Fixer Upper Loans
- Adam Garrett
- Jun 21, 2023
- 6 min read
Updated: Jun 9
Renovation loans (rehab loans), are an option that can be viable, especially for singles with some liquid capital & time on their hands looking for a deal, although it’s important to look at the positives and the negatives and do things wisely.
Common Fixer Upper Loan Types
While there are many varieties of renovation loans (likely dozens - I work with 1 lender with 16 varieties), some of the most common are:
VA fixer upper loan (least flexible & certain properties excluded)
FHA 203k fixer upper loan
Conventional fixer upper loan (most flexible & most properties included)
Additional fixer upper mortgage types include USDA, NACA, & more.
Often there is a "streamline" fixer loan type that has more limitations but that is cheaper.
Positives
A fixer upper loan is a way where you can more easily acquire instant equity in a house following repairs financed by the lender as long as you play your cards right, especially by getting a good deal on the house to begin with, then by getting a good deal on labor/materials
A fixer upper loan is a way to add your own preferences to a home to make it more uniquely yours
A fixer upper loan is a way to have more liquid capital than if you paid for the materials and labor costs in cash at an interest rate that can be less than the positive cashflow of other investments (though it’s important to consider the impact of taxes when doing a comparison of profits if your investments are being taxed)
I personally like fixer upper loans (despite there being less positives than negatives) IF you can get a great deal on a fixer upper and don’t have the cash for the repairs and plan on using mostly contractors anyway for the financed work
A renovation loan is a way to acquire a home that is priced well especially in cases where only owner occupants are able to get it (i.e. Hudhomestore.com exclusive period & even better for Good Neighbor Next Door Period and homepath.com first look period)
A fixer upper loan is a decent option when considering as is homes that would not be able to be sold without one.
Negatives
A great deal, whether a fixer-upper or otherwise, is often not something that satisfies buyer’s typically narrow preferences. While many fixer-uppers are out there, there is a lot of competition from investors for those that are “great deals.” The profit margins today are lower than the profit margins before rehabbing became popular due to shows like “Fixer Upper” & HGTV.
Not all mortgage lenders do renovation loans, and those that do often only do certain kinds of them. If you use a lender who can do a fixer-upper loan, the same lender may be unable to do other things. For instance, last I checked, Lower is unable to do renovation loans, but their ability to do refinances at no fee for the buyer to them up to once a year isn't something that is common among lenders, and while they may exist, I don't know of any renovation loan lenders who offer that.
A fixer-upper loan typically (An exception would be NACA if you are below the median income for an area) increases your rate & adds further to your APR. Check with your lender about the impact on rate & how much that will add to your total cost over the life of the loan but it’s typically ⅜-½ a percent.
Additional time and hassle
Higher probability than a traditional purchase of wasting money on inspections/appraisals with more out-of-pocket fees than a typical sale as well.
Additional unknowns
Final costs can be higher than projected initially, especially if new problems are found or if an attempted repair doesn’t actually solve a problem
Final time frames for repairs can be much longer than projected. It is not unheard of for a 1 month job to turn into a 1-year job, so it is better for a bachelor than a family with small children
Some repairs do not add enough value to a home to be worth the money spent on contractors
Typically it is not possible or complex to get the renovation loan to pay for materials that contractors themselves are not installing, so DIY work is often not possible with a renovation loan within the loan and needs to be done with your own material funding
Sellers typically want short inspection timeframes, so by the time you know what the after-repair appraisal value is, it may be beyond the inspection time frame, and if the after-repair appraisal is just slightly over the total cost after the close of the inspection time frame, you are on the hook for a large and time-consuming project
It is possible, especially if the projected after-repair appraised value is close to the total price, to be billed for the difference out of pocket
If dealing with an FHA loan especially, FHA may require that items be included in the loan that they typically wouldn’t if not getting a renovation loan because of how thorough the FHA inspection is.
Higher probability than a traditional mortgage of running out of time during the home inspection period and being forced to make a decision before you know what you need to know regarding renovation costs to make an informed decision about how to move forward. This increases the probability of lawsuit and EMD loss if you try to walk after you've already run out of time. While no buyer I have worked with has ever lost a portion of their EMD, the closest I've ever gotten to EMD loss was during a reno loan when the appraisal came back lower than the after-repair appraisal amount, with reno loans being a small minority of the purchases I help buyers with.
Alternatives
Escrow Hold Back - where you buy a house with money that you have put forward in escrow until certain appraisal required renovations that the seller is unwilling to complete have been done and that is then paid from escrow, usually within a few weeks of closing. Keep in mind though that some sellers, especially when not dealing with individuals, won’t care if you have an escrow hold back and could automatically ignore your offer if you are not using a reno-loan even if you state that you have escrow holdbacks as an option. Also these are typically less than $10k whereas a reno loan can often have more than $10k in renovations. Also some lenders aren’t able to do escrow holdbacks.
Fix over time - often buyers opt to gradually fix a home over time, whether themselves or hiring contractors. Sometimes they will accomplish this task paying cash and sometimes they will acquire personal loans or other forms of financing, such as one specific to the company doing the work.
HELOC - you typically wouldn’t use a home equity line of credit unless you needed one years after purchasing, but it is an option for those who love a home, are near their budget max, and are alright with a multi-year wait before performing repairs/updates. In order to acquire a HELOC, you’ll need some equity first, your debt to income ratio is a factor, and your credit is a factor.
Additional options on my page focused on doing repairs prior to sale (rather than prior to purchase)
Appraisal Requirements
All:
https://www.homelight.com/blog/appraisal-required-repairs/
FHA:
https://www.investopedia.com/articles/mortgages-real-estate/11/fha-minimum-property-standards.asp
Conventional:
http://appraisersblogs.com/appraisal/fannie-mae-releases-new-selling-guide/ (see pg 549)
https://nationwidemortgageandrealty.net/conventional-loan-appraisal-requirements/
https://budgeting.thenest.com/conventional-appraisals-require-repairs-22673.html
Freddie Mac Incomplete Improvements:
https://guide.freddiemac.com/app/guide/section/5601.3
VA:
https://www.benefits.va.gov/WARMS/docs/admin26/m26-07/Ch12_Minimum_Property_Requirement_NEW.pdf
https://www.veteransunited.com/education/processing/va-appraisal/ (see section on “A Closer Look at Minimum Property Requirements”)
Conventional vs FHA Borrowing Limits
Conventional:
With a HomeStyle loan, you’re also able to finance renovations costing up to 50% of the completed appraised value.
While the FHA 203(k) and the HomeStyle loans both allow you to borrow up to a value that’s supported by the comps, the FHA Streamlined 203(k) allows financing only up to $35,000 into the mortgage for repairs and improvements.
DIY Projects
“If you’re going to do things yourself, the only program that allows that is the FHA 203(k), and it would only be allowed for minor repairs — small-dollar-size repairs where the customer can provide evidence that they’ve the time, tools, and the assets to do the renovations,” says Bill Trees.
(Conventional) HomeStyle loans, on the other hand, don’t allow for any do-it-yourself repairs. However, while they allow borrowers to make the same renovations as in a FHA 203(k) loan, they also allow for the addition of luxury items.
VA Reno Loans
Contractor must be registered with the VA and have a valid builder identification number. He must also be licensed, insured, and bonded
None of the following can be financed - possibly $2k in total:
construction fee - up to $500
inspection fee
renovation title fee
renovation permit fee
While there's an appraisal that occurs prior to closing, there is no guarantee that spending 30k on repairs (typical of 200k purchase price) will actually appraise and that the forecast appraisal will actually come true. There is another appraisal after construction is complete. If that is the case, you would need to pay the difference out of pocket.
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