Renovation Purchase: Loan Explained

Today’s real estate market is like none other. Inventory is tight, homes are getting multiple offers, properties often sell above list price, and rents are climbing. How can a would-be home buyer cope with all these challenges? 

It’s tough out there, but not hopeless: rates are still very low and mortgages are attainable for many. One option to consider during this low-rate, low-inventory market is a Renovation Purchase Loan, a.k.a. Renovation Loan.

A Renovation Loan, when used in conjunction with the purchase of a home, can pay for professional updates, repairs, or modernization. With less inventory to choose from, some buyers are switching gears and adding “fixer-upper” homes to their search. This expands their selection of available homes. Prospective homebuyers who might not have been in the market for a big project are now entertaining the possibility. Renovation Loans are different from the typical home purchase/mortgage application scenario, so it helps to familiarize oneself with the product.

How Does a Renovation Purchase Loan Work?

Renovation Purchase Loans are one-time closing products. This means you’ll only have to pay for, schedule, and attend one mortgage closing. The allowable loan amount is based on the appraised future value of the home. A Renovation Loan assumes that work will be completed in a timely manner by a licensed professional. For this reason, your lender will probably require an estimate from a licensed contractor before issuing the final loan approval. The mortgage company will release funds directly to your contractor, as needed and based on acceptable inspection of ongoing work.

What Can a Renovation Purchase Loan Pay For?

A renovation purchase loan can pay for simple improvements like a new roof or bathroom remodel, or it can cover a large project like a room addition.

What Loan Products Are Available?

Fortunately for today’s home buyers, multiple products exist for the financing of repairs and renovations. The FHA 203(k) loan is designed for this purpose, as is the Fanie Mae HomeStyle Conventional loan. Freddie Mac also offers a newer Conventional product called the CHOICERenovation. Veteran borrowers may qualify for VA’s Renovation loan product. Following are some of the features these loans offer:

FHA 203(k) Purchase Loan – The Department of Housing and Urban Development (HUD) will extend FHA mortgage insurance on renovation purchase loans under its 203(k) program. Mortgages obtained through this program must be underwritten to FHA guidelines. The subject property must be at least one year old and the cost of the renovations must meet a minimum threshold of $5,000. Of course, the cost to update, repair, and/or modernize the home could far exceed $5,000. Money for the repairs will be held in an escrow account and released to the approved contractor when appropriate.

HUD does put an upper limit on loan amounts for FHA-backed products. A 203(k) loan is subject to HUD’s current maximum loan amount for the area in which the subject property is located. For more on maximum mortgage limits visit https://www.hud.gov/program_offices/housing/sfh/lender/origination/mortgage_limits.

Fannie Mae HomeStyle Loan and the Freddie Mac CHOICER – The HomeStyle and CHOICER mortgages are similar to the 203(k) loan but instead adhere to Conventional underwriting guidelines. Conventional loans have a higher maximum loan amount than FHA.

VA Renovation Loan – This product is backed by the United States Department of Veterans’ Affaris (VA) and may be an option for eligible veteran-borrowers. VA loans must be underwritten by a VA-approved lender. VA loans are not subject to a maximum loan limit.

What are the Underwriting Guidelines?

Each product follows published underwriting guidelines, which may have been updated since the date of this blog’s publication. However, your lender may or may not offer loan approval even if your application falls within the basic parameters. Underwriters are expected to use discretion when considering character, capacity, credit, and collateral as part of a loan decision. Visit www.ruoff.com for more information and to get pre-approved for a Purchase Refinance Loan. Following are some of the benchmark guidelines for Purchase Renovation Loans:

FHA - In general, FHA guidelines call for a debt-to-income ratio (DTI) of 43% or less and a credit score above 580. Lower credit scores and/or higher DTI’s may be acceptable, but the lender is likely to raise the down payment requirement in these cases. Borrowers without a credit score may be underwritten in accordance with non-traditional credit guidelines.

Conventional – Conventional underwriting guidelines are tighter than FHA. While a DTI of 43% is still acceptable, a credit score of at least 620 is the industry benchmark. For more on Conventional loan requirements, check out the Fannie Mae Eligibility Matrix. The Freddie Mac Seller/Servicer Guide is also a useful guide, but navigating these resources can be time-consuming. For quick answers, get in touch with a Ruoff Loan Expert.

VA – VA lenders usually like to see a lower DTI of 41% or less, but the underwriter does have some discretion here (source: The VA Lender’s Handbook). As with any VA loan, the veteran-borrower must be considered eligible and furnish a Certificate of Eligibility (COE) and present an acceptable credit history.

Work With the Pros

If you’re ready to apply for a Renovation Purchase Loan, contact a Ruoff Loan Expert to start the pre-approval process. Also, find a Realtor ASAP – preferably before you start looking at homes. It is essential to have representation as a home buyer, especially in a fast-moving market.        If you need a referral to a reputable contractor in your area, ask your Realtor to recommend several companies that he or she has worked with in the past.