Editor’s Note: This blog was originally published in July 2018 and has been revised to reflect industry updates.
With the current real estate market experiencing low-interest mortgage rates, and higher demand than supply, more and more buyers are seeking creative options to achieve their dream homes. Rather than facing another lost bid, or not meeting mortgage specifications, some are gravitating toward purchasing rehabilitation or renovation properties.
Similar to any loan product, there are several factors to consider when determining between rehab mortgages, including the specific type, requirements, and qualifications. The government-backed Federal Housing Administration (FHA) 203(k) loan offers two: Limited and Standard. Conventional options, such as the Freddie Mac CHOICERenovation and Fannie Mae HomeStyle, are also appropriate solutions.
When considering what’s best, it’s important to work with a reputable and approved lender, such as Contour Mortgage, for guidance.
Below we’ll examine various rehab mortgages, and outline the key advantages and disadvantages of each.
Government-Backed Rehab Loans
These differ from conventional rehab loans in their backing by the FHA. Whether for improvements by yourself or professionals, 203(k) renovation loans secure funding for home purchase and renovations.
It’s important to note this loan has two sub-types designed for renovation type, location, and work scope:
This is best for non-structural repairs, such as flooring, appliances, plumbing and electrical work, as well as kitchen and bathroom renovations. Depending on your location, total costs are capped at a specific amount.
Geared toward foundation damage caused by flooding, hurricanes and other natural disasters, this loan boasts higher limits due to more costly and time-consuming repairs.
You could make money in the long run.
Fixer-uppers garner a significant return on investment (ROI) through value increases from upgrades and repairs. Depending on your location, you could land an even lower purchase price if the property requires an extreme makeover.
You can personalize your new home as your own.
A limited 203(k) loan funds value-added, non-structural changes to customize the home as your own. These include paint colors, flooring, cabinetry, countertops, and other cosmetic improvements.
The qualifications are slightly more lenient.
Offered through the FHA, 203(k) loans carry less-stringent requirements concerning credit histories and scores, loan limits, and debt-to-income (DTI) ratios. While the FHA doesn’t actually provide buyers with the funds, it does insure the loan through approved lenders, such as Contour Mortgage.
Only a 3.5 percent down-payment is required.
In addition to other requirements, 203(k) loan down payments are also significantly lower than conventional loans. With just 3.5 percent of the selling price down at closing, you can achieve your dream home. You’ll also have more available cash for furniture, moving expenses, and other essentials.
You won’t spend all your money at once.
Since you'll be utilizing loan funds to upgrade your new or current home, you won't be allocating a large amount of money all at once. Instead, you can streamline your monthly payments until the loan is paid off.
There’s a limit on the number of units in the home you purchase.
203(k) mortgages permit buyers to purchase multi-family homes with the stipulation the property doesn’t exceed more than four units.
Only certain upgrades are covered.
All repairs and improvements must be outlined and itemized prior to approval. A reputable lender can ensure you have the most accurate and correct information. It’s also prudent to check specific coverage items and dollar amounts.
It's not ideal for borrowers requiring a turnkey home.
AWhile some might be excited to renovate and customize a home, others prefer to purchase a move-in ready property. Buyers who aren't interested in making any major changes to their next home would benefit from other loan options.
Conventional Rehab Loans
In addition to the aforementioned FHA-backed 203(k) rehab loans, the Federal National Mortgage Association, also known as Fannie Mae, offers its HomeStyle Renovation Mortgage. Another option is the CHOICERenovation loan, through Freddie Mac.
Fannie Mae Homestyle
Offered as both a fixed- or adjustable-rate mortgage (ARM) this loan’s original principal cannot exceed Fannie Mae’s maximum loan limit amount. According to the HomeStyle Renovation Mortgages: Loan and Borrower Eligibility requirements, borrowers purchasing a home cannot incur rehab costs more than “75 percent of the lesser of the sum of the purchase price of the property plus renovation costs, or the ‘as-completed’ appraised value of the property.”
Both fixed- or ARM options are available.
Choose from either option to best suit your needs. Note the original principal cannot exceed the association’s maximum mortgage amount for a conventional primary mortgage.
This loan can be combined with other Fannie Mae products.
Fannie Mae permits borrowers to bundle their renovation loan with its other products, such as HomePath or RefiNow.
Teardowns and complete rebuild projects don't apply.
This loan won’t cover a complete teardown or foundation reconstruction.
Additional paperwork will be required.
Because this is a specialized loan, you’ll need to disclose additional documents, such as a work proposal, standard renovation loan agreement, consumer renovation information, and others.
Renovations must be completed within a specified time frame.
All work must culminate within 12 months of the closing date.
Freddie Mac CHOICERenovation
Suitable for single-family and multi-unit dwellings, CHOICERenovation loans can also be applied toward second homes or investment properties. Similar to the aforementioned Fannie Mae HomeStyle, this fixed- or ARM is available at a 15- or 30-year term, and has lower down payment, DTI, and credit requirements.
Lower down payment and credit scores acceptable.
Similar to the aforementioned FHA 203(k) and Fannie Mae HomeStyle loans, lenders will accept a down payment as low as 3.5 percent, and lower credit scores.
It's not just for single-family homes.
This loan is suitable for investment properties, second homes, and other multi-family dwellings. Certain limitations will apply per geographic location.
Bank-owned properties could require additional approvals.
If you’re seeking foreclosure or auction properties, you might want to consider building extra time into the approval process.
You cannot be affiliated with any parties involved in the loan transaction.
Borrowers can’t be in business with, or connected to the home’s builder, developer, or seller.
When it comes to choosing the best rehab loan, it’s important to work with a reputable lender, such as Contour Mortgage. We can assist with financing requirements and help navigate what’s best for your needs.