs in your loan estimate.
Another way to finance a Fixer-Upper
FHA 203(k) loans and other home improvement loans may be the right choice for some homebuyers, but they’re not ideal for do-it-yourself renovators with relatively small home improvement projects. If you want to buy a repairer without the limitations of a home improvement loan, there is another common strategy to consider:
- Borrow a traditional loan to cover the purchase of the house. Note: Some government-backed mortgages, like FHA and VA loans, have strict ownership requirements that make closing on a servicer difficult.
- Take out a home improvement loan, such as an unsecured personal loan or line of credit, to pay for your renovation project.
- Refinance your original mortgage once the work is complete. This effectively allows you to tap into the increased equity in your home to pay off the rehab loan at a lower rate.
A separate loan can be a good option if you have the skills and equipment to do the repairs yourself or if you plan to live in the house while you renovate it. But if a property is in dire need of expensive professional repairs by a licensed contractor before you can move in, a repair mortgage may be a better option.