The best way to find your dream home is to give a fixer-upper your own personal makeover. But how can you get the funds to buy a house and fix it? Discover the best way to finance your fixer-upper purchase.

Getting a mortgage for a home is already complicated enough. Trying to convince a bank to give you a loan for a home that needs a lot of work can get even trickier. A fixer-upper can be a great investment if you know what you’re doing. Here’s how to finance your fixer-upper purchase and your construction costs to transform it into your dream home.

Will a bank give you a conventional loan for a fixer-upper?

It’s often a double edged sword when it comes to borrowing money for a fixer home. Banks don’t want to lend the money to buy a property until repairs are already done; but you can’t do the repairs until you close on the home. Unless you’re an all cash buyer and you only need a renovation loan or you have the funds to cover construction costs with cash, you’ll have to find a way around this problem.

One way is to put less than 20 percent down and get a conventional loan with private mortgage insurance (PMI). PMI is required when you put less than 20 percent down. Then you can put any down payment funds you’ve freed up toward renovations. Other workarounds are to take out a home equity or personal loan after you close, or to do a cash-out refinance to get more funds for construction, but they often have a six-month waiting period. 

Another option is to get a Fannie Mae HomeStyle Renovation loan, which is not a conventional loan. It allows you to borrow up to 75 percent of your home’s after-renovation value for your mortgage and renovations from a lender that participates in the HomeStyle program. Your contractor will need to submit detailed plans and adhere to a building schedule in order to receive the money. 

What if you’re a cash buyer?

Even if you have cash to pay upfront for a property, you may still get more value out of getting a mortgage and using the money you save upfront on renovations. Home improvement loans have shorter terms and significantly higher interest rates. Plus, saving 80 percent of your money to put it into repairs and upgrades can create value that outpaces the interest on your monthly mortgage payments.

What is the 203(k) loan program?

The 203(k) program from the Department of Housing and Urban Development (HUD) is designed to let buyers purchase real estate as a primary residence that is in need of repair. It allows buyers to finance the cost of buying a house and repairing it into a single mortgage. The 203(k) is insured by the Federal Housing Administration (FHA) and may also be used to refinance a property that is in need of repairs. Expect to pay a slightly higher interest rate than you would for a conventional loan (usually 0.75 to 1 percent more).  

Is a 203(k) loan better than getting a loan from a bank?

Is it hard to get a loan to renovate a fixer-upper?

It’s possible to finance a renovation with a conventional loan and a bridge loan or interim financing, but that can be complicated and may end up costing more in fees than the 203(k) loan package. You’ll need to apply for these short-term loans on your own, separately from your mortgage. The interest rates on these loans are also much higher than normal mortgage programs, and they are definitely higher than 203(k) loan rates.

How do I get a 203(k) loan?

Once you find the right fixer-upper, a feasibility analysis is conducted and a sales contract is executed stating that you’re looking to get a 203(k) loan. This contract will usually be contingent on the approval of the loan based on the needs of the lender.

The buyer sends this contract to the chosen lenders along with a proposal from a contractor that details the repairs and the cost. Then the lender will do an appraisal to determine the approximate value of the home after the upgrades.

If the lender sees value in the contract and the repairs, then they’ll approve the loan contract for the amount that will cover the purchase and the repairs. 203(k) loans usually include a contingency reserve that covers any extra work that will be required to fully execute the contract—usually between 10 and 20 percent of the total repair and remodeling costs.

If there are any remaining funds at closing after the seller is paid, the remainder goes into escrow for any additional repairs that the house may need during its rehab period. With all of the money in its proper place, the remodeling and mortgage payments begin at the same time. There are some limitations on the amount of money and time that can be spent on repairs: You can borrow up to 110 percent of the after-repairs value and the repairs can’t take longer than six months.

The contractors who are actually completing the repairs are paid through draw requests. A percentage of the draw is always held back by the lender until phases of work are completed on a schedule.

Should I get a 203(k) loan?

As the premier program for borrowers who are looking to buy and upgrade a property simultaneously, a 203(k) loan can give you leverage as well as financing. If you’re trying to get away from the problems that normally accompany a fixer-upper, then a 203(k) loan is one of your best options. Make sure that you do business with a reputable 203(k) lender for best results, and be sure to pick a real estate agent with experience in properties that need to be renovated.

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