Financing a renovation or remodeling project
Thursday, October 2nd, 2008Rehab/renovation/remodel financing
Simply put – the housing market has changed. Buying a home today requires a larger investment, better credit history, solid reserves and verifiable value. Lenders want to avoid risk. The area where you can see this most clearly is with existing homes that either need rehab or renovation or require a basic change in their utility for their owner. Let’s look at four different, but very common situations where renovation is necessary or desirable:
1. The purchase of a foreclosure or a REO.
In days of old, when a bank was forced to foreclose on a home, it was commonly “restored” to marketable condition. Due to the number of these properties now, most banks can’t afford even the simplest repairs on them all. However, the new lender will want the home to be in livable condition. The “as-is” purchase may not be an viable option if the work is extensive.
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2. The purchase or refinance of a home that is either “functionally obsolete.”
Functionally obsolete can be a home where the appliances are pastel pink and has baseboard heating or one whose use has to be changed (i.e. an owner is wheelchair bound and access needs to be provided both inside and out).
3. Going “green” and making a home ecologically current.
A typical change might be energy upgrades that could include solar panels, Energy Star appliances, or efficient windows and roofing. Your motives maybe be noble or you may just want to save money.
4. Buying an older home and updating.
With the rising cost of gas, many are rethinking the viability of the long commute. Instead they are looking at older, closer in housing that may lack both the size and the amenities that distant, new communities offer. With one loan, it is possible for purchasers to buy and create the home of their dreams. Once you have decided to undertake a renovation, a key step will be figuring out what sort of financing is needed.
How much the work will cost will have an impact on financing options. The exact number may differ from lender to lender, but $35,000 is a reasonable line of demarcation. Once you spend more than about $35,000, you are in major remodeling or rehabbing mode.
Financing for Current Owners
Homeowners who have been in the house for a while can tap their equity with a cash-out refinance and have only a modest increase in their mortgage payment. So long as you stay at 80% loan-tovalue (LTV) or lower, you will get the most competitive rates and avoid mortgage insurance. Cash-out loans with LTVs in the 70-80% range may carry some extra charges. A cash-out refinance allows the homeowner to act as contractor for the project. Here, sweat equity (doing it yourself) can be used to keep costs down and you don’t answer to anyone about how you use the money.
If the straight cash-out is not an option due to LTV considerations, you could consider a Fannie Mae HomeStyle Renovation mortgage. The difference is that the appraisal will be based on the “best-value” of the property once the renovation work has been completed. However, the work has to be done by a licensed contractor and the renovations have to be completed within a six month time period. Another option is the FHA 203k rehab loan. If the work needed is basically cosmetic (no structural work is allowed) and the total cost is under $35,000, it is considered a “streamlined” renovation and the process is greatly simplified. If the job is more extensive or it requires structural work, the traditional FHA 203k is available. There are few restrictions and the cost of the rehab work is only limited by the FHA limits for your area. There are cases, especially in urban areas, where a “shell” is purchased for a nominal fee (let’s say under $1,000) and $250,000 is used for completely restoring the house, all with one loan.
Rehab Purchases
What if you want to purchase a home that is in need of work, whether it be a few cosmetic improvements and upgrades or a more substantial rehab? The previously described Fannie Mae and FHA financing is available for this situation. Be aware, though, most lenders will require you to determine in advance the value added.
The lender will want to see detailed plans and costs broken out for each stage of the project and may want to see appraisals both in “as-is” condition and with an estimate of the value after the work has been completed. Construction costs will be escrowed and doled out as each section of the project is completed. In addition to construction costs, you can include the cost of architect drawings, inspections, permits, as well as mortgage payments if the property is unlivable while the work is being performed. To offset cost overruns or unexpected expenses, 5-10% in additional funds can be added to the estimate.
The Fannie Mae option requires a minimum of a 5% investment on the acquisition cost (purchase price + cost of repairs). The FHA option requires a 3.5% investment on the acquisition cost. Both will require mortgage insurance with the minimums. FHA will allow for much lower credit scores. As always, if this is an approach you want to consider, make sure that you consult your Realtor, a qualified mortgage professional/Bill Mulligan (not every lender offers these options) as well as an experienced contractor.
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