Did you know it’s possible to buy a home and borrow money to renovate the home at the same time? Most people think they have to wait until they own the home and then take out a home equity loan once they build up equity in it. That’s not the case, though.
There are two loan programs you can use – one is government-backed and one is conventional.
The FHA 203K Loan
The government-backed loan is the FHA 203K loan. This loan is guaranteed by the FHA, and it has flexible guidelines just as the standard FHA loan. The FHA offers two versions of their renovation loan. They are:
- FHA 203K (full) – This loan entitles you to make any type of changes to the home that fits within your loan amount. This includes structural changes, such as knocking down walls. This loan is for major repairs and/or renovations. You can borrow up to 115% of the after-repaired value of the property according to the appraiser. You must also hire a loan consultant for this loan.
- Streamline FHA 203K – This loan allows you to make minor and/or cosmetic changes to the home. You can borrow up to $35,000 for the renovations and you cannot make any structural changes to the home. This loan doesn’t require the use of a loan consultant.
You’ll need a 3.5% down payment for either loan, just as you would with a standard FHA loan. You can get the down payment from a family member, employer, or charitable organization if applicable.
In order to qualify for the loan, you’ll need at least a 580 credit score, a maximum 31% housing ratio, and a maximum 41% total debt ratio. You must prove to the lender that you will occupy the property as your primary residence and you must be able to move into the home within 6 months (for the full 203K). You must be able to live in the home while the contractors do the renovations for the streamline 203K.
You must hire contractors to do the work in most cases. The lender must approve the contractors and their proposed work. The contractors must provide the lender with a written contract showing the prices agreed upon, the work that will be done, and the timeline it will be completed. It’s usually best to use contractors that are familiar with the 203K process, as they will receive their funds right from the bank in predetermined increments according to the timeline.
The Fannie Mae HomeStyle Loan
The conventional version of the renovation loan is the Fannie Mae HomeStyle loan. Before you move forward with this process, know that you’ll need good qualifying factors, as you would with a standard conventional loan. This means:
- 680 credit score or higher
- Maximum 28% housing ratio
- Maximum 36% total debt ratio
- Stable income/employment
- No recent bankruptcies or foreclosures
Fannie Mae requires you to hire a contractor, just as you must do with the FHA loan. The contractor must be licensed and insured. You must also run the contractor past the lender to make sure they agree with your choice of contractor.
If you want to do the work yourself, you may be able to petition to do so. In order for it to work, though, the repairs/renovations must not exceed 10% of the after-repaired value. You must also be able to convince the lender beyond a reasonable doubt that you have the qualifications and the time to complete the repairs. All repairs must be done within six months, which if you work full-time and have a family could make it hard to fit rigorous renovations into your schedule.
Both renovation loans allow you to buy a home that otherwise might not pass an appraisal. It’s a great way to buy a home that you love the layout of, but know that it needs some work. If the renovations are extensive, you may be best off with the FHA 203K loan. Even if you can afford the down payment of a conventional loan or have the credit score for a conventional loan, you’ll get more out of the FHA 203K loan. Once the renovations are complete and you have a little equity in the home, you can always refinance out of the FHA loan and into a conventional loan.