The house has it all — location, price, space and a short commute. The problem is that it’s also a fixer-upper that needs everything — roof, windows and a new furnace. Many prospective buyers walk away, scared off by the complexities of construction financing. But loans that include cash for renovations are catching on among homeowners ready to tackle “as-is” housing.
Rehabilitation loans are designed for homeowners who want to close on a house that needs extensive renovations.
Before rehabilitation loan packages came along, lenders would require buyers to close on a house and apply for additional financing to cover construction. Then, the owner would have to close on the final mortgage when the renovation was completed.
Two closings meant two sets of closing costs. Two loans meant two payments.
Renovation loans take care of both construction costs and cover the mortgage, based on the projected value of the completed property. A $500,000 house could qualify for $250,000 in renovations in one closing — depending on the appraisal, according to area lenders.
“It’s all included in one loan,” and it’s a one-step process, says Powell Jones, a renovation specialist for Wells Fargo, based in Washington.
The company offers a renovation package for home buyers and a refinancing package for existing homeowners. Like a traditional mortgage, homeowners can choose between an adjustable-rate mortgage and a fixed-rate mortgage, he says.
The Department of Housing and Urban Development was the first to roll out renovation financing packages, more than 20 years ago, as a way to restore areas targeted for redevelopment.
The loans combine a mortgage with construction costs to attract first-time home buyers. This kind of financing is used by housing coalitions to boost rehabilitation of targeted areas.
The financing covers system upgrades such as plumbing, electrical and furnace renovations with closing costs rolled into the terms of the package. Last year, 154 homes in Maryland were updated through the state’s rehabilitation loan program, says Eileen Hagan, senior manager of the Maryland Department of Housing and Community Development.
“For many of our borrowers, there is no choice; if you have very limited income, you aren’t going to get a home equity loan,” Ms. Hagan says.
The average loan administered by the state is $26,000, with terms ranging from zero to 6 percent based on income eligibility and other factors, she says.
Government-backed renovation loans are growing in popularity — especially among buyers shopping in older communities, where homes dating to the 1940s and 1950s require extensive renovations.
The loans work like a traditional mortgage, with comparable interest rates and options including fixed-rate and adjustable-rate packages.
But the financing includes a cash reserve set aside to cover construction. Properties covered by the financing include single-family homes, condominiums and dwellings containing up to four housing units.
Construction costs can cover architectural and engineering costs, building permit fees, examination costs and appraisal fees, according to HUD rules.
“You can also finance inspection fees and other soft costs,” says Brad German, a spokesman for the Federal Home Loan Mortgage Corp. (Freddie Mac).
How much cash you can borrow varies by lender.
Most allow up to 30 percent of the value of a home or higher depending on your income, market sales in your area and other factors.
As a precaution, most lenders set funds aside in escrow accounts or in joint accounts requiring a signature by both the lender and buyer before construction funds are released.
Lenders also require inspections to ensure work is completed on schedule, and homeowners have to work closely with the lender to make sure work is completed as scheduled.
One-stop financing allows buyers to avoid added closing costs associated with obtaining either a second mortgage or a construction loan, which can carry higher interest rates than a straight mortgage.
Those loans could cost more depending on the length of the renovations, and consumers should compare prices of other loans to a renovation loan to make sure the financing is a good fit.
A smaller renovation project may be easier and cheaper to finance through a short-term loan — such as a home equity line of credit — rather than a renovation loan.
“A renovation loan is not for everybody,” says Mr. Jones, who leads seminars for Realtors about renovation mortgages. “It varies.”
He says one of the biggest problems his clients face today is finding a contractor because there is so much demand.
For many buyers, however, the attraction of the renovation program is the simplicity of one closing.
“You only have a one-time cost, so you are obviously saving a lot of money in closing costs,” says Gregg Busch of First Savings Mortgage.
First Savings offers a one-time closing rehabilitation loan that provides the amount needed to buy the property and construction funds set aside by the lender for construction.
The separate accounts are designed to protect the lender and require inspections before construction funds are released, he said.
For homeowners who have to stay in their existing house until their new home is complete, Mr. Busch offers a financing package that defers mortgage payments on the property undergoing renovations while construction is under way.
Homeowners who qualify pay only the mortgage on their existing home and interest-only payments on the new house for a period of 12 months, he says.
Then, after they move into the new house, the mortgage is modified to a traditional mortgage so the buyer is not carrying two separate mortgage payments, he says.
“You can stay in your old house while your new house is undergoing renovation, and you won’t have to make two payments,” Mr. Busch says.
Homeowners need to work with licensed contractors to qualify for a rehabilitation mortgage.
Many lenders also will require a separate contingency fund for unexpected problems that crop up during construction.
“The lender is involved during the renovation period. There are inspections that are required as part of the process,” says Jim Matheson, senior product manager for Fannie Mae.
The Fannie Mae program — HomeStyle Renovation Mortgage — was established in 1999 to help buyers finance renovations with a traditional-style mortgage.
The program offers the same rates as traditional mortgages but sets aside cash for renovations in a joint account with the lender and buyers. Qualified buyers can receive up to 50 percent of the value of their mortgage, depending on their income and other criteria.
For a $400,000 home, that means a loan up to $200,000 is possible, depending on the appraiser’s report and the buyer’s qualifications, Mr. Matheson says.
Buyers can choose from fixed-rate mortgages with 15- to 30-year terms or an adjustable rate mortgage. There also is a provision to finance up to six months of mortgage payments if the house is unlivable during construction.
“The program has drawn a lot of interest. There are a lot of cities that have aging neighborhoods where people want to stay put,” Mr. Matheson says. “It’s a good fit.”
Freddie Mac offers a similar program. The Affordable Gold Rehabilitation Mortgage offers one mortgage and one closing. If needed, clients can roll six months of mortgage payments into the financing plan while construction is under way, Mr. German says.
“Our biggest problem is education. People just don’t know the product is available,” Mr. Jones says.