Renovation Home Loans: The Dual-Purpose Mortgage

Renovation home loans are like a mortgage and a construction loan rolled into one, with a single closing process. Through these programs, borrowers can obtain financing to cover the cost of the home purchase (or refinance) as well as the cost of renovation or rehab. This makes them well-suited for home buyers who want to buy a fixer-upper. Here are some key points you should know about renovation loans and rehab loans.

Available for Purchase or Refinance

Home renovation loans come in two varieties: purchase and refinance.

  • Home buyers can use them to finance the purchase of a house that needs a little work to make it livable.
  • Homeowners can use them to refinance their current mortgages while obtaining extra funds for a home-improvement project.

In most cases, the loan amount is based on the value of the home after rehab or renovation. For example, let’s say I am buying a fixer-upper foreclosure home for $200,000. After renovation, the property will be worth around $260,000. The bank or lender would base the renovation loan amount on the estimated property value after improvements ($260,000 in this case), minus any down-payment requirements they have.

So I’m receiving funds for both the purchase and the repairs in a single transaction. Renovation home loans are particularly popular among investors and house flippers, for this very reason.

That was a home-buying scenario. Homeowners can also use renovation and rehab loans, in much the same way. In the refinancing scenario, homeowners can replace their existing mortgages while also funding a home-improvement project. They might even secure a lower mortgage rate at the same time, which brings additional money-saving benefits.

Different Types of Rehab And Renovation Loans

Borrowers have several options when it comes to renovation loans. In this article, I’ll focus on the three most popular types of rehab mortgages:

  1. HUD/FHA 203(k) rehab loans
  2. Fannie Mae HomeStyle renovation mortgage
  3. Freddie Mac renovation mortgage

Let’s start by discussing one of the most popular types of rehab loans in use today, the FHA 203(k) program.

1. FHA 203(k) Rehab Loans

The Federal Housing Administration (FHA), a federal agency, insures mortgages made by private-sector lenders. There are several different types of FHA-insured loans. The FHA 203(k) program is basically a government-backed rehab loan. Through this program borrowers can use a single loan, with either a fixed or adjustable interest rate, to finance the purchase and rehabilitation of a house.

According to the Department of Housing and Urban Development (HUD), which manages the program, “the mortgage amount is based on the projected value of the property with the work completed, taking into account labor costs.” In this way, it is similar to other types of rehab and renovation loans.

FHA 203(k) rehab loans are available for purchase and refinance purposes. So they are equally well-suited for buyers who want to purchase a fixer-upper property, and homeowners who want to refinance while also improving their existing homes.

To learn more about the FHA 203(k) program, refer to HUD Handbook 4240.4, “Rehabilitation Home Mortgage Insurance.”

2. Fannie Mae HomeStyle Renovation Mortgage

Fannie Mae and Freddie Mac are the two government-controlled mortgage corporations that buy and sell home loans via the secondary mortgage market. They do not make loans directly to consumers. But they do establish the guidelines and parameters for the conforming loans they are willing to buy. Both organizations purchase rehab / renovation loans from lenders, and they have specific guidelines for how those mortgages are to be generated.

The Fannie Mae product is called the HomeStyle Renovation Mortgage. With this program, borrowers can combine the purchase or refinance of a home with home-improvement financing. Borrowers can receive funding for repairs and/or renovations up to 50% of the completed value of the property. For instance, if the estimated value of the home after repairs is $200,000, the borrower could receive up to $100,000 for the actual renovation work.

The funding provided through a Fannie Mae HomeStyle renovation mortgage can be used for any type of renovation or repairs that are (A) permanently affixed to the property and (B) value adding. Individual buyers and investors are eligible for the program, as are nonprofit organizations and local government agencies.

Additionally, the renovation loan must meet all of Fannie Mae’s general underwriting guidelines for mortgages. Most HomeStyle lenders require a credit score of 660 or higher. Borrowers with credit scores below this mark might want to look into the FHA 203(k) loan instead, since it offers more flexible credit requirements.

As a reminder, Fannie Mae does not offer loans directly to consumers. If you would like to apply for this type of renovation / rehab mortgage, you must find a lender that participates in the program. You can do this with a quick Google search. They are not hard to find, as many lenders offer HomeStyle renovation loans.

To learn more about Fannie Mae’s rehab financing product, refer to the following fact sheet:
https://www.fanniemae.com/content/fact_sheet/homestyle-renovation-factsheet.pdf

3. Freddie Mac Renovation Mortgage

Freddie Mac, the other government-sponsored mortgage giant, also has a renovation home loan product. Their program is aimed at two types of borrowers:

  • Home buyers who wish to purchase and restore, repair, rehabilitate or renovate the home they are planning to buy
  • Homeowners who wish to renovate or make additions to their existing home

So in this way, the Freddie Mac renovation mortgage is similar to other types of rehab loans. It can be used by purchase and refinance-minded borrowers alike.

Guidelines at a glance: The property being financed and renovated must be a “site-built” home. This means the home was built entirely on site without any prefabricated (prefab) sections. Prefabricated homes are not eligible for Freddie Mac’s renovation loan product. The property can be a primary residence, a second home, or an investment property. The loan can be a 15-year or 30-year fixed-rate mortgage, or an adjustable-rate mortgage (ARM), as long as it is eligible for sale to Freddie Mac.

To learn more about this product, refer to Chapter K33 and Section 17.35, of Freddie Mac’s Single-Family Seller/Servicer Guide, or contact a mortgage lender who offers this type of renovation home loan.

Note: This is not meant to be an all-inclusive guide to renovation and rehab mortgages. There may be other products and programs available to consumers that are not listed above. This article is meant to be a jumping-off point for your additional research. This article covers the basic guidelines and requirements for three of the most commonly used renovation home loans: FHA 203(k), Fannie Mae HomeStyle, and Freddie Mac renovation mortgages. We encourage you to learn more about all three of these programs, so you can make an informed decision.