February 6, 2020
Interested in buying a fixer-upper? There are several different methods of acquiring a renovation loan, but two federally backed renovation mortgage programs will allow you to do a combined purchase and repair mortgage loan – the FHA 203(k) loan and the Fannie Mae Homestyle Renovation mortgage. They are perfect for rehab work on foreclosed properties, and also may be used to combine renovation and refinancing of your existing home.
For 203(k) eligibility, the home must be from single-family up to four-family occupancy and construction must have been completed for at least one year. FHA loans are intended for residents and not investors, but Homestyle loans may also be used for investment properties. Both types can be used for refinancing as well as purchasing.
FHA loans allow lower down payments and larger loan amounts. The loans follow typical FHA guidelines, with minimum down payments of 3.5% and loan limits determined by regional guidelines (typical limits are around $270,000). Homestyle loans require a minimum 10% down (20% for investments), allow adding up to 50% of the as-completed value of the property, and may even allow luxury items such as pools or spas.
Private Mortgage Insurance (PMI) will be required in both cases, with any loan below the standard 20% down.
For the FHA 203(k) loan, you will need to provide a detailed proposal for the renovation, including cost estimates for each section of the repair and improvement, and an appraisal that includes the estimate of the value added through the completed improvements.
FHA 203(k)’s have stricter oversight on the money. Your borrower will hire a consultant to assess the construction plan before approval, and inspect the work before each draw (disbursement to the contractor). The construction must be completed within six months to finish the contract, and you are limited to five draws. (By contrast, Homestyle loans only have initial and final inspection steps.)
In return, your 203(k) can cover all materials and labor, design costs, up to six months of the mortgage payments during the remodeling – even a 10-20% contingency for cost overruns. However, you cannot alter the amount of the loan to handle further cost overruns, so take care with your estimates. You will also have to meet HUD energy efficiency and construction standards with respect to heating, ventilation and air conditioning (HVAC), smoke detectors, insulation and caulking, etc., as well as FHA requirements.
Drawbacks of 203(k)/Homestyle loans are longer closing periods (60-90 days), and typically higher than market interest rates because of the associated renovation risk.
FHA 203(k)s can tolerate credit scores of 640, and perhaps even as low as 600. Homestyle loans generally have a minimum near 680, and 740 may be required for a decent interest rate.
In addition to these programs, there are two other programs targeted for lesser remodeling tasks.
- Streamlined FHA 203(k) – This is limited to $35,000 for minor remodeling tasks; there are no structural repairs or major remodels allowed. It does not require the use of a consultant and has significantly less paperwork and monitoring requirements.
- Fannie Mae Homepath – The Homepath program is also limited to $35,000, or up to 35% of the as-completed value, but it applies only to specific properties that Fannie Mae owns, and for purchase only. It can be used for investment properties as well as for primary residences. Down payments may be as low as 5% for primary residences, and will typically be in the 20-25% range for investment properties.
In general, Homestyle loans give you better flexibility and potentially better interest rates if you can afford a larger down payment and have better credit, but FHA 203(k)s allow a greater borrowing amount and less money down. The Streamlined 203(k) and Homepath are variations of these two loans for smaller scale improvements or repairs.
If you plan to renovate, check out these options to see if any of them will work for your situation. Best of luck with your project!
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