3 Ways to Finance a Remodel on Your Home Purchase

Many investors purchase a home below market value that needs updating. Then, they’ll renovate it to significantly increase the value. As the market naturally lifts, as it has lately, they get a significant return on investment when they turn around and sell the home again. It’s a smart financial step if you tread carefully and don’t purchase a money pit.

The first step is buying a home that’s structurally sound. It might be in a great location with a lot of square footage, but if it’s extremely old, the foundation is cracking, the roof needs replaced, it needs new windows and an HVAC system, and has a list of other serious issues, then you probably won’t make a profit.

“Buyers will say, ‘This is the best house in the location I really want,’ but they know they will need to do some improvements to make the home what they want,” says Bud Dietrich, an architect in New Port Richey, Florida. “A homebuyer who wants to remodel must tread carefully: Are the desired changes structurally possible? How much will it cost? Can the remodeling expense be financed?”

Carefully consider each of these matters before you purchase a home in need of a remodel. When you’ve found the perfect home for renovating, consider these financing options.

  1. FHA 203(k) Mortgage

This mortgage is designed for those who have minimal cash on hand for a down payment or who may have a lower credit score that still supersedes 580.

There are two types of FHA 203(k) mortgages. The first is the standard 203(k) loan. You can do almost any kind of repair, even building on a demolished house if the foundation is still intact. You can go as low as 3.5 percent on the down payment and borrow up to 110 percent of the home’s value, as long as your intended home repair will increase the assessed value. Once you qualify, there are a few extra stipulations.

Your repairs must cost more than $5,000. You must also hire a 203(k) consultant, which costs a few hundred dollars, to determine the financial feasibility of your intended project. They’ll inspect the property, make stipulations regarding certain coding requirements, and oversee the contract work.

Secondly, there’s the limited 203(k) mortgage, which is for minor remodeling projects that don’t involve structural modifications. Most people use them for roofs, patios, HVAC systems, plumbing, flooring, etc. You can borrow $35,000 more than the purchase price of the home with all the usual FHA requirements attached. You’ll also have to pay mortgage insurance upfront of 1.75 percent of the loan until the equity of the home reaches 20 percent.

  1. Fannie Mae Homestyle Renovation Mortgage

The FNMA (Fannie Mae) Homestyle renovation option is an FHA mortgage for those with higher credit scores and more disposable income. You’ll need a down payment of just 5 percent and a credit score of 680 or higher, unless your debt-to-income ratio is between 36 and 45 percent, in which case you’ll need a credit score of 700 or higher.

There are fewer limitations on the work to be completed. It can be done anytime in the 12 month period after you take out the loan, and there’s no minimum requirement for performing the renovations. You can borrow up to 95 percent of the home’s current value to make your repairs, although your bank may make certain stipulations depending on your scope of work and the appraisal of the home.

You will also have to pay private mortgage insurance based on the as-completed value of the home rather than the purchase price. If your credit score is 740 or above and you have 10 percent down, you’ll qualify for cheaper insurance premiums than an FHA 203(k) home renovation mortgage. This style of mortgage is also significantly cheaper than credit cards, personal loans, and other types of financing.

  1. Home Equity Line of Credit

If your mortgage is solid, you’ve kept up with your payments, and your credit score is good, you might consider a home equity line of credit. This style is a little riskier than an FHA or Fannie Mae loan, but it has its advantages.

A home equity line of credit uses your mortgage as a sort of credit card. You’ll draw out money from equity as you need it for your renovations, and you can pay it back at your own speed as long as you make the minimum monthly payments. You also don’t have to pay interest on the money until you use it, leading to significant savings.

The risks are substantial, since if you don’t make payments on the credit borrowed, you could lose your home. The interest rates can be a little higher as well. Only consider this option if you’re financially stable.

Renovating your home for profit isn’t nearly as difficult as you might think. You have plenty of options. Talk to your bank about the next steps.

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