Published August 29, 2011
Two little-known home renovation mortgage programs offer solutions for buyers and homeowners who want to renovate.
Fannie Mae and the Federal Housing Administration have home renovation mortgage programs that allow buyers to borrow based on what the house is expected to be worth after the home rehab is completed. Homeowners can also use both programs to refinance their existing mortgage plus the renovation costs into one loan.
FHA's 203(k) program and Fannie's HomeStyle Renovation Mortgage have been around for years. In the old days, when most borrowers could easily get second mortgages or generous credit lines to pay for renovations, these loans weren't as appealing as they are today.
"A couple years ago there wasn't as much demand for these loans," says Leesa Sandoval, a loan officer with PrimeLending in Dallas who specializes in renovation mortgages. "But now they are great to get some of this (housing) inventory sold and get these foreclosures out of the market."
The FHA insured 22,491 home renovation mortgages in the 2010 fiscal year, according to the agency's latest report on 203(k) loans. That is more than six times the number of 203(k) loans the agency insured in 2007. Fannie says the volume of HomeStyle loans has picked up recently, but declined to provide details.
Dustan Shepherd, a loan officer and 203(k) specialist with BNC National Bank in Overland Park, Kan., says while demand for the rehab loans is up, many borrowers are not aware of the programs or think they are too complicated.
"But it's not as complex as it sounds," Shepherd says.
Unlike credit lines, these renovation loans require borrowers to show the money was spent on the house. In the standard FHA 203(k) program, the borrower hires a consultant to assess the construction plan and to perform an inspection before each draw is made. A "draw" happens when a portion of the money is disbursed to the contractor. Borrowers have up to six months to finish the project and are allowed up to five draws. The HomeStyle program does not require a consultant to monitor the work, only an initial and final inspection.
While rehab loans involve more work than traditional mortgages, they can be a great tool for those who want to buy discounted homes that need repair.
Shepherd says he recently helped a couple who bought a foreclosed house in Kansas City, Mo., for $26,000 and borrowed $136,000 to renovate the property. An appraisal estimated the home would be worth about $135,000 after the work is completed. The couple was able to take out an FHA 203(k) mortgage totaling $144,000, which covered the price of the house, renovations, and loan costs, minus a down payment. "It's a great way to buy low and renovate to the buyer's specific style and taste," says Sandoval.
But how do you know which loan is best? It depends on the situation.
Those who don't have great credit should probably opt for an FHA 203(k). Most HomeStyle lenders require a credit score above 680. To get the best rate on a HomeStyle mortgage, borrowers need to have a minimum 740 credit score, Sandoval says.
"If you have a 740 score and 10% down, a HomeStyle is definitely cheaper," she says. That's because FHA mortgages carry higher mortgage insurance premiums for borrowers who put the least amount down. FHA 203(k) home renovation mortgages have a 1% upfront fee that is rolled into the loan amount.
For borrowers with credit scores lower than 740, it's best to compare estimates, Sandoval says.
FHA does not set a minimum score requirement for 203(k) loans, but many lenders require a score of 640 or greater. There are a few exceptions and some lenders accept scores as low as 600, Shepherd says.
Under the FHA's 203(k) program, borrowers can get a mortgage with a down payment as little as 3.5%. HomeStyle requires a minimum 5% down payment.
The FHA 203(k) program is available only for owner-occupants. The HomeStyle program allows investors.
Another key factor a borrower should consider when deciding whether to go with a 203(k) or a HomeStyle home renovation mortgage is the size of the loan.
The 203(k) rehab mortgage has to comply with FHA loan limits. The limit varies by county but is $271,050 in most places. In high-cost areas, the limit is as a high as $625,500 starting Oct. 1. The upper limit in highest-cost areas is $729,750 through September.
You may be able to borrow more with the 203(k) than with HomeStyle if you are borrowing up to the local loan limit.
With a 203(k) loan, borrowers can get up to 110% of the home's appraised value, compared to 95% with a HomeStyle loan. Both appraisals are based on what the house is expected to be worth after repairs.
FHA's 203(k) rehab loan does not allow borrowers to use the money for luxury items such as adding a swimming pool or a spa, but HomeStyle does.
Borrowers can opt for a streamline FHA 203(k) home rehabilitation loan if they need less than $35,000 and don't have to do any structural repairs or major landscaping work. The streamline 203(k) is similar to a standard 203(k) but is easier to get and involves less paperwork and less bureaucracy, Shepherd says. Streamline loans don't require the borrower to hire a consultant.