The residential housing market has seen some banner years recently in terms of sale prices. It’s also coinciding with a period of low inventory in residential real estate.
That low inventory has made buying homes tricky for some. The surge in home prices has made real estate a popular side hustle for others. Both groups often focus on fixer-upper properties.
Yet, in this market, most people still need financing. That means a rehab loan. Not sure what a rehab loan is or how to qualify?
Keep reading for a breakdown of these loans and how you get one.
Why Fixer-Upper Properties?
Many home buyers and those more interested in properties as investments look at fixer-uppers as a good opportunity. Why?
The base cost of a fixer-upper property is often substantially lower than similar homes that need only minor renovations.
Let’s say that a property in a given neighborhood normally sells for around $275,000 to $300,000. Now, let’s say that there is a fixer-upper property for sale in that neighborhood. No one will pay the going rate for it because they know it needs renovations.
Let’s also say that the property needs around $65,000 in renovations. You might make an offer in the $200,000 to $220,000 range. That subtracts the projected renovation costs from the projected sale price and leaves some room for profit.
A fixer-upper is always less attractive to traditional buyers, even if they plan on doing renovations. The house simply looks worse than other properties, which reduces the overall curb appeal.
Beyond that, a fixer-upper may look like it needs more work. That isn’t always the case, but the perception limits interest. Those factors work together to cut down on the competition, which gives buyers a better shot at actually buying the property.
Now, let’s dig into the loan options.
FHA 203k Loan
The FHA 203k loan is meant specifically for those looking to purchase and renovate a home for themselves. It lets you roll the purchase cost of the property and renovation costs into the same loan.
It does come with caveats. For a standard FHA 203k, you must typically get the services of a HUD consultant. You’ll also need an FHA-approved bank or lender.
You can’t carry out the renovations yourself. You must use a licensed contractor for the work. Most states license general contractors and, where they don’t, cities typically issue licenses.
Your renovations may also prove subject to approval by an FHA-approved appraiser.
This type of rehab mortgage covers a lot of ground. Assuming you go with the standard loan, some of the qualified renovations include:
- Energy efficiency upgrades
- Cosmetic improvements to the exterior
This is a partial list but provides a sense of the possibilities.
The FHA 203k loan is also aimed at those with less than stellar credit. Some of the basic requirements include:
- 500 or better credit score
- Down payment, varies by credit score
- Loan amount under the cap
- No foreclosures within three years
- An acceptable debt-to-income ratio
Those with credit scores beneath 580 must typically make a down payment of 10 percent. If your credit score is 580 or higher, the lender will typically reduce the down payment to 3.5 percent.
You have two debt-to-income ratios: front end and back end. Your front-end debt-to-income ratio is how much you’ll spend on housing relative to your income. Your back-end debt-to-income ratio is how much you spend on bills overall relative to your income.
You need a front-end debt-to-income ratio of around 31 percent or less. You need a back-end debt-to-income ratio of about 43 percent or less.
Hard Money Loans
For those interested in buying homes with intention of fixing and flipping it, loan options are comparatively scarce.
Most traditional lenders don’t like giving them, seeing the fix-and-flip approach as inherently risky. If the bottom drops out of a market before you sell, the lender is stuck with a property they may struggle to sell. Traditional mortgages also come with lower interest rates because lenders expect to collect interest for 15 to 30 years.
Hard Money Terms
This is where hard money loans enter the picture. Hard money lenders provide financing for fix-and-flip projects but under very different loan terms.
As a general rule, hard money rehab loans are very short-term loans that run from around 6 months to around 18 months. Although, you can find ones that last as much as a few years.
They also come with much higher interest rates. They typically top out at around 15 percent, which is as much as five times the interest rate of traditional loans.
Hard Money Qualifications
Hard money lenders are far less concerned with things like your credit score or your debt-to-income ratio. They’re primarily concerned with the value of the property because the property is your collateral. If you don’t pay the loan back, they get the property.
There typically aren’t fixed caps on the amount of this kind of fixer upper loan. The estimated market value of the home after renovations will determine how much most lenders will give you.
Most hard money loans also come with tough down payment terms. The exact amount will depend on the lender, but you should expect anywhere from 10 percent up to 25 percent of the cost of the property.
Some lenders won’t work with you unless you successfully flipped properties in the past. You can learn more about these kinds of fix and flip loans here.
A Rehab Loan and You
A rehab loan can prove a viable way for you to purchase a home for your own use or even get into real estate as a side hustle.
For those interested in buying their own home, the FHA 203k is your best option. The qualifications allow most people to meet the requirements. The upper limits are adequate for a home purchase in most locations.
For those interested in getting into the fix-and-flip game, you’ll likely need a hard money loan.
Looking for more tips on buying a home? Check out the posts in our Real Estate section.