203k & Homestyle Loans; Roll Renovation Costs into your Mortgage!
Updated: Aug 22, 2022
If you would like to purchase a fixer-upper to renovate and live in and enjoy the fruits of your labor, these rehab loans might be for you! Though it is a strenuous process with many hurdles, it is also the SMARTEST way to acquire a newly renovated home and fund the renovations! Where there's a will, there's a way.
How it works:
The 203k and Homestyle Rehab Loans cover both purchasing the property and the renovations all in one mortgage. Here's a basic overview of the steps one would take to utilize this loan:
Find a lender who does rehab loans, and get prequalified
Find a fixer-upper and make an offer
Get quotes for the renovation from licensed contractors
Select the licensed contractor(s) you'd like to work with and finalize your project list
Coordinate with appraiser to gather current appraisal and After Renovation home Value (ARV) appraisal per your project list
Lots of additional paperwork
Close on the home and begin renovations, your lender will pay the contractors as work is completed
Enjoy your beautifully renovated home!
The 3 most common rehab loans to utilize:
The most common loans utilized to purchase a home are FHA and Conventional. FHA only requires 3.5% as a downpayment, and you don't necessarily have to have excellent credit. Conventional requires great credit and typically more money down. Under the umbrella of these two most common loans, there are rehab loans available!
FHA 203k Limited (or Mini) Loan - Minor home renovations; your basic cosmetic updates and necessary repairs, except NO structural changes. No moving or taking down walls nor repairing structural issues. It has the least amount of paperwork thus making it easier to close. This loan requires a minimum of 5k and a max of 35k in renovations.
FHA 203k Loan - Major home renovations; just about anything and CAN include structural changes. More paperwork and more work to do within your escrow period. 5k minimum and a max of lesser of purchase price + rehab costs, or 110% of the after-repair home value.
(Conventional) Homestyle Loan - Major renovations and may include luxury updates such as a pool, outdoor kitchen, etc. Allows for a significantly higher renovation budget, but the total loan amount will have to cap out at $650,000 (this amount may vary per area). It also requires a higher credit score to qualify and, as previously mentioned about conventional loans, will require more cash for the downpayment.
This is the most affordable way to enjoy a fully renovated home. Say the purchase price is 400k, you put 15k as a downpayment, and renovations are 50k, which leaves you with a 435k mortgage (400k - 15k + 50k = 435k). The appraiser says your ARV is 550k. Wouldn't you much rather purchase a home for 450k than 550k? Yes!
This is the cheapest way to fund home renovations. For every 10k in a home's purchase price, your monthly payment will increase by $50. If your renovations are 40k, your mortgage payment only went up $200/month just to have a fully renovated home. That's pretty cheap! And assuming you live in the home for 5 years, that's only an extra $12,000 in payments. (My fully gutted and renovated kitchen renovation ALONE was more than that, and we had to have that money in CASH!)
After renovations are complete, you've now raised your home value a TON; you can expect your equity to increase a minimum of 3x the cost of renovations! If you wanted to turn around and sell the property, you could turn a quick profit (make sure you wait till the 2-year mark, though, to avoid capital gains tax!). If you'd like to keep the property and still utilize the equity, you can get a HELOC or do a Cashout Refinance.
This loan keeps you (and the lender) totally protected from contractor scams. It is common for contractors to ask for money upfront before beginning a project to cover purchasing materials, cover labor, etc. Which can be scary because they could potentially run off with your money and you'll never see them again (it happens!). But, with the 203k/homestead loan, the lender pays the contractor directly upon work completion.
You get to fully customize your home the way YOU like it! You pick the materials, paint color, flooring, hardware, everything! All you, baby! Or, if you aren't a designer by nature, I will gladly help you out there ;)
A long closing period (60-day closing MINIMUM). There are so many extra steps in the closing process that make this escrow period extra busy. Finding the right contractor with the right quote, coordinating those renovation plans with the lender and inspector... what if the inspector comes back with things that should be fixed and now you have to coordinate that with the contractor and inform the lender of the new quote. It's an extensive amount of work for everyone involved.
Sellers aren't always excited to accept an offer with a 203k/homestyle loan. They know it will be a lot of work and very time-consuming. Hopefully, it's a buyer's market and your seller is desperate and/or not in a huge rush! Luckily, outdated homes sit longer on the market, leading sellers to get a little desperate, and ideally more willing to accept your offer with a rehab loan.
After you close on the home, you can then begin renovations (which do have to be finished within a designated time frame). You will either have to coordinate another place to live during the renovations or deal with living in a home that's under construction.
It's very likely the renovations could take longer than anticipated. Construction timelines are more like goals. Goals that can be achieved if absolutely no hiccups or unforeseen obstacles are presented.
Your interest rate on a rehab loan could possibly be 0.5% to 1% higher than a typical FHA loan. Having great credit will help.
This loan is only eligible for a primary residence.
No DIY work is allowed - all renovations must be performed by a licensed contractor.
Renovations must be attached to the real property, so BBQ pits, exterior hot tubs, swimming pools, tennis courts, etc. would not be permitted under rehab loans (may be permitted with Homestyle loan).
You must be prequalified for the ARV amount. Say the home is currently valued at 400k and after your planned renovations conclude the new value would be at 550k; you'd have to be prequalified for a 550k home even though your loan is for 435k (after downpayment subtracted and renovations added). This shouldn't be too much of an issue considering you're typically prequalified for much more than one feels they can actually afford.
Every party involved must be prepared with experience, knowledge, and willingness in order to have a smooth transaction and renovation process. Make sure you find a realtor who has experience/knowledge of this loan. You also want to find a mortgage broker who has done many of these loans and is still willing to offer them. Your licensed contractors must also be willing to work with your lender via the loan, as their payment structure will be different.
This loan might be for you if...
...You have a flexible move-in date, you're not in an urgent rush to get in a new liveable home, you're wanting to make a smart investment and enjoy a renovated home, you may not have the cash to fund renovations or want to utilize this tool to leverage your money wisely, and have the initiative to manage the renovations and keep them moving along in a timely manner.
If you're willing to put in the work, this is the SMARTEST way to cover renovation costs and purchase an affordable newly renovated home. I'm obsessed with these rehab loans and wish I had utilized them earlier in our real estate investments! Please reach out if you need a realtor, mortgage broker, or interior designer to help you with your rehab loans - The Do-over-neck Team LIVES for this stuff!