Rehabilitation Loans: The Under-Utilized Alternative to Home Buying
Tips to be a successful Home Buyer in a Sellers's Market
Amid the current sellers’ market where the number of properties for sale is too low to satisfy the existing home demand, competition is still raging despite the recent hike in the interest rates. Nowadays, the main concern of every home buyer is: How do I beat the competition and get my offer accepted before the Federal Reserve raises the interest rates again?
The answer given to that question is oftentimes the same: be persistent, and smart. While you have to be persistent to succeed, lots of buyers do not seem to be aware that using a rehabilitation loan to purchase a home can be a smart move in the current real estate market.
Let’s say, you want to buy a 3 bed/ 2 bath, move-in ready, or at least livable immediately because you cannot afford to pay the rent and pay the mortgage at the same time. Your realtor has written several offers but was outbid every time.
At that point, you only have 2 alternatives left: Looking for a smaller place in your areas of interest or searching for a house of the same size in less expensive areas.
But what about, buying the “almost perfect” home in the right location that is selling at a reduced price because it needs work? if you are up to the challenge of living in a house that needs to be upgraded and/or rehabilitated as long as it is located in an area you like, a rehabilitation loan is an option you might want to consider.
Below is a synopsis including the different categories of rehabilitation loans and what are the plus and minus of these loans to help you make an informed decision.
1). What is a rehabilitation loan?
To put it simply, rehabilitation mortgages let you fund both the renovation and the purchase of a home for sale using a single loan. In other words, it allows you to combine renovation costs with your mortgage and, pay both off in the form of one monthly payment.
Typically only interest is paid during the rehabilitation/ renovation period. The funds are advanced incrementally during the construction process. Once the certificate of occupancy is issued, the outstanding balance of the loan will amortize over the remaining term of the loan.
There are 2 major categories of rehabilitation loans: Government-backed rehabilitation loans and conventional rehabilitation mortgages.
2). Government backed rehabilitation loans
The government-backed rehabilitation loans are known under the denomination of FHA 203k loans and allow a borrower to buy a home and fix it up, all with one affordable mortgage and with only a 3.5% down payment. These loans are backed by the Federal Housing Administration (FHA), and follow the general FHA guidelines for upfront fees and monthly insurance.
That said, be aware, that the FHA 203k rehabilitation loan has two sub-types designed for renovation type, location, and work scope:
The limited 203(k) is usually used for non-structural repairs, such as flooring, appliances, plumbing, and electrical work, as well as kitchen and bathroom renovations. Depending on your location, total costs are capped at a specific amount. This is the type of loan you want to enquire about as a home buyer.
The standard 203(k) is usually used toward foundation damage caused by flooding, hurricanes, and other natural disasters, this loan boasts higher limits due to more costly and time-consuming repairs. This loan usually does not apply to home buyers.
3). Conventional rehabilitation mortgages
If the size of your project is larger than the limited 203(k) if FHA loan limits or you need more flexibility with rates or terms, many lenders offer what is called conventional rehabilitation mortgages.
3-1). The HomeStyle Renovation Mortgage: offered by the Federal National Mortgage Association, also known as Fannie Mae, this loan is offered as both a fixed or adjustable-rate mortgage. According to the HomeStyle Renovation Mortgages Loan and Borrower Eligibility requirements: Borrowers purchasing a home cannot incur rehab costs more than “75% of the lesser of the sum of the purchase price of the property plus renovation costs, or the ‘as-completed’ appraised value of the property.”
3-2). Another option is the CHOICE Renovation loan, through Freddie Mac. Suitable for single-family and multi-unit dwellings, the CHOICE Renovation loans can also be applied toward second homes or investment properties. As the Fannie Mae HomeStyle, this fixed- or ARM loan is available at a 15 or 30-year term and has a lower down payment, debt-to-income ratio, and credit requirements.
4). The plus of using a rehabilitation loan to buy a property
Your return on investment (ROI), is usually higher once the upgrades and repairs are completed allowing you to build equity faster than when you purchase a move-in-ready home;
A renovation loan will allow you to borrow more money as the amount of the loan is based on the expected value of the upgraded home;
You can customize your home the way you want ( layout, paint colors, flooring, cabinetry, countertops);
Since you are taking out only one first mortgage for the home and the renovation, your interest rate is usually going to be lower and you might have a longer period of time to repay your loan.
Since you are taking out only one first mortgage, the interest, including the cost for renovation, will be tax-deductible;
You will be in a better position to beat other offers when you will submit your offer as the “professional rehabbers” are usually looking for at least an immediate 10% ROI. As a result, they usually come to the negotiation table with lower offers.
5). The minus of using a rehabilitation loan to buy a property
Only certain upgrades are covered and all the repairs and improvements must be outlined and itemized before approval.
More preparation is usually required. You'll need to be able to prove to the bank or mortgage lender that the home, when completed, will have a high enough value to justify the cost.
It might take longer to qualify for the loan: Since there are more people involved in the approval and since you need to have a contractor, the approval process sometimes takes longer than for a traditional mortgage.
When it comes to choosing the best rehabilitation loan, it’s important to work with a loan officer who knows how to handle this type of loan. Also, bear in mind that in the end, only your loan officer can tell you if a rehabilitation loan is right for you.
I hope this helps. Should you have any questions, feel free to contact me.