Homebuyers looking for a “fixer-upper” loan for a house in need of repair or to finance needed maintenance to their current home often find themselves in a quandary: They can't borrow the money to buy a house because the bank won't make the loan until the repairs are done, and the repairs can't be done until the house has been purchased.
The Department of Housing and Urban Development (HUD) offers two loan programs that can make the dream of rehabbing a fixer-upper a reality: the Federal Housing Administration's 203(k) mortgage and Fannie Mae's HomeStyle Renovation mortgage.
The 203(k) Program
HUD's 203(k) program can allow a buyer to purchase or refinance a property plus include in the loan the cost of making repairs and improvements. The Federal Housing Administration (FHA)-insured 203(k) loan is provided through approved mortgage lenders nationwide. It is available to persons wanting to occupy the home.
The down payment requirement for an owner-occupant (or a nonprofit organization or government agency) is approximately 3 percent of the acquisition and repair costs of the property.
Renovations aren't limited to rot and decay. They can include buying new appliances, painting or replacing outdated flooring.
- Minimum credit score of 580 (Or 500 with 10% down payment)
- Minimum 3.5% down payment.
- Primary residences only
How the Program Works
The HUD 203(k) loan involves the following steps:
- A potential homebuyer locates a fixer-upper and executes a sales contract after doing a feasibility analysis of the property with their real estate agent. The contract should state that the buyer is seeking a 203(k) loan and that the contract is contingent on loan approval based on additional required repairs by the FHA or the lender.
- The homebuyer then selects an FHA-approved 203(k) lender and arranges for a detailed proposal showing the scope of work, including a detailed cost estimate on each repair or improvement of the project.
- The appraisal is performed to determine the value of the property after renovation.
- If the borrower passes the lender's credit-worthiness test, the loan closes for an amount that will cover the purchase or refinance cost of the property, the remodeling costs, and the allowable closing costs. The amount of the loan will also include a contingency reserve of 10% to 20% of the total remodeling costs and is used to cover any extra work not included in the original proposal.
- At closing, the seller of the property is paid off and the remaining funds are put in an escrow account to pay for the repairs and improvements during the rehabilitation period.
- The mortgage payments and remodeling begin after the loan closes. The borrower can decide to have up to six mortgage payments (PITI) put into the cost of rehabilitation if the property is not going to be occupied during construction, but it cannot exceed the length of time it is estimated to complete the rehab. (PITI stands for principal, interest, taxes, and insurance.)
- Funds held in escrow are released to the contractor during construction through a series of draw requests for completed work. To ensure completion of the job, 10% of each draw is held back; this money is paid after the lender determines there will be no liens on the property.
- Private Mortgage Insurance (PMI) is required, but unlike conventional loans, it is not removed once equity in the property reaches 20%.
For a list of lenders who are offering the 203(k) Rehabilitation Program, see HUD's 203(k) Lenders List. The interest rate and discount points on the loan are negotiable between the borrower and the lender.
Fannie Mae HomeStyle Renovation Mortgage
The HomeStyle Renovation mortgage through Fannie Mae provides a convenient and flexible way for borrowers considering home improvements to make repairs and renovations with a first mortgage, rather than a second mortgage, home equity line of credit, or other more costly methods of financing.
The HomeStyle mortgage can be used to buy:
- Principal residences, from one to four units
- One-unit second homes (granny units)
- Single-unit investment properties (co-ops, condos)
Types of renovations mortgages include 15- and 30-year fixed-rate mortgages and Adjustable-Rate Mortgages (ARMs). Fannie Mae notes that “The original principal amount of the mortgage may not exceed Fannie Mae's maximum allowable mortgage amount for a conventional first mortgage.”
While the average Fannie Mae HomeStyle loan's minimum down payment is around 5%, there are no specific minimum down payment stipulations. Instead, HomeStyle lenders use factors including the home's equity and borrower's credit rating to determine the cost of the loan.
HomeStyle mortgages are unique in that Fannie Mae based them on the “as completed” value of the home after repairs and upgrades have been made. As a result, the homebuyer is assured that all costs of renovations will be covered by the mortgage. Also, money for improvements is not released until the work has been completed and approved by an FHA-certified inspector. There is no need for “sweat equity.”
The HomeStyle mortgage offers a generous range of costs for inclusion in the loan including:
- Architects or designers expenses
- Energy efficiency assessments
- Engineering and design updates
- Required inspections
- Permit fees
All work must be completed promptly by lender-approved, licensed and certified contractors and architects. All repairs made using this type of loan must be permanently affixed to the property.