If you are looking to purchase a home, chances are you may have come across the term “rehab loan”. It sounds strange, we know. Who would be looking to buy a home that needs to be rehabilitated?
Well, depending on the circumstance, a lot of people. Some enjoy renovating old homes, others may feel the need to make a property feel more like their own. In many cases, buyers come across a house that’s almost perfect – great location, right price point. But, the property may need some serious repairs in order to be livable. A rehab loan could be the perfect solution in all of these scenarios.
But what exactly is a rehab loan and how does it work? Allow us to explain.
A rehab loan essentially allows you to borrow money from a lender in order to purchase and renovate a home under the same loan. In many cases, a rehab loan will increase your chances of lender approval for the purchase of a property that requires repair.
Under normal circumstances, lenders would see property that needs major renovation as a bad investment and are usually unwilling to approve loans on a house with extensive issues. However, if you borrow enough money to purchase the home and make repairs, approving your loan seems more appealing. The lender will have assurance that you will be able to turn the property into a livable home and they will no longer need to sit on a problematic property.
Lenders like rehab loans because they provide an opportunity to add value the market. Chances are, with renovations, the property will be easier to sell in the following years. Also, rehab loans can be used as a negotiating tool to save deals that are dependent on repair contingencies.
For borrowers, rehab loans are an inexpensive way to fund repairs or improve a home. In most cases, bundling renovations with the home purchase loans means you could be paying lower closing costs and walk away with a lower than average interest rate. While different types of rehab loans are available, a common one you’ll hear about is the FHA 203K Loan.
A major benefit of the FHA 203K is that it’s backed by the Federal Home Association. A guarantee from the FHA means the loan is less risky for lenders, so you will be more likely to be approved and usually with a smaller interest rate than other rehab loans. However, you should still explore your options to find the best rehab loan for your situation.
Any individual home buyer or non-profit organization is eligible for almost any rehab loan, but investors are not always covered. If your goal is to renovate an investment property, you may need to do some shopping around to find a loan that better fits your needs.
For example, an alternative rehab loan for investors would be the Fannie Mae HomeStyle Renovation Mortgage. Although it’s similar to the 203K in terms of benefits, one major difference is that the HomeStyle loan qualifies investment properties as well, in case you were looking to renovate a rental property or vacation home.
To qualify for a rehab loan, the borrower needs to meet the credit requirements, which varies from lender to lender. Another benefit of the 203K is that the FHA protects lenders in case you default, so you don’t need perfect credit to qualify.
You do, however, need sufficient income and debt ratio, no matter which loan you apply for. With most rehab loans, borrowers will need to provide a down payment of at least 3.5 percent of the entire loan amount.
You also need to ensure that the home you’re trying to purchase is eligible for a rehab loan. For example, the 203K only qualifies a one to four-person family home in one of the following conditions:
- Completed for at least a year
- Torn down but still has foundation
- Can potentially be relocated to another space
When applying for a rehab loan, it’s important to understand exactly what repairs are included. Most renovation loans cover common repairs you would see in problematic property, from roof replacement to flooring to HVAC installations.
Your loan can even cover some of the more enjoyable repairs, like room additions, decks or patios, and bathroom or kitchen remodels. However, rehab loans do not cover luxury items, like swimming pools.
If you enjoy renovating property, just be aware that using a rehab loan could put a few kinks in your plans. Most rehab loans don’t permit the borrowers to work on their homes themselves, so don’t get your hopes up on too many DIY projects.
Instead, focus on hiring qualified, licensed contractors that have experience working within the constraints of rehab loans. This will make your payment process and paperwork much less of a headache.
Rehab loans require that all home projects be completed within a set amount of time – usually six months. That may sound like ample time to complete everything you need, but the months fly by quickly and you also have to account for waiting periods.
For example, the 203K loan process is built on paperwork and everyone is involved. You, your contractor and the FHA will need to complete multiple forms throughout each stage of the renovations, which is time consuming within itself. You will have to factor in the wait time for others to complete their paperwork, and in many cases, for the FHA to approve your renovations.
Rule following is another major factor in rehab loans, particularly for the 203K. You won’t experience the same flexibility you would have if the renovations were coming out of your own pocket, and the FHA may want to address certain issues first.
The FHA’s primary focus is resolving health and safety issues and making sure the property meets all building codes. As the buyer, these should be your concerns as well, but you may want to handle them at a different pace. If you are buyer that’s hoping to flip homes quickly and with your own personal touch, you may want to explore other rehab loan options outside the FHA 203K.
While the process may sound a bit like a headache, it’s not all bad. Most rehab loans hope to take care of the buyers as well, so usually it will cover temporary housing while your new home is being renovated. In most cases, six months’ worth of rent or mortgage payments are included so you and your family won’t have to worry about living in a construction site while the house is being completed.
If you want to purchase a home that needs a little TLC, it can be overwhelming to explore the rehab loan options. That’s why it’s important to find a trusted mortgage company that can advise you on programs that best fit your situation. The Tim Bullock Team of Union Home Mortgage can help you find and secure a rehab loan that will help you and your family build the home you deserve. If you’re ready to take the next step, contact us today to set up a consultation.