2 for 1: Buying a home while paying for repairs

Maryalene LaPonsie | Improvement Center Columnist | September 13, 2012

It may be a buyers' market for houses today, but much of what's available falls into the distressed category. According to the National Association of Realtors, one in four home sales from May 2012 were short sales or foreclosures.

While distressed houses can be a bargain, they generally need a little TLC to shine. Even non-distressed properties may be dated, cramped or otherwise begging for a renovation. So how exactly are you going to pay for that work if you don't have a pile of cash sitting in the bank?

Fortunately, you have financing options. Renovation loans can provide home buyers with the money needed for both the mortgage and the repairs.

Renovation loans 101

With a renovation loan, you can conveniently roll the cost of repairs into your mortgage. This allows you to borrow enough to buy a home and finance repairs while only having a single monthly payment.

While conventional loans are generally available only for the current market value of a property, a renovation loan is based upon the expected value of a home after improvements have been completed. As a result, you can borrow more than the purchase price. That extra money can then be put to use making repairs or upgrades to the property.

Although some banks may offer other lending solutions, these two programs most commonly provide renovation loans:

  • FHA 203(k)
  • Fannie Mae HomePath

The Fannie Mae HomePath program replaced an earlier HomeStyle Renovation program and is available only to those purchasing qualified homes that are owned by Fannie Mae, a government-sponsored mortgage lender. Meanwhile, the 203(k) program is administered by the Federal Housing Administration and can be applied to single family homes as well as properties with up to four units.

HomePath vs. 203(k) options

Once you locate the fixer-upper of your dreams, the first step is to find a real estate professional and lender who are familiar with the government renovation programs. Since both the HomePath and FHA 203(k) programs have special requirements, working with individuals who have experience with renovation loans is essential for a smooth transaction.

The HomePath website describes several potential benefits of the renovation mortgages offered through this program:

  • Low down payments -- program guidelines require only a minimum of 3 percent down
  • No private mortgage insurance requirement
  • Opportunity to borrow up to 35 percent of the renovated value of the property or $35,000, whichever is less, in addition to the purchase price of the property
  • Expanded seller contributions toward closing costs
  • Mortgages available to both owner occupants and investors

However, if the home you want to purchase is not eligible for a HomePath Renovation Mortgage, the FHA 203(k) program may be an option. This program offers guidelines like these:

  • Minimum repairs of at least $5,000
  • Down payment requirement of 3.5 percent of the total cost of the purchase price and repairs
  • Mortgage for the as-is value of the home plus the cost of renovations or up to 110 percent of the after-improvement value, whichever is less
  • Ability to finance up to six months of payments within the mortgage

Another alternative, the Streamlined (k) Limited Repair Program, has different guidelines than the full 203(k) program. The Streamlined option allows homeowners to borrow up to $35,000 for repairs before move-in.

Applying for a renovation loan

Depending on the lender, the application process may vary slightly. However, home buyers should be prepared to go through the following steps:

  1. Complete an analysis of the property to identify needed renovations and estimate the after-improvement value
  2. Submit a purchase offer contingent upon renovation loan approval
  3. Select contractors approved by the lender
  4. Identify any zoning/permitting requirements
  5. Submit contractor bids for the renovations
  6. Have an appraisal completed
  7. Close on the loan once approved

While the FHA does not require a contractor to actually complete the work for its loans, lenders may make this requirement. In addition, lenders may distribute the renovation money in the form of two-party checks made out to you and the contractors.

A loan officer may check in on a monthly basis to determine work progress, and a final inspection at the end of the renovation confirms that repairs were completed per the loan agreement. According to FHA guidelines, renovations under the 203(k) program must begin within 30 days and be completed within six months. However, lenders are free to impose tighter timelines if they wish.

While the application process involves several steps, the convenience of having one loan for both your mortgage and home repairs could be worth jumping through a few hoops. So when you are shopping for a new home, don't overlook the house with the 1970s kitchen or the falling drywall. A renovation loan can turn that fixer-upper into the property of your dreams.

About the Author

Maryalene LaPonsie has been writing professionally for more than a decade on topics including education, insurance and personal finance. She holds a Bachelor's Degree in Political Science from Western Michigan University.