Part 4 – Rationale:
If you’re looking to buy a home at a price you can afford in a desirable neighborhood, you may have to consider homes that aren’t in perfect shape, or even ones that require a complete overhaul. The good news is that some mortgage companies may allow you to wrap the costs of a remodeling project into the loan. This could be true when you use this type of mortgage to purchase a property, or when you decide to remodel a home you already own and refinance to access funds for your project. However, there are Pros and Cons going into each types of renovation loans. Here are a few of them…
Pros and cons of an FHA 203(k) loan
FHA 203(k) rehab loans come with both advantages and disadvantages. Some reasons to consider these loans are listed below, along with some of the pitfalls that make them a less attractive option.
Pros of FHA 203(k) loans
- FHA loans have low credit-score requirements: You can qualify for an FHA 203(k) loan with a credit score as low as 500. It’s a much lower minimum standard credit score than many other types of home loans.
- Wrap your remodeling costs into your home loan: The biggest benefit of FHA 203(k) rehab loans is that you don’t have to pay for remodeling costs out of pocket. You can wrap the costs of your project into your primary home loan instead.
- Interest rates are typically lower than some other mortgage options: FHA loans also come with low closing costs, and FHA interest rates may be lower than some other types of home loans.
Cons of FHA 203(k) loans
- Standard 203(k) loans require you to work with a loan consultant. Not only can working with a 203(k) loan consultant cost up to $1,000 in fees for the service, but this layer of work adds yet another step to the process. Remember that your 203(k) loan consultant will have to complete an inspection of the home, sign off on all improvements and their costs and address any health and safety issues.
- Government-backed loans tend to come with a lot of rules. Government-backed FHA loans have many rules, and FHA 203(k) loans are no exception. For example, you cannot use this type of loan for “luxury items” including hot tubs, outdoor fireplaces or swimming pools.
Pros and cons of an HomeStyle Renovation Mortgage Pros
HomeStyle Renovation Mortgage Pros
The HomeStyle Renovation Program enables you to finance the purchase of a home or refinance plus the cost of major home renovations with one mortgage as opposed to arranging a mortgage plus a second construction or home equity loan to finance the renovations. The HomeStyle Renovation Program offers borrowers a simple and more cost-effective solution to finance the purchase or refinance of a property plus major renovations, repairs or remodeling.
Low Down Payment or Equity Position Required
For the purchase of a single unit property with a fixed rate mortgage, the HomeStyle Renovation Program only requires that borrowers make a down payment of 5% of the property purchase price or the case of a refinance, borrowers are only required to have 5.0% equity in the property, which implies a loan-to-value (LTV) ratio of 95.0%. The required down payment or equity position of 5% is lower than the 10% – 20% required by other standard mortgage or construction loan programs, although it is higher than the 3.5% down payment required by the FHA 203(k) Home Improvement Loan Program.
Applies to Investment Properties
The HomeStyle Renovation Program applies to both owner-occupied and non-owner occupied properties, unlike the FHA 203(k) Program which only applies to owner-occupied properties. Borrowers can use the HomeStyle Program to purchase rental or investment properties that require significant repairs or rehabilitation. Please note that only single unit investment properties are eligible for the program and borrowers are required to make a much higher down payment on investment properties. Borrowers, however, can use the HomeStyle Program to purchase multi-family properties with up to four units as long as they occupy one of the units.
Financing Based on Post-Renovation Property Value
The HomeStyle Renovation Program, allows you to qualify for a mortgage based on the post-renovation property value. For the purpose of qualifying for the HomeStyle Program, the property value is defined as the property purchase price plus the estimated cost of the renovations or the appraised as-completed property value, which is less. Using the higher post-renovation property value enables borrowers to qualify for a larger mortgage and also eliminates the need to arrange a separate construction or home equity loan.
No Restrictions on Mortgage Type or Loan Program
While the HomeStyle Renovation Program is typically used to buy homes that require significant renovations borrowers can also use the program to refinance their existing mortgage and finance a major home improvement project at the same time. Borrowers with high mortgage balances and limited equity in their homes may find it challenging to qualify for a construction loan, HELOC or home equity loan to finance a home improvement project. Borrowers, however, can use a HomeStyle Renovation Mortgage to both refinance their existing mortgage and finance their home renovation. Additionally, borrowers can use either a fixed rate mortgage or an adjustable rate mortgage (ARM) with the HomeStyle Renovation Program. Although the down payment or equity position required for an ARM is higher than for a fixed rate mortgage, the ability to use multiple loan programs increases your financing flexibility.
No FHA Mortgage Insurance Premium
Unlike the FHA 203(k) Program, the HomeStyle Renovation Program does not require borrowers to pay an upfront mortgage insurance fee. Additionally, borrowers that make a down payment of at least 20% are not required to pay ongoing monthly private mortgage insurance (PMI). Borrowers that make a down payment of less than 20%, however, are required to pay PMI, which is an extra monthly cost on top of your mortgage payment. Depending on your credit score, LTV ratio and mortgage program, monthly PMI may be less than monthly FHA mortgage insurance premium (MIP). Additionally, PMI is removed when your LTV ratio falls below 78% whereas borrowers are required to pay FHA MIP over the entirety of their mortgage.
HomeStyle Renovation Mortgage Cons
Higher Interest Rate
The interest rate for a HomeStyle Renovation loan is usually .125% – .375% higher than the interest rate on an FHA 203(k) loan or other conventional mortgage program. Additionally, borrowers with lower credit scores and higher debt-to-income ratios usually pay higher interest rates with the program. The HomeStyle Loan Program is offered by traditional lenders such as banks, mortgage brokers, mortgage banks and credit unions so borrowers should compare proposals from multiple lenders to find the mortgage with the lowest rate and fees.
Higher Closing Costs and Longer Closing Timeline
The HomeStyle Program requires borrowers to submit to the lender plans and specifications for the home renovation project. Preparing these plans can be costly and time-consuming. Additionally, due to the additional work required to review and process a HomeStyle mortgage, most lenders charge an extra fee which increases your closing costs. Some appraisers may also charge higher fees because they are required to appraise the property both before and after the home renovation project is completed. Additionally, because of the complexity involved, it can take more than three months to process and close a HomeStyle loan as compare to one-to-two months for a regular mortgage. Borrowers should understand the extra cost and time associated with a HomeStyle Mortgage before selecting a lender.
Mortgage and Renovation Budget Limits
The HomeStyle Renovation program limits the size of loan you can obtain through the program. The HomeStyle Program uses the conforming loan limit, which ranges from $484,350 to $726,525 in the contiguous United States for a single unit property. Additionally, please note that the value of the renovations can total up to 50% of the as-completed appraised value of the property.
No Sweat Equity
Unlike the FHA 203(k) Loan Program, the HomeStyle Renovation Program does not permit home owners to be reimbursed for the labor or sweat equity they contribute to a renovation project from the loan proceeds. Home owners can be reimbursed for any supplies or materials they purchase for the project but they cannot receive any cash proceeds from the loan.
In my next blog, I will go into details on the most important player in the home renovation process.