Not every homebuyer wants a turnkey property. Some would rather build home equity right from the start by buying a fixer-upper. To help these bold customers achieve their goals, mortgage lenders offer construction, rehabilitation and renovation mortgages. Loans include private and government-backed programs for both purchase and refinance transactions. If you own a fixer-upper, or you’re considering buying one, here are some financing options that may be available, depending on the subject property and applicant information.
FHA 203(k) Rehab Loans
The most commonly offered fixer-upper finance programs are 203(k) rehab loans, which are backed by the Federal Housing Administration (FHA). With one loan, you can purchase your home and land, and include renovation costs. The maximum loan amount is the purchase price of the home plus the projected renovation costs times 96.5 percent. Note that you need a FICO score of at least 580 to get a 96.5 percent loan, and the maximum loan amount is subject to FHA loan limits that depend on the property location.
For standard 203(k) loans, your lender, which will be approved by the U.S. Department of Housing, will assign you a 203(k) consultant. This person will help you by inspecting the house, working up a cost estimate for you and assisting you with the required paperwork.
Some applicants may be able to use this program to combine a refinance and rehabilitation. There is even a streamlined (“limited”) version available to those financing no more than $35,000 in construction costs. Finally, there are Title I loans — which can be used in conjunction with 203(k) loans — for those who want to finance up to $25,000 in improvements on a single-family home without refinancing their existing first mortgage. It’s important to note that FHA loans are for primary residences only, and improvements can’t include luxury items like swimming pools.
Fannie Mae Homestyle and Freddie Mac Renovation Mortgages
These two similar products are funded by private lenders. The loans are then sold to Fannie Mae and Freddie Mac, the two government-sponsored enterprises that buy mortgages from lenders and sell them to investors.
These mortgages may be used to include home improvements in a purchase or refinance loan. Unlike FHA loans, however, these mortgages can be used for second homes and rentals, as well as primary residences. They can also finance any improvement, as long as it is permanently affixed to the property and increases its value. Renovations should be completed within 12 months after the loan is funded.
The loan amount is based on the lesser of the improved value, or the purchase price plus renovation costs. Borrowers can use any Freddie Mac or Fannie Mae product for which they are eligible, including Home Possible or MyCommunityMortgage loans. Eligible borrowers can even add a Community Seconds mortgage to finance up to 105 percent of the purchase and construction costs. Note that Fannie Mae and Freddie Mac loans are subject to maximum amounts determined by the property location, and renovations cannot exceed 50 percent of the home’s purchase price.
Jumbo Purchase and Renovation Mortgages
Jumbo mortgages, however, are not backed by government entities, which allows lenders to set their own guidelines. In other words, these loan amounts can be as high as the lenders are willing to go. Because there are no mandatory national underwriting guidelines, these mortgages are harder to find and are more challenging to compare.
Typically, jumbo construction lenders require excellent credit, with minimum FICO scores ranging from the high-600s to the mid-700s. You’ll most likely need to put at least 20 percent down, or more for higher loan amounts, and have a relatively low debt-to-income ratio. There is a maximum time to complete the improvements, and most types of renovations are allowed. Most loans advertised today are limited to $1.5 million, and come with both fixed and adjustable terms.
How to Finance a Purchase and Renovation
When buying a fixer-upper, you can choose any licensed contractor to do the work. However, the builder must be approved by your lender. Some programs allow you to do some, or all, of the work yourself if you’re qualified. Others do not allow owners to be involved in renovations under any circumstances. Most include a reserve amount if the home won’t be habitable while under construction. This will be used to pay the mortgage interest until you can move in.
To apply for a rehabilitation mortgage, you’ll need to be approved as a buyer. In addition, the builder, property and project will need to be validated. The builder will also need to submit a set of plans and specifications, a description of materials and a cost breakdown. The property will be appraised by a licensed appraiser. Expect to pay higher escrow, title and lender fees because there is a lot more administration involved. When you close on your purchase, the seller gets paid and the property changes hands. The money for construction is held in escrow and paid to the builder as each step in the construction is completed.
If you’re ready to start your search for the perfect fixer-upper project, head to Owners.com.
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