Buying a fixer-upper provides lots of opportunities for home buyers. In any real estate market, a fixer-upper allows you to find a house that needs some major repairs and turn it into your dream house for a purchase price you can more easily swallow.
But what happens if you aren't able to fully fund your home improvements with your cash on hand? For those buying a home in that boat, there is the option of a fixer-upper mortgage.
How to Get a Mortgage on a Fixer-Upper
Getting a renovation loan isn't as difficult as you think, and you really don't have to jump through any particularly tough hoops. With most of the loan programs, you are going to have a loan limit based on the renovation cost, your credit score, debt to income ratio, and the current (and projected) value of the home.
Knowing what you should expect in advance will help you navigate through the process of actually getting your home loan.
You'll first want to talk to your mortgage lender as soon as you know you are buying a fixer-upper. This could be before you even start looking for a house or after you fall in love with the historic charm of one you walk through with your real estate agent.
Your mortgage lender will help you prequalify for the renovation loans on the market and a loan amount that you'll need to stay within. Your lender will also help lock you into interest rates, as they are prone to fluctuation and you'll want to get locked into a great one as soon as possible.
From there, your mortgage lender will walk your through the loan process clear until the closing costs. The money set aside for you renovations is then put into a separate escrow account where you must follow specific loan guidelines to get them out.
Sound pretty simple to understand? Let's dive into loan options.
Fixer Upper Mortgage Options
There are two main types of mortgages available for your fixer-upper. They are the FHA 203(k) loan, and the Fannie Mae HomeStyle Renovation Mortgage.
FHA 203(k) Loan
You may have already heard about the FHA mortgage, which allows first-time homebuyers to purchase a home with lower-than-average credit scores and less of a down payment. The FHA 203(k) has similar guidelines, but you don't have to be a first time homebuyer to take advantage of this loan.
Who is the FHA 203(k) loan for?
The Federal Housing Administration created this type of loan for those with lower credit scores to make repairs on their home. There are two types of loans that fall under the umbrella of FHA 203(k) Loan, each geared toward a different set of issues.
The limited 203(k) mortgage is for smaller projects that don't involve tearing down walls or altering the structure of the home. These loans are primarily for projects such as:
- Repairing or replacing your HVAC system
- Updating your roof
- Replacing your siding
- Changing out doors and windows for higher efficiency models
- Bringing your plumbing and electrical up to code
- Redoing your flooring
The limited 203(k) mortgage caps out at $35,000 worth of repairs and upgrades on top of the purchase price of your house. There is no minimum amount that you must use out of that $35,000.
The standard 203(k) loan covers nearly every type of home improvement process—granting the foundation of the home is still intact. This means if you demolish the house and leave the foundation, you can still use this loan.
The home must be older than one year and the repairs must cost more than $5,000 if you want to use this type of loan. To use this loan, you must hire a 203(k) consultant who will ensure the project's feasibility and oversee the entire project. You'll have to pay the consultant a fee of a few hundred dollars.
You can borrow as much as 110% of the appraised value pot renovations or the cost of the home plus the costs of the renovations (as estimated by your 203(k) consultant), whichever is less. This value does not include your downpayment, which must be a minimum of 3.5% of the house purchase price.
Benefits of the FHA 203(k) Loan
There are several benefits to using the FHA 203(k) loan. The first is that it wraps into your home loan, so you don't make separate loan payments every month. That also means your lender takes both loans into consideration when deciding the amount you're approved for, and won't approve you if it puts you above 36% DTI ratio.
Another benefit to the FHA 203(k) loan is that those with lower credit scores can qualify. While FHA approved lenders are known for approving credit scores as low as 580, it's best if you keep your credit score above 620 for the best rates.
Drawbacks of the FHA 203(k) Loan
If you want this loan, you must qualify for the FHA guidelines. That includes paying mortgage insurance if you put down a down payment that is less than 20% of the purchase price. The interest rates that typically come along with the FHA 203 (k) loan and FHA loans along with the mortgage insurance adds up, so make sure you can afford it before you sign the papers.
The 203(k) loan also only applies to your primary residence, not multiple units. This means if you want the loan for investment purposes, use a different loan.
Fannie Mae HomeStyle Renovation Mortgage
If you have a higher downpayment and credit score, the Fannie Mae homestyle renovation mortgage might be for you.
Who is the Fannie Mae HomeStyle Renovation Mortgage for?
With a minimum down payment of 5%, many qualify for the homestyle renovation mortgage. This mortgage is for those who have a credit score of at least 680 if putting down less than 25% upfront. Those who have a DTI ratio between 36-45% need a credit score of at least 700.
Guidelines of the HomeStyle Loan
The HomeStyle guidelines are stricter than the 203(k) loan in some aspects, but less stringent in others. Here are some basic guidelines:
- You'll have 12 months to complete the renovations.
- You can borrow up to 50% of the appraised value after renovations.
- That 50% must include inspection fees, permits and licensing, an optional 10% contingency reserve, and architectural and engineering fees.
- The loan amount is subject to conventional loan limits.
- You must pay PMI if you put a down payment that's less than 20% of the home purchase and loan amount.
Which loan should you use? That really depends on which one you qualify for. If both are available, take a look at the interest rates. These loan options typically offer lower interest rates than refinancing your house or taking out an additional loan on top of your home loan.
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