Thanks to television home makeover shows, buying a fixer-upper is becoming increasingly popular with folks who want to find a less expensive home in a pricey neighborhood or customize a home to fit their personal aesthetics.
What’s more, buying a fixer-upper is a good way to build equity, said Nathaniel Butler, marketing manager for Washington Capital Partners, a Falls Church, Va. lender that specializes in fixer-upper loans. After repairs are completed on a fixer-upper, the home is typically significantly more valuable than it was at purchase time.
“The buyer can either choose to cash in on this profit margin right away as a ‘flipper,’ or hold on to the property and let the equity continue to grow as the market value increases,” Butler said. “If they time it right, they can make a lot of money from smart purchasing and cost-effective repairs.”
So how can you get started on the path to purchasing a fixer-upper?
What loans are available?
If you’re thinking of buying a fixer-upper, you could contact your regular lender to ask what sorts of loans they might have available to help you fund the project. But fixer-upper loans, sometimes called “fix and flip loans,” are another option that Butler said are often helpful when you’re buying this type of property. Provided by private lenders, rather than banks, these types of loans are sometimes called hard money loans because the lender approves the loan based on the “hard asset,” i.e., the real estate that’s being purchased.
“They’re more flexible than banks on the condition of the home that you purchase, and they will often work with buyers with poor credit that have been turned away by a bank,” Butler explained. “While the interest rates on these loans tend to be higher than a bank, they are willing to lend on properties with much worse conditions and much higher profit/equity margins for the buyer.”
If you don’t qualify for a hard money loan or are interested in going another route, there are also several government-backed loans that are designed for fixer-upper buyers:
- VA home improvement loan. If you’re a veteran or active duty service member or even a surviving spouse of a someone who served in the U.S. military, and you have decent credit (preferably a credit score of 620 or higher), you might qualify for a VA home improvement loan.Guaranteed by the United States Veterans Administration (VA), these loans are typically offered by private lenders and banks, which confirm eligibility with the U.S. government. The loans cover the cost of purchase as well as the cost of renovations. Payments are disbursed to a VA-approved builder to improve the property.The advantages of a VA loan? Eligible buyers have little or no down payment requirements and there are limits on closing costs. To find out if this loan might work for you, check out the VA loan eligibility guidelines.
- FHA 203(K). This program, run by the U.S. Department of Housing and Urban Development (HUD), allows buyers to borrow the money needed to fund repairs and improvements to a home as part of their mortgage, rather than requiring an additional repair loan on top of that used to purchase the property.Processed by FHA-approved lenders, a portion of the FHA 203(K) loan is used to pay the seller, while the rest goes into an escrow account to be paid out to the contractor making repairs. Buyers are subject to some limitations — such as minimum repair costs and types of repairs — but there are benefits, too. FHA 203(K) borrowers — especially those with lower incomes — might be able to provide lower down payments upfront than they would with a conventional loan, and fees are limited as well. To find out if you’re eligible, contact an HUD housing counselor.
- Fannie Mae HomeStyle. The Federal National Mortgage Association (nicknamed Fannie Mae) offers up its own renovation loan to fixer-uppers. The Fannie Mae HomeStyle Renovation Loan is open to buyers and owners of existing properties, and it allows for renovations to be made to a property, whether they enhance the value or not. Built like a conventional mortgage, this special loan allows borrowers to fund up to 75% of the as-completed appraised value of the property. Funds can be made available even before construction starts.Some borrowers may qualify for low down payments and cancellable mortgage insurance. Another bonus? You won’t need to get your contractor pre-approved by Fannie Mae. While your lender will likely want pre-approval, contractors are only required to be licensed where state law applies.
Conventional loans vs. fixer-upper loans
Why can’t you just go to your local bank and ask for a conventional loan? Well, technically you can, but it might not be in your best interest to pursue that route, Butler said.
Cons of conventional loans:
- It could be harder to find a lender. Because of the state of the fixer-upper you’re eyeing, you may not be able to find a conventional lender who will offer you a loan. “Banks tend to focus on low-risk, long-term loans like a 15- or 30-year mortgage on a livable property,” Butler explained. “[Fixer-upper] properties are typically in such bad shape that they are deemed unlivable, and therefore they are a high-risk investment.”
- Two bills to pay. A conventional loan is the name lenders use for the financing provided to purchase a home the borrower is going to live in. If you do find a lender willing to allow you to purchase a fixer-upper with one of these loans, it won’t cover the cost of repairs. Unless you can afford to pay for renovations out of pocket, you might find yourself taking out a second loan to cover property improvements, which means two bills to pay.
That said, if you can find a lender who’s willing to lend to you, there are some benefits to going this route, said Robert E. Tait, senior loan officer with the Allied Mortgage Group in Jamison, Pa.
Pros of conventional loans:
- Eliminating mortgage insurance. Many people who take out conventional loans but can’t afford the traditional 20% down payment are required to buy private mortgage insurance to cover the difference between what they can up front and that 20%. If you buy a fixer-upper this way and start making improvements, you might be able to eventually eliminate that mortgage insurance. “After some of the projects are completed, … a homeowner can request an appraisal on their home if they believe the value has increased to a price point that provides more than 20% equity,” Tait explained.That can save you thousands of dollars compared to government loans such as the FHA 203(K). It does not allow you to eliminate mortgage insurance.
- Ability to find other assistance. Sometimes small local lenders have access to home improvement loan programs that are local, rather than national. These can often be used in conjunction with a conventional loan, but don’t be afraid to ask if they can be combined with a federal fixer-upper loan as well.
- Freedom to DIY. If you can afford to borrow just the amount needed to buy the property, then sink your own cash into the place, a conventional loan leaves you the ability to do renovations on your own or choose your own contractor. According to Evan Wade, co-founder and partner at Philadelphia Mortgage Brokers, the conventional loan in particular frees you from the HUD-approved contractors required by some loans, who can be difficult to find. That said, some hard money lenders do provide “acquisition-only” loans that cover the majority of the purchase price, which also opens buyers up to that sort of option.
Other things to consider before purchasing
A fixer-upper can be a great purchase, no matter what you’re looking to do with it, but the experts offer a few caveats to keep in mind.
- Be patient. Renovations take time, and you need to keep in mind that you won’t typically be able to buy, fix and sell the home again right away — at least not if you want to do the job well. “For maximum resale value, high quality, well-done home improvements are a must,” Tait said.
- DIY isn’t always the best option. Doing renovations yourself is a great way to save cash, if you can afford to do them. But the DIY approach can limit your loan options. “It is almost unilaterally recommended by lenders to have any and all home improvement work done with a licensed and bonded contractor,” Butler said. “Unless you yourself meet these qualifications, many lenders will not consider lending money toward an amateur renovation.”
If you’re eyeing that run-down property, don’t be shy! You have a host of options out there that might make it yours.
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