How can I get a House Renovation loan?
The first step if you want to renovate your new house is to engage a contractor to draw up plans and specifications for the work that will be done. The lender wants to see every detail of where the money is going. Based on these plans, they will add a 10 or 15 percent contingency for cost overruns, and lend based on this final number. The work does not start until the loan closes. Then the money for the repairs is put into an escrow fund and disbursed as the work is completed. For simpler projects, there are only two disbursements. For larger renovation projects there may be many draws on the escrow fund. A typical time frame for completing the work is six months. Sometimes the lender will give you a year to complete the project.
A rehab loan finances the costs to renovate your home along with the purchase price. It bases the appraisal on the plans for repairs. Your down payment is calculated off the total costs of both purchase and repair. The FHA 203k rehab program only requires a 3.5 percent down payment. Conventional rehab loans can technically be done with as little as 5 percent down. But realistically you should expect to need a 20 percent down payment for conventional rehab financing. This is because of the difficulty in obtaining private mortgage insurance for these loans. For this reason, many banks simply do not offer conventional rehab loans at higher than 80 percent of the final cost. If you buy a home for $150,000 with plans for an additional $50,000 in repairs, the down payment required for a conventional rehab loan would be $40,000. For FHA, it would be $7,000. The maximum loan amount would be the same as the FHA or conventional loan limit for the county the property is in.
On FHA loans, including the 203k rehab loan, mortgage insurance is built into the loan. There is not a separate mortgage insurance approval process the way there is with conventional loans. Mortgage insurance adds a significant upfront and ongoing monthly cost to the FHA loan compared to conventional, yet because of the reduced down payment requirement, the 203k is by far the most common kind of rehab loan. A significant renovation project should increase the value of a house by more than the amount spent on the work. For this reason, many people will refinance a year after getting a 203k loan. One year of seasoning is required before the current value can be used for a new loan. If the house now has 20 percent equity, a conventional loan can be used which will not require mortgage insurance. FHA 203k and conventional rehab loans can also be used for a refinance renovation on a home you already own, if you want to add an addition or make major repairs to your home. The same equity requirements would apply as on the down payment for a purchase loan.
If you are buying a home with a rehab loan, you should expect the process to take longer than for a regular purchase loan. Sixty days would be a standard time frame from contract to closing, while 90 days would not be unusual, depending on the scope of the project. The underwriter will need to document the loan file in detail. The contractor needs to be vetted with references and sometimes even a credit report. Going into a rehab transaction, whether FHA or conventional, it is helpful for the buyer, realtor, contractor and even seller to understand that they need to have a high level of involvement throughout the loan approval process.
A lender requires a high level of expertise to underwrite and fund FHA 203k loans and conventional rehab loans. Not all lenders are approved for these kinds of loans. Check HUD.gov for FHA-approved rehab lenders in your area.