Have you fallen in love with a house that despite it’s rough exterior, it “has potential”? If you’re looking for a new home to live or invest in, buying a fixer upper is a unique option that has significant advantages.
Aside from being able to purchase the home at a lower price, you can also remodel it to its “full potential”, such as installing a new kitchen, updating the floor plan, maybe even putting in a pool … all of which can increase the home’s value.
But these renovations can be costly — often tens of thousands of dollars.
What’s more, a conventional mortgage won’t cover these costs.
So if you want to buy a home and remodel it, how can you pay for the renovations?
That’s where rehab loans come in.
So what are your rehab loan options? And more importantly, which one is right for you?
In this article, we will break down:
If you’re ready to learn about rehab loans, let’s get started!
Why Rehab Loans Exist
Let’s imagine that you’re interested in a house listed for $200,000. After some research, you think you’ll need $50,000 on top of that for renovations to the house.
With a conventional mortgage, your lender is not going to approve a $250,000 loan to buy a house that is appraising at $200,000.
If you don’t have the extra cash to make the renovations before moving in — whether that’s renovations you simply want or renovations that are required — what can you do?
A rehab loan can be the solution.
The loan addresses a common problem when buying a home that needs renovation: lenders often don’t approve loans for homes in need of major repairs.
What Are Rehab Loans?
A rehab loan allows you to finance the purchase price as well as needed or wanted repairs in the same loan. same loan.
With a rehab loan, there’s peace of mind because you’re not left wondering if you’ll have all of the money to make renovations.
Plus, by using a rehab loan, you won’t have to empty your savings account or put home renovations on a high-interest credit card.
Types of Rehab Loans
Next, we’ll explore types of rehab loans you can choose from. This includes:
FHA 203(k) Loan
A FHA 203(k) loan allows you to borrow the amount you’ll need based on what your house is expected to be worth after you finish the renovations. based on what your house is expected to be worth after you finish the renovations.
The loan allows buyers to finance the home and up to $35,000 in repairs with one loan.
The FHA 203(k) loan is regarded as a stepping stone, allowing first time home buyers the option of rolling the costs of the repairs into the mortgage.
Pros
Cons
There are two types of FHA 203(k) loans: Limited and Standard. Next, we’ll look at each in depth.
Limited Vs Standard FHA 203(k) loan
Limited 203(k)
The Limited 203(k) Loan is used for minor modeling and non-structural repairs — keep in mind that with the Limited 203(k) proceeds may not be used to finance major renovations.
For example, eligible improvements include:
Standard 203(k)
The Standard 203(k) can be used for larger remodeling and repairs, compared to the Limited 203(k).
There is a minimum repair cost — $5,000 — and the use of a 203(k) Consultant is required. As is the case with any 203(k) loan, the maximum amount is $35,000.
Eligible improvements include:
Fannie Mae HomeStyle Renovation Loan
Another rehab loan option, the Fannie Mae HomeStyle loan is a conventional renovation loan that allows home buyers to finance the cost of purchasing and remodeling a home in the same loan.
Though it does have similarities to the FHA 203(k), there are many notable differences, the biggest of which is that while FHA 203(k) loans can only be used on primary residences, HomeStyle loans can be used on secondary homes or investment properties.can be used on secondary homes or investment properties.
Because of this, and it’s stricter requirements, the Homestyle loan is regarded as a step up from the FHA 203(k) loan, but it is still available for first time home buyers who qualify.
Pros
Cons
Alternative Options to Rehab Loans
Are there other options besides the FHA 203(k) and the Fannie Mae HomeStyle Loan?
There are, and next, we’ll look at alternative options to rehab loans.
As you explore each option, it’s important to think long term and how much each loan option will cost over the entirety of your loan — not just the initial cost.
While many of these alternative options can wind up being far more expensive than the rehab loans mentioned above, it’s important to see the full gamut of what is available for you.
Credit Card
Some homeowners may consider paying home renovations on a credit card. After all, it can be the easiest way — simply swipe and go.
If you have a credit card with a 0% APR for an introductory period and you are charging an amount small enough that you can pay off within a single billing cycle, then this is an option.
But creating a large balance on a credit card with a high-interest rate is a recipe for financial disaster.
According to recent Federal Reserve data, the average APR across all credit card accounts is over 15 percent — the highest rate recorded in the last 15 years.
If you put renovations on a credit card, you’ll be in danger of piling up high-interest debt that grows every month the balance isn’t paid.
Over time, you can end up paying tens of thousands more than you would have by utilizing a rehab loan. more than you would have by utilizing a rehab loan.
Just to reiterate: unless it’s a small amount that you can pay off within a single pay period, and you have a long introductory 0% APR, we do not recommend using a credit card for a renovation.
Cash-out Refinance
Known as a mortgage refinancing option, a cash-out refinance is when a mortgage is refinanced for more than what is owed and the borrower takes out the difference in cash to then be used for renovations.
Here’s how it works: let’s say that you bought a home for $150,000 and you’ve paid off $50,000. You owe $100,000 on your home.
You want to make $25,000 worth of renovations.
Using a cash-out refinance, you would take an amount of your equity and then add what you’ve taken out onto your new mortgage principle.
This means your new mortgage would be worth $175,000 (the original $150,000 owed on the home plus the additional $25,000 you need for renovations), and your lender gives you the $25,000 in cash for renovations.
Home Equity Loan or Home Equity Line of Credit (HELOC)
A home equity loan or HELOC gives you the ability to withdraw a portion of your home’s equity in cash utilizing a second mortgage.
Keep in mind there are differences between the two.
A home equity loan is a lump-sum loan with a fixed rate. On the other hand, a line of credit acts similarly to a credit card and has a variable rate.
Personal Loan
Another option to pay for home renovations is personal loans. Personal loans typically have lower interest rates than credit cards, but often higher interest rates than rehab loans, costing you more in interest in the long run.
Rehab Loans: What’s Best For You?
While renovating a home can be difficult, choosing how to pay for it doesn’t have to be.
Choosing from one of the rehab loan options comes down to what’s best for your financial needs.
Here are a few examples.
Whether you choose the FHA 203(k) or FannieMae HomeStyle, ensure that you examine the total cost of the loan.
Most of all, stay away from accruing high-interest debt for home renovations — and for other personal finance needs.
Continued Learning: Rehab Loans
Now that you know more about what rehab loans are, as well as the types of rehab loans to choose from, don’t stop your home buying education there. Here are additional (and free!) WealthFit approved home buying resources: