If you have read my Blog, “How2FundRenovation.com” in the past, I write about the benefits of buying outdated or damaged properties with either a Fannie Mae HomeStyle or FHA 203k rehab loan. As I speak with buyers who are looking for properties and hear inventory is low and choice is limited I wanted to review the basics of rehab mortgages. The concept is basically buy the worst house but in the best location for value reasons.
Many Buyers may not have heard of these mortgages before or know that a home needing work can be purchased and the renovation cost financed all in one loan, with one mortgage payment, amortized over 30 years. That is perhaps the least expensive way to finance a home renovation or repairs. The reason why is the dollars are financed over 30 years rather than as any kind of short term, high interest rate loan. The cost is generally $5 a month in payment for each thousand dollars borrowed this way with typical interest rates today for qualifying borrowers. An example might be borrowing $10,000 extra to remodel a kitchen. That would add about $50 a month to a 30 year mortgage payment but the new kitchen adds value now and is enjoyed now.
Below are the main aspects of using these two loans that allow a buyer to purchase a home or 2 to 4 unit apartment building. I will present HomeStyle first and 203K second. There are some significant differences between the two and I will illustrate them accordingly.
The underlying principle of each loan type is to borrow funds to purchase property like any other mortgage but then add to that SAME mortgage more funds to remodel, repair, or update. In both loans what matters is the future, “as finished” value the home will later have to approve the loan now, before rehab work is done.
HomeStyle:
- Available for a single family home, condo, townhouse, 2 to 4 unit apartment building and second/vacation home or vacation condo
- Investors buying a single unit property to lease out or flip are allowed (condo, house, townhouse but not multi-units at this time)
- Down Payment can be as little as 5% for a single unit owner occupied property type which is calculated off the total of the purchase price plus rehab dollars; Investment property is always a 20% down payment; 2 unit owner occupied is 20% down payment and 3 & 4 unit owner occupied is a 25% down payment; vacation home/condo is a 10% down payment
- An Inspection and Scope of Repair document (SOR) done up front by a Construction Consultant to forecast costs and specific rehab work to be done as a guide to then securing a General Contractor to execute to that specification
- The “as finished” or “as completed” future value of the property is used to calculate the loan size and approve the loan, not what the property is worth currently- a huge plus in today’s market
- The rehab dollars portion of the loan is limited to be equal to 50% of the “as finished” or “as completed” future value of the property as determined up front before loan approval
- Current Conventional loan limits apply for 1 to 4 unit property types
- Up to 6 months of mortgage payments, including property taxes, insurance & mortgage insurance can be added to the rehab portion of the loan so borrowers have funds for house payments during the time the property cannot yet be lived in while still paying current housing costs elsewhere; this option only for owners who will occupy, not an available option for Investors who will rent or sell
- Financeable fees can include a 10% Emergency Reserve fund for unforeseen defects occurring during renovations; plus Title costs, Building Permit, Architect and Inspection fees; any leftover monies are applied back to reduce the final mortgage size
- Luxury items like new swimming pools, Jacuzzi tubs, basketball courts, etc. allowed provided each adds measurable value to the property
- HomeStyle is a great option for Buyers with larger down payments or home owners needing funds to expand or update a home that may have some equity already
FHA 203K
- 203K has two types, Limited for rehab budgets $35,000 or less and Standard for rehab budgets over $35,000; in reality the Standard version works much better for most borrowers and is what I always recommend
- Available for a single family home, FHA pre-approved condo, townhouse, 2 to 4 unit apartment buildings and 2 to 4 unit Mixed Use buildings – all must be owner occupied for at least 12 months if done at purchase time, then can be leased out- a great benefit for first time buyers
- For 2 to 4 unit Mixed Use buildings the commercial square footage can be a max of 49% of total with residential square footage at least 51% of total; no 203k rehab funds can be spent to repair commercial space- perfect for those who may wish to run a business and live in the same building
- An Inspection and Scope of Repair document (SOR) done up front by a Construction Consultant to forecast costs and specific rehab work to be done as a guide to then securing a General Contractor to execute to that specification
- Down Payment can be as little as 3.50% for any property type which is calculated off the total of the purchase price plus rehab dollars
- For 2 to 4 units FHA allows 75% of gross rental income to be used as qualifying income for loan size needed
- The “as finished” or “as completed” future value of the property is used to calculate the loan size and approve the loan, not what the property is worth currently- plus FHA will allow the mortgage to be up to 110% of the “as finished” future value to ensure homes are restored for community housing needs
- Non-occupying co-borrowers allowed to help with affordability and loan approval if needed
- Current FHA county loan limits apply for 1 to 4 unit property types
- Financeable fees can include a 10%, 15% or 20% Emergency Reserve fund for unforeseen defects occurring during renovations; plus Title costs, Building Permit, Architect and Inspection fees; any leftover monies are applied back to reduce the final mortgage size
- For any property that does not have all utilities on and functional the Emergency reserve must go to at least 15% to protect the homeowner against unforeseen renovation cost increases
- Up to 6 months of mortgage payments, including property taxes, insurance & mortgage insurance can be added to the rehab portion of the loan so borrowers have funds for house payments during the time the property cannot yet be lived in while still paying current housing costs elsewhere
- 203K is a Great option for first time buyers with lower down payments and especially for 2 to 4 unit properties needing rehab and a great alternative to a Commercial loan for a 2 to 4 unit Mixed Use building
In reviewing the highlights above of how each loan type works I wanted to direct this Blog to first time buyers not certain of all mortgage options out there and anyone having a challenge finding the right home in the right location. Do consider a renovation loan at purchase time if you would like the chance to design how the property will look and be updated, all based on what the “as finished” future value will be when all work is considered by the Appraiser based on what your Contractor has written out.
I hope this post has been helpful and encouraging to those that may have thought a Renovation project was too complex or beyond their ability to manage. My intent is always to inform, educate, and generate discussion. Please call me or email me directly or visit my website for more information on renovation loans. I welcome your comments and questions!