These mortgages pay for home renovations

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Couple reading paperwork in the middle of kitchen renovation

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.

Home renovation loans in demand

"A couple years ago, there wasn't as much demand for these loans," says Leesa Sandoval, a senior loan originator with HomeBridge Financial Services in Dallas, who specializes in renovation mortgages. Demand surged in the aftermath of the housing crisis, when borrowers saw them as a way to buy and renovate distressed properties.

Dustan Shepherd, area manager with Prospect Mortgage in Overland Park, Kansas, says that while demand for rehab loans is up, many borrowers are not aware of the programs, or else they think they are too complicated.

"But it's not as complex as it sounds," Shepherd says.

How it works

Unlike credit lines, these renovation loans require borrowers to show that 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.

Great for foreclosure hunters

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 helped a couple who bought a foreclosed house in Kansas City, Missouri, 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 was 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.

But how do you know which loan is best? It depends on the situation.

203(k) vs. HomeStyle

Those who don't have great credit should probably opt for an FHA 203(k). Most Fannie Mae HomeStyle lenders require a credit score above 660. 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 percent 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 an upfront fee that is rolled into the loan amount.

Less-than-stellar credit

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 percent. HomeStyle requires a minimum 5 percent down payment.

The FHA 203(k) program is available only for owner-occupants. The HomeStyle program allows investors.

How much do you need?

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 high as $625,500.

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 percent of the home's appraised value, compared with 95 percent with a HomeStyle loan. Both appraisals are based on what the house is expected to be worth after repairs.

What do you want to fix?

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.


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