With vision and the right financing, a homeowner or buyer can turn a fixer-upper into their dream home and a great investment. Bank-owned homes and pre-foreclosures often reflect the financial distress of previous owners and require a lot of work to bring them up to par. Borrowers can finance a home and its repair with a rehabilitation loan, which combines a mortgage and construction loan into one closing. The maximum amount of these unique loans is based on a projected value of the renovated home.
In general, lenders finance only move-in ready homes. Buying a fixer-upper usually requires cash or private financing to get your foot in the door, and a separate construction loan to make repairs. Construction loans are short-term loans with high interest rates, typically requiring a home refinance to pay off. To avoid the expense and hassle of two separate loans, you can get a rehab loan for more than the home's current or "as-is" value. You must have the resources to qualify for the loan's monthly payment, which includes the cost of repairs.
Although rehab loans have become more commonplace since the housing crisis began in 2007, only certain lenders offer them. The Federal Housing Administration's version, known as the 203(k) rehab loan, is available only through FHA-approved lenders, and only some of them are qualified to originate this loan type. Fannie Mae lenders may offer HomePath or HomeStyle renovation loans, which serve similar purposes but have key differences. Certain lenders also offer their own brand of rehab loans.
Lenders require an appraisal of the home in its current condition. Appraisers determine an as-is value by considering the home's features and comparing the home to recent sales in the area. How the home measures up to its neighbors shows the lender the home's potential and helps it determine how much it can lend. A separate inspection process by a contractor determines how much work is needed and its cost. Lenders limit the amount of repair funds and what they cover. For example, the 203(k) can finance more than $30,000 in repairs, but it prohibits luxury items, such as the addition of a pool. The 203(k) maximum mortgage amount is based on the lesser of the as-is value plus rehab costs, or 110 percent of the expected value of the property after rehab, according to Forbes.
Loan-to-value restrictions on loan amounts help ensure that the lender does not over-finance a project, rendering the home worth less than the balance owed on its loan. The LTV ratio compares the amount financed to a home's value. On a rehab loan, the LTV is based on the value of the final outcome, as estimated by the appraisal and analysis of project plans. FHA's 203(k) rehab loan has a 96.5 percent LTV, requiring only a 3.5 percent down payment on a purchase or 3.5 percent equity on a refinance. HomePath and HomeStyle renovation loans have 95 percent LTV requirements.
- Bankrate.com: FHA Offers Home Renovation Help
- Wells Fargo: Renovation Loans
- Forbes: The FHA 203(k) Loan: A Home Repair Loan and Mortgage All in One
- Kiplinger: "I Owe More Than My House Is Worth."
- Bankrate.com: These Mortgages Pay for Home Renovations
- 203k Rehab Now: FHA 203k Rehab Loan vs. Fannie Mae’s HomeStyle Rehab Loan
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