The housing supply in the core and close-in areas of our Front Range cities is aging, especially in the single-family home category. There is a strong desire to live in an area with good walk scores and easy access to the amenities a city offers. However, since there are so few new single-family homes being built in core areas, the home buying public is turning to renovating existing homes. Sometimes the condition of the home to be renovated keeps the buyer from obtaining more traditional financing for the purchase. When that is the case, here are a few options.
FHA 203(k) is a loan that allows home buyers to borrow enough to both purchase a home and provide the funding for necessary repairs including labor and materials. The end result can be a fixed-up home with a mortgage that could be a fixed rate for 15 or 30 years, or an Adjustable-Rate Mortgage (ARM).
The basic framework for the structure of the FHA 203(k) program is as follows:
This type of loan is only for those who will occupy the property as a primary residence after renovations are complete and the loan is closed. It is not available for investors.
One of the good things about FHA 203(k) is that you only need to make one loan application for purchase AND the renovation. The initial funding from the loan will provide the money for the home purchase, and subsequent dispersals of loan funds from an escrow account will pay for the renovations.
The amount which can be borrowed is subject to the FHA loan limit in the geographic area. In Boulder County the loan limit is $747,500 for a single unit home. The other determining factors for the loan size are borrower income, credit, and down payment. The nice part about the down payment is that it is the same as regular FHA financing at 3.5%. You can put more down, but if you have a large sum of cash, you probably will not be looking at this program. The low down payment is made possible by the payment of mortgage insurance, which protects the lender in the event of a borrower default. In most cases the mortgage insurance can be included in the loan.
The loan size is also limited to 110% of appraised value and that amount cannot go over the loan limit for the area. An appraisal is done on the home to determine the home’s value before and after the improvements.
There are two types of FHA 203(k) loans. One is designed for limited repair costs of less than $35,000 and one for extensive projects that are going to cost more than $35,000. Generally, you will have more paperwork to complete than a straight purchase loan, especially if the projects are bigger and are valued at over $35,000.
In most cases, the mortgage lender will require that the renovations and repairs be completed by licensed contractors, especially for items like electrical and plumbing. Check with your mortgage lender to see if you are allowed to carry out any of the repairs on the list yourself. Timing for getting the work done is critical for FHA 203(k) loans. Renovation work must begin within 30 days of the initial home purchase and closing, then be completed within six months of the original closing.
This loan program is designed to upgrade a home’s essentials such as structural repairs, roofing, flooring, plumbing, health and safety issues, and changes that will improve appearance and obsolescence. Luxury items such as hot tubs, tennis courts, outdoor fireplaces, and satellite dishes won’t be approved items.
It is possible to use an FHA 203(k) loan on your existing home. This amounts to making an application for refinance. Your original mortgage will need to be paid off and you will need to have enough equity to generate cash for the renovations. The cash generated is then held in escrow until the work is completed and the contractors need to be paid.
Closing costs for an FHA 203(k) loan are much like any other mortgage loan. Expect costs such as a loan origination fee, appraisal and inspection fees, title insurance, credit report, and maybe an Improvement Location Certificate (ILC), etc. FHA will require mortgage insurance to be paid both upfront and monthly.
Fannie Mae has a loan program for renovations called the HomeStyle® Renovation loan. The main advantage is that it is what is known as a “single close loan”. You complete a loan closing for the renovation part of the process and when the renovations are done, you don’t need to complete another loan application and closing for the permanent loan. Using a HomeStyle® Renovation loan, the final loan is based on the projected value of the home after the renovation is completed. Loan options include 15- and 30-year loans and also adjustable-rate options.
Hard money-investment properties only
A property in need of serious renovation may not qualify for conventional lending sources. Hard money is a way to get the property purchased and then structure cash draws to complete the renovation. Once the renovation is complete, the property could qualify for conventional financing or be sold or rented.
When you hear the term “hard money loans,” you might picture money changing hands in a dark alley and rough collection techniques when the loan comes due. However, that couldn’t be further from the truth as hard money lending can be a very valuable and useful tool in many real estate transactions.
In the “regular” real estate financing world, 1- to 4-unit lenders usually need to follow strict guidelines and procedures set out by entities like Fannie Mae or Freddie Mac. Following those guidelines naturally takes time and in a hot market time can make the difference between whether an offer on a property is accepted or not. Hard money lenders use their own money or closely affiliated investors to lend. This enables them to make quick decisions on loan approval and funding. Hard money lenders are typically collateral based, which means they look mostly to the property for securing the loan. Hard money is only available for investment property and not for owner-occupied properties. Your Realtor® is likely to have a resource for this type of lending for you.
Cash-out first mortgage
If you have enough equity in your home, one of the easiest ways to raise cash for renovation is a cash-out refinance. In this case, you get a new mortgage loan to pay off the old first mortgage and enough cash to finance your improvements. In today’s low interest rate environment, if you start a new 30-year amortization, you might find your payment won’t increase that much. Your mortgage lender can help you brainstorm the different options.
Second mortgage or Home Equity Line of Credit
Sometimes the existing first mortgage on your home is just so attractive you don’t want to change it. If that’s the case, the answer might be to add a second mortgage or a Home Equity Line of Credit (HELOC). A second mortgage usually has a slightly higher interest rate and a shorter term than a regular 30-year amortized loan. HELOCS can offer quite a bit of flexibility as far as drawing only enough cash you need for the moment and can offer flexible repayment options.
Your own cash and refinance upon completion
If you have your own cash available to take care of the renovation, but would like the cash back after the project is complete, here is an option. Once the renovation work is done, you can apply for a new mortgage, get a new appraisal based on the improved property, and then hopefully get enough cash back to replenish your source of funds.
Other options might be available for you. Be sure to consult with your mortgage lender and your Realtor® to determine the availability of different financing programs and identify the one which works best for you.
By Duane Duggan. Duane has been a Realtor for RE/MAX of Boulder since 1982. Living the life of a Realtor and being immersed in real estate led to the inception of his book, Realtor for Life. For questions, e-mail DuaneDuggan@boulderco.com, call 303.441.5611 or visit BoulderPropertyNetwork.com.