By John Cherveny
If you’re interested in buying a home that needs a lot of renovations, a typical fixed-rate mortgage isn’t going to help you pay for repairs. Unfortunately, you cannot request your lender to give you a $400,000 loan on a home that is only appraised at $325,000. You also can’t rely on a home equity loan, as many other homeowners do, for your renovations because you don’t have any equity. So, how can you still have the home of your dreams, without needing to pay in cash? There are actually two options available to help make your dreams come true: a Federal Housing Administration (FHA) 203K mortgage, or a Fannie Mae HomeStyle Renovation mortgage. Both programs are able to offer the homeowner a mortgage, and access to the money for necessary improvements, but there are different requirements, so it’s important to know which will be best for you.
FHA 203(k) Mortgage
This mortgage is an ideal option for borrowers who may not have a large down payment, or who have average or slightly below-average credit scores. If you are able to put 10% down on your new house, this loan only requires a minimum 500 credit score. However, if you are opting for a smaller down payment, the FHA requires a minimum credit score of 580.
Also, investors with a 15% down payment cannot take out a 203(k) loan. Your individual lender may have a higher credit score requirements, it will be important to discuss your options with him/ her.
FHA 203(k) mortgages are broken down even farther in to specifically the standard 203(k) and the limited 203(k).
Standard 203(k) Loan:
- Covers almost any kind of repair or improvement. This can include even the reconstruction of a demolished home, as long as the foundation is intact (minor foundation repairs are allowed though).
- Covers any home older than 1 year
- Repairs must cost at least $5,000
- Home owners must hire a 203(k) consultant for inspection and project management.
- 203(k) consultant also determines the feasibility of proposed projects
- Allows for borrowing of 110% of appraised value after renovations, or cost of the home plus the estimated renovations, whichever is less
- Minimum down payment 3.5%
- Maximum borrowing limit based on location between $314,827 and $726,525
- One rule: you cannot use the money to add a pool, or repair any existing pools
Limited 203(k) Mortgage:
- Used for minor remodeling projects that do not require any structural modifications, like adding a room
- Ideal loan for repairing or replacing roofs, gutters, decks, heating and cooling systems, windows, siding, plumbing, electrical systems, and flooring
- Remodel your kitchen and add new appliances
- Finish the basement
- No minimum required cost
- Max loan of $35,000 in addition to the purchase price of the house
The basic requirements for a standard FHA loan also still apply. You can find out about an FHA 203(k) lender by searching on the Department of Housing and Urban Development’s website. The biggest consideration with this type of loan is that you have to pay mortgage insurance, and it cannot be removed, even when there is more equity in the property.
Up-front mortgage insurance on one of these loans is 1.75%, and then 0.85% annually on the principal balance. You can drop to a private mortgage insurance on a conventional loan, but only after your home’s equity has reached 20%.
Fannie Mae HomeStyle Renovation Mortgage
This type of loan works best if you are looking to flip the home you are purchasing, or you are a property investor. It requires a little higher minimum down payment than FHA, 5%, and you will need a better credit score, especially if you have a high debt-to-income ratio. Minimum credit score accepted for a Fannie Mae loan is 680, but you could need to have a 700 or higher.
Features of this type of loan are:
- 12 months to complete the work
- Non minimum amount you must devote to renovations
- All renovations must be permanently affixed to the property and add value
- The lender will oversee the renovations, so they will need copies of your plans and specifications
- The most you can borrow is 95% of the home’s appraised value after renovation
- Total cost of renovation can be up to 50% of the loan amount
- HomeStyle loans are subject to conventional mortgage limits
- PMI will be added to the mortgage cost, and it will be calculated based on the as-completed value of the home, not the purchase price
- HomeStyle Loans are available to investors with 15% down
No matter which loan you choose, there are a few things every home renovation loan will need. It’s important to draw up a budget based on contractors’ estimates for your proposed scope of work. This should be done before the appraisal. Once the appraisal arrives, she will use this information to estimate an after-improvements value for the home, which dictates how much you can borrow.
There is some room for DIY, but you cannot pay yourself labor, remember your lender will be monitoring all renovations. If you are hiring a contractor, make sure they are licensed and bonded. Consider these loans to help you finance the home of your dreams.
References
Fontinelle, A. (2019, July 3). Interest.com. Retrieved from How to finance a fixer-upper: http://www.interest.com/fha-loans/news/finance-fixer-upper/