Whether you’re looking for a house to buy and remodel or have big renovation plans in 2017, financing a major (or minor) overhaul of a property can be a challenge. Unless you’ve got a robust savings account or received a windfall from a rich uncle, your options are likely to be to use a credit card or personal loan or to borrow against your home equity. However, there’s a better way: wrap your renovation costs into a long-term mortgage with a 15 or 30-year term.
Mortgage loans for renovations
Unlike a home equity loan or second mortgage, Fannie Mae, Freddie Mac and FHA (Federal Housing Administration) all offer renovation loans that include the financing to buy a property and to make home improvements with one mortgage. These renovation loans are available to purchase a home and for refinancing for homeowners.
The main advantage of these loans as opposed to home equity loans is that you can get a fixed-rate loan for a longer term. Since the loan is your first mortgage, it will typically have a lower interest rate than a second mortgage.
There are some differences between these loan products, so it’s best to consult a lender familiar with renovation loans to determine which is best for your needs. Keep in mind that these loans have limits. For Charles County, FHA and conventional conforming loans are capped at a maximum of $636,150.
- FHA 203(k) loans. FHA 203(k) loans are only available to owner-occupants and can’t be used for a second home or investment property. FHA 203(k) are available as standard or streamlined products. The streamlined FHA 203(k) is limited to a maximum of $35,000 worth of repairs, with no minimum repair requirement. The streamline loan limits repairs to non-structural, non-luxury items, but that does include things like renovating your kitchen and replacing windows and floors. The standard FHA 203(k) allows structural repairs, requires at least $5,000 of renovations and requires a HUD consultant to supervise the renovations.
You’ll need an appraisal of the current home value plus an estimate of the renovation costs.
The fees for an FHA 203(k) loan are slightly higher than a traditional FHA loan.
FHA loans require a down payment of just 3.5 percent, but you also have to pay mortgage insurance for the life of the loan unless you opt to make a down payment of 20 percent. However, FHA loans are generally easier to qualify for, with lower credit scores and a slightly higher debt-to-income ratio still acceptable.
- Fannie Mae HomeStyle mortgage and Freddie Mac renovation loan. Conventional renovation and financing loans are available for owner-occupants, second home buyers and investors. Buyers can make a down payment of as little as five percent if they chose a fixed-rate loan and 10 percent with an adjustable rate mortgage (ARM). Refinancing homeowners need either five or ten percent in equity after the renovations are complete.
If you are financing a second home, you’ll need 90 percent in home equity or a 10 percent down payment with a fixed-rate loan and 80 percent with an ARM. Investors must make a 15 percent down payment with a fixed-rate loan and a 25 percent down payment with an ARM.
Borrowers who make a down payment of less than 20 percent or who have less than 20 percent in home equity will need to pay private mortgage insurance.
The cost of renovations can’t exceed 50 percent of the total loan amount, but any type of renovation can be financed with these loans as long as they add value to the property.
Tips for qualifying for a renovation loan
- Work with an experienced lender who understands the details of renovation loans.
- Identify contractors who have experience with renovation loans. An experienced renovation loan lender can recommend contractors.
- Get more than one estimate for the renovation project.
- Have a budget in mind for your total housing payments and for your renovation plans.
- You’ll need to qualify for the loan based on the total amount of the home purchase (or refinance) and the renovation budget. The down payment is also based on the total loan amount.
- Be prepared with down payment funds.
- Raise your credit score as much as you can before applying for a new mortgage.
- Reduce other debt as much as possible. Your total debt-to-income ratio, which compares your minimum payments on all recurring debt including the new loan payment to your gross monthly income, should be a maximum of 43 percent, preferably lower.
Wrapping your costs into a long-term loan can help you accomplish your goals and put your dream home within reach, as well as adding value to what for most people is their number one asset: a home.
Michele Lerner is a freelance writer with more than twenty years of experience writing articles and web content for newspapers and magazines on topics related to real estate, personal finance and business. Her work has appeared in The Washington Post, NewHomeSource.com, Realtor.com, Bankrate.com, Insurance.com, HSH.com, The Washington Times, NAREIT's Real Estate Portfolio, and numerous Realtor association publications. Her latest book, "New Home 101: Your Guide to Buying and Building a New Home" and her first book, "HOMEBUYING: Tough Times, First Time, Any Time" are available now at Amazon.com or from MicheleLerner.com.