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.
What is the role of a HUD Consultant in a FHA 203K Loan?
There are basically two types of FHA insured 203K loans. While both loan types can be used for either a purchase or a refinance, they differ in a few key areas. For the financing of renovation work that exceeds $35,000, or if there are any structural repairs, the only option for borrowers is to go with the Standard 203K loan, also known as the Consultant 203K loan. The 203K streamline loan may be used for minor repairs, additions to the exterior or for the purchase of appliances, with a budget under $35,000.
Basically, if your repairs are structural in nature or they exceed the maximum amount from a Streamline 203K ($35,000) you need a 203K Consultant, period.
Not all Consultants are created equal, in fact quite a few of the ones can turn out to be flat out terrible. However, there are plenty of great ones out there. HUD Consultant selection can make or break a deal. Seriously, you choose wrong and you could just kill your loan.
This is yet another reason why using an experienced renovation loan officer is important. If they specialize in 203K loans then they have a good HUD Consultant, use that experience and save yourself some grief.
While all Consultants are not created equal, the inspection fee schedule IS! The fee is set by HUD on a fixed schedule and is based on the amount of renovation you are doing.
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REPAIR AMOUNT
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CONSULTANT FEE
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$5,000-7,500
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$400
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$7,501-15,000
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$500
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$15,001-30,000
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$600
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$30,001-50,000
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$700
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$50,001-75,000
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$800
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$ 75,001 -100,000
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$900
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$100,000 and up
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$1,000
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203K Feasibility Analysis
The first role of the Consultant is to do an initial inspection of the property. This occurs during the loan process. There are varying schools of thought on when this should be done. Most suggest that a 203K consultant be brought in prior to getting the contractor in to bid the project. Those guys are wrong.
The Consultant does not dictate the repair, they are there to ensure that everything that is required to be done is getting done and to take a 2nd look at the Contractor’s numbers to make sure they seem accurate. If you have no idea what repairs are needed to meet FHA 203K guidelines then sure, get the consultant in from the get go.
If you have a pretty good idea what is needed then bring them in AFTER the contractor has bid on the scope of work you want.
203K Post-Close Draw Inspections
This is the truly valuable part of what the 203K Consultant does. He protects YOU and ensures your renovation is how YOU want it! When you have a good one, they will come in and ensure the quality of the work, ensure that it meets FHA guidelines and make SURE YOU ARE HAPPY before they sign of on the release of the draw.
If you are not happy with the quality of the work let them know! Your loan officer can make sure the contractor corrects the issue or he won’t get paid. Remember, you (along with the Consultant) control the funds on a 203K Loan. For first-time buyers or first time renovators this piece of the renovation, and the HUD Consultant’s role in it, is vital to success.
The Consultant should also be getting Lien Waivers signed during the draw inspections. Another bit of protection for you and your renovation. This ensures all the sub contractors have been paid and protects you against mechanic’s liens that could potentially go on the property if everyone has not been compensated correctly.
Conclusion
Although the HUD Consultant is an added expense they really do provide VALUE and PROTECTION to you during your 203K Renovation. However, if you get the wrong one then all they provide is additional expense. That is why it is really important to heed the advice and experience of your 203K lender. A good 203K Expert will have participated in HUNDREDS of Standard 203K loans and can tell you a good Consultant from a bad one without hesitation.
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 the Gott Real estate website, Gottre.com.
