Renovation loans are handy but hard to find
Construction loans for existing homes
- Lenders won’t approve loan amounts above the property value.
- Moreover, you can't borrow from nonexistent equity.
- The FHA offers two renovation options under its 203(k) rehabilitation program.
- Fannie Mae’s HomeStyle Renovation Mortgage requires better credit than the FHA program.
- Low-income rural residents may qualify for the USDA renovation program.
If you're looking to buy and do major remodeling on an existing home, you can obtain a construction loan that'll cover both the cost of purchase and the remodel.
The options are limited for people looking to buy a fixer-upper. Most lenders won't approve a loan for an amount more than what a property is worth. And since a new buyer has yet to put equity into the home, they're not eligible for a home equity loan or home equity line of credit (HELOC).
However, there are a handful of entities — national, regional and community lenders — that offer renovation loans for a wide range of needs. These loans are particularly useful if you’re purchasing a short-sale or foreclosure home, since traditional lenders may require the upgrades prior to closing.
FHA and Fannie Mae loans
The Federal Housing Administration (FHA) offers a 203(k) rehabilitation loan for single-family homes. There's a limited loan option for projects up to $35,000, which is rolled into the mortgage payment. There's also a standard loan for repairs over $35,000, with added supervision requirements built into the process, and the minimum amount of needed repairs is $5,000.
In both cases, the home must be at least a year old. The minimum down payment is 3.5 percent of the purchase price ($7,000 on a $200,000 purchase, for example). Practically speaking, obtaining a 203(k) loan on a home purchase only makes sense when the upgrades cost more than down payment.
The FHA requires a credit score of 580 or above with the minimum down payment. Borrowers with scores of at least 500 can qualify if they provide a 10 percent down payment. Individual lenders may have more stringent requirements, however.
With the FHA standard loan, virtually any sort of improvement qualifies — foundational repairs are allowed, a relatively recent change. With the limited loan, however, repairs are restricted to more modestly priced items such as roofs, decks, heating and cooling systems, windows, plumbing and electrical. You can borrow up to 110 percent of what the home will be worth after renovation, or the purchase price of the home plus the estimated improvement costs, whichever is less.
Fannie Mae also offers a fixer-upper loan: The HomeStyle Renovation Mortgage. It offers one-time closing costs while removing the need for a second mortgage or HELOC.
Fannie Mae's program offers 15- and 30-year fixed or adjustable interest rates. It requires a down payment of only 5 percent, although down payments of 20 percent or less require the borrower to purchase private mortgage insurance (PMI). If a contractor is being used, the borrowing limit is 50 percent of the completed property value. Borrowers may do their own work for up to 10 percent of the completed property value and inspections are required for any items more than $5,000.
Fannie Mae requires higher credit scores than the FHA — 620 for primary residences, 700 for second homes and investment properties. One caveat with the HomeStyle loan is that many lenders and brokers aren’t qualified to set it up and they can take longer to close than the standard 30 days with conventional mortgages.
FHA and Fannie Mae loans allow you to miss up to six months' worth of mortgage payments while renovations are ongoing. Interest for those months are added to the principal.
Low-income households may be eligible for rural repair and rehabilitation loans and grants through the U.S. Department of Agriculture, also known as the Section 504 program. To receive a loan up to $20,000, borrowers must make less than 50 percent of their area’s median income. Grants up to $7,500 are available to those 62 and older who are unable to repay a loan.
Loan terms go up to 20 years and include a 1 percent fixed-interest rate. Grants can only be used for repairs and improvements that address the health or safety of residents. And USDA can recoup the grant from any sale profits if the home is sold within three years.