Fixer Upper Loans
- Adam Garrett
- Jun 21, 2023
- 10 min read
Updated: 5 days ago
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.
USDA Section 502 Direct: Purchase + Repair / Rehabilitation Financing
USDA’s Section 502 Direct Home Loan Program can potentially be used not only to purchase an eligible home, but also to finance eligible repairs or rehabilitation. This is the USDA Direct program administered by USDA Rural Development, and should not be confused with the more commonly used USDA Guaranteed mortgage offered through private lenders.
USDA's HB-1-3550 handbook states that Section 502 is intended to help eligible applicants “buy, build, relocate, rehabilitate, or improve” a property that will be used as their principal residence. The handbook also specifically includes acquisition and repair costs among eligible dwelling-related costs.
Buying a Fixer-Upper With USDA Direct
An existing home does not necessarily have to be in perfect condition before a USDA Direct purchase. USDA's handbook states that an existing dwelling must be in good repair “or be placed in good repair with loan funds.”
For an initial Section 502 Direct loan used to purchase an existing home, USDA generally requires the buyer to obtain a whole-house inspection by a state-licensed inspector, or a qualified independent inspector where the state does not license home inspectors.
The inspection is particularly important with a fixer-upper because USDA reviews identified deficiencies. Depending on the circumstances and USDA's approval, deficiencies may be handled by:
the seller completing required repairs before closing; or
repairs being required after closing.
That second option is what makes USDA Direct especially interesting for some fixer-upper purchases: eligible repairs may potentially be incorporated into the USDA financing rather than requiring the seller to complete everything before settlement.
Repair Estimates, Contractors & the Appraisal
If repairs are going to be financed, expect more work before closing than with a typical move-in-ready purchase.
USDA may need a detailed repair list along with estimated costs or contractor bids. Those repairs may then be considered as part of the appraisal. For planned rehabilitation, USDA's appraisal guidance provides for an “as-improved” value—the estimated value of the property assuming the approved construction, repairs, or rehabilitation are completed.
That means the process can involve:
Home inspection → identification of deficiencies → repair scope → contractor estimates/bids → USDA review → appraisal considering the proposed repairs → loan approval/closing → completion of approved post-closing work.
Because of those additional steps, I would be particularly cautious about writing a fixer-upper offer with an unnecessarily short inspection or closing period. USDA does not provide one universal contract-to-closing timeline for every Section 502 Direct renovation purchase, and processing time can vary based on the property, repair scope, documentation, funding, local office workload, appraisal, contractors, and other factors. Buyers should discuss realistic deadlines with their USDA loan specialist and Realtor before submitting the offer.
Larger Renovations Can Involve Construction Draws
USDA distinguishes relatively simple repairs from more substantial rehabilitation.
Substantial rehabilitation can include work such as additions, remodeling, moving walls, foundation changes, or work affecting the structural integrity of the home. More involved rehabilitation may be handled using USDA's construction-management procedures.
That can include:
contractor bids and a defined scope of work;
permits and local inspections where required;
USDA or qualified third-party inspections during the work;
a draw schedule established before loan closing;
partial contractor payments as work is completed and inspected; and
final inspection/documentation before final payment.
In other words, with qualifying transactions, the buyer may close on the property before all financed rehabilitation is finished, with approved funds subsequently disbursed as the work progresses.
Important USDA Direct Fixer-Upper Limitations
This does not mean that any distressed property or renovation project will qualify.
The buyer, property, proposed repairs, loan amount, contractor arrangements and completed home still need to satisfy USDA Direct requirements. Among other things, USDA considers the home's condition, value, environmental requirements, site eligibility, whether it will be the buyer's principal residence, the applicant's eligibility and repayment ability, and whether the proposed work will result in an acceptable property.
A buyer also should not assume that every desired cosmetic upgrade will automatically be financed simply because USDA Direct permits rehabilitation. The specific repair scope and loan structure should be reviewed with the USDA Rural Development office handling the application.
For a fixer-upper, I would verify before committing to the purchase:
whether USDA will finance the particular repairs being contemplated;
what USDA needs from contractors;
which repairs USDA will require because of the inspection;
whether additional specialty inspections are needed;
whether the appraisal will be based on an as-improved value;
how much repair financing fits within the maximum approved loan;
whether the rehabilitation will be treated as repairs or as construction;
how repair funds will be held and disbursed;
what inspections will be required during construction;
how quickly work must begin and be completed; and
how much time USDA recommends putting into the purchase contract.
USDA Direct can therefore be a valuable fixer-upper option for the right buyer and property, but it is more complicated than simply getting a mortgage and receiving a check for renovations. The repair scope, inspection findings, contractor documentation, appraisal, USDA approval and post-closing construction process all need to work together.
USDA Sources
USDA Single Family Housing Direct Home Loans: https://www.rd.usda.gov/programs-services/single-family-housing-programs/single-family-housing-direct-home-loans
USDA HB-1-3550 Direct Single Family Housing Loans and Grants Field Office Handbook: https://www.rd.usda.gov/resources/directives/handbooks
Especially relevant portions of HB-1-3550 include:
Chapter 5, §5.7 — Decent, Safe and Sanitary Dwellings: existing homes and repairs using loan funds;
Chapter 5, §5.17 / appraisal guidance: proposed repairs, contractor bids and as-improved valuation;
Chapter 5, Section 6 — Managing Construction: rehabilitation, inspections and construction draws; and
Chapter 6, §6.4 — Eligible Loan Purposes and Uses: acquisition, repairs, rehabilitation and improvements.
Program requirements and USDA guidance can change. Buyers should verify current eligibility, property requirements, repair requirements, funding availability and processing procedures directly with USDA Rural Development before making a binding purchase decision.
GPT Business assisted with this section.
Related:
Comments