A rehab loan is primarily used in the rehabilitation to fix, renovate or upgrade a home. In most cases, this loan can be used to purchase the property as well as fund the improvements on the property. This particular type of loan allows a homebuyer to be approved for more than the current value of the home.
Rehab loans are available through traditional lenders. These include construction loans as well as construction-to-permanent financing programs. One example of a conventional mortgage for renovations is a Fannie Mae HomeStyle loan. While Fannie Mae does not finance or issue this loan, the government will guarantee this rehab mortgage.
However, most rehab loans are insured by a government agency, such as the Federal Housing Administration or FHA. Government-issued rehab loans are known as FHA 203(k) loans, which are obtained through the Housing and Urban Development or HUD 203(k) loan program.
FHA 203(k) loans usually require a 3.5 percent down payment or a 3.5 percent equity after improvements. On the other hand, Fannie Mae HomeStyle loans require a minimum down payment of 5 percent.
FHA 203k loans are generally repaid over 30 years. Fannie Mae HomeStyle Renovation loans can be 15 or 30 years.
It is easier to be approved for an FHA 203(k) than a Fannie Mae HomeStyle loan. In general, this loan requires a FICO score of 620. Homebuyers with a score lower than 620 must meet additional requirements. Additionally, this loan can only be used on your primary residence and do not cover “luxury” upgrades.
Fannie Mae HomeStyle loans have a stricter underwriting process because it is a conventional loan. They do not accept lower credit scores than 640 or extremely high debt ratios. Fortunately, these loans are not limited to your primary residence.
FHA 203(k) requires a flat percentage every month for mortgage insurance, typically for the life of the loan.
Because Fannie Mae is a conventional loan, private mortgage insurance or PMI is contingent on your down payment, credit score, and loan-to-value or LTV ratio. In general, the lower your LTV, the lower your PMI.
FHA 203(k) loans have a minimum of $5,000 and a maximum total property value subject to FHA mortgage limit requirements. The FHA’s maximum loan-to-value or LTV ratio is 97.75%.
Fannie Mae HomeStyle loans include a 75 to 97 percent LTV ratio. What lenders will approve are contingent on the property type and the borrower’s creditworthiness.
Rehab loans are beneficial for simplifying the application process. These loans allow you to combine the renovation or construction loan with a mortgage, saving you time and closing costs.
Rehab or renovation loans also allow you to borrow more based on the anticipated value of the upgraded home. Additionally, fixing up a house can yield a higher return on your investment in the future.
Another attractive advantage of a rehab loan is the ability to customize your new home, such as paint colors, flooring, cabinetry, and countertops, to suit your personal style.
A rehab loan comes with risks. You are anticipating that the improvements will increase and justifying the cost of the home’s purchase and renovation.
With rehab loans, more preparation and paperwork is required before loan approval. For example, you will need to select an approved lender as well as an approved contractor. Furthermore, the approval process takes longer than a conventional mortgage.
Since this home will require extensive renovations, it is not ideal for people who want a move-in ready home. If the homeowner cannot live on site, he will need to find and pay for another residence until the construction is complete.