In some housing markets, affordable homes come at a high price. In exchange for a low-priced home, a buyer must invest extra time and money in rehabilitating the neglected, abandoned or vandalized property just to bring it up to standard. Home owners may also need to perform extensive, deferred maintenance or repair damage caused by fire or natural disaster to their homes, which can easily add up to tens of thousands of dollars. The Federal Housing Administration and conventional lenders offer rehabilitation mortgages to finance the cost of renovating.
Conventional lenders offer more variety than the FHA, which only offers the 203k program. Non-government rehab loans include construction loans--short-term financing due upon completion of the work--and construction-to-permanent financing programs, in which the construction loan is converted to a regular mortgage loan, such as Fannie Mae's HomeStyle Renovation loan.
FHA's 203k rehab loan is similar to construction-to-permanent financing. It combines the money needed to purchase or refinance the home--plus the funds to make repairs--into a single loan due up to 30 years after work is completed.
Conventional rehab loans generally finance owner-occupied, one- to multi-unit properties, as well as second homes and investment properties. They finance the rehabilitation of approved (Fannie Mae-warrantable) condominiums, cooperative housing and planned unit development (PUD) properties.
FHA finances only owner-occupied homes that have one to four units, condominiums in FHA-approved projects and certain "mixed-use" properties that have residential and commercial zoning.
FHA 203k loans require a 3.5 percent down payment or 3.5 percent equity after improvements, based on the new value. The loan is repaid over the life of the loan, generally 30 years.
Conventional financing typically requires a higher credit score and down payment. In refinance transactions, the home requires sufficient equity to make the improvements. The home must have equity after repairs are completed, based on the new appraised value. Fannie Mae rehab loans are repaid over a loan term of 15 or 30 years. Construction loans are due upon completion of the work. A home owners may refinance the home and cash out on the new value to repay the lender.
Appraisals are conducted before the lender approves the loan and after work is completed.
Minimum and maximum loan amounts for conventional rehab loans depend on the lender and the area's conforming loan limit.
On a 203k loan, "the cost of the rehabilitation must be at least $5,000, but the total value of the property must still fall within the FHA mortgage limit for the area," says the Department of Housing and Urban Development, which sets FHA loan caps each year. Loan limits are less in areas where home prices are low and moderate, and higher in high-priced areas.
The loan-to-value (LTV) is the loan amount expressed as a percentage of the home's estimated value after the rehabilitation. FHA's maximum LTV is 97.75 percent. Conventional loans require between 95 and 80 percent LTV, depending on the property type and the borrower's credit qualifications.
The main draw to FHA-insured programs are the relatively flexible credit qualifying standards, low down payment and added financial protection for the borrower and lender. FHA may reimburse the lender with a one-time partial claim payment if the borrower defaults on payments but is able to begin repayment. FHA also pays the lender for losses if the home owner fails to make payments and ends up in foreclosure.
The advantage to a conventional construction-to-permanent-style loan such as Fannie Mae's is that the borrower only has one application process and one closing. You can buy a home and repair it without having to take out a more expensive second mortgage such as a home equity loan or line of credit. It can also be used as a refinancing tool for an existing mortgage, allowing home owners to borrower renovation funds without having to pay them back soon after construction.
Conventional construction loans benefit investors and those who only need the funds temporarily. Investors who "flip" properties for a profit within 90 days of purchasing them are good candidates for such loans.
Conventional rehab loans allow borrowers to make significant renovations from the ground up. Construction loans allow borrowers to demolish and build a brand new structure.
FHA limits work to properties that are at least one year old; i.e., no new construction. Homes that have been or will be demolished during renovation are eligible, but the foundation must remain intact. Improvements may range from minor--such as making energy efficient improvements--to major, such as structural reconstruction and conversion to a one- to four-unit property.
- construction image by Greg Pickens from Fotolia.com