How to Finance a Fixer-Upper Home | Mortgages
Key Takeaways
- Renovation mortgages allow you to purchase a fixer-upper and roll construction costs into the loan amount.
- Depending on the type of loan, there may be rules limiting the scope of projects you can finance – such as no luxury additions or rebuilds – and you may need to use an approved contractor.
- You’ll likely need to come prepared with a contingency reserve, worth up to 15% or 20% of the home’s estimated repair costs, and there may be added fees compared to a traditional purchase mortgage.
As home prices continue to rise and interest rates stay higher for longer, many of today’s homebuyers are struggling to keep their monthly mortgage payments affordable. But for those who are willing to buy a lower-priced home that needs a little TLC, there’s a glimmer of hope: fixer-uppers are priced 54.2% lower than the median single-family home in the U.S. and account for 5.2% of all single-family homes for sale, according to research from Realtor.com.
Still, buying a fixer-upper home isn’t always the seamless undertaking seen on reality TV shows – especially when it comes to financing. Some mortgage programs have strict property requirements, which can pose a problem for buyers who lack the cash to make urgent repairs up front.
For homebuyers who don’t mind putting in a little sweat equity, though, there are several types of fixer-upper mortgages that roll the cost of home improvements into your total loan amount. If you’ve decided to buy a diamond in the rough, a renovation mortgage may be the right home financing option for your needs.
Types of Mortgages for Fixer-Uppers
Many fixer-uppers are sold to investors who pay in cash, renovate the home and sell it for a profit – but DIY-savvy homebuyers also have options for financing fixer-upper homes. Besides paying in cash, there are a few types of renovation mortgages that can cover the cost of urgent home repairs available through the Federal Housing Administration, the Department of Veterans Affairs and the government-sponsored enterprises, Fannie Mae and Freddie Mac.
Here’s a breakdown of the different types of mortgage programs for fixer-uppers that offer a built-in repair budget.
FHA 203(k) Loans
A 203(k) loan is a type of FHA mortgage that covers the purchase of a property as well as the cost of repairs and renovations. You can borrow up to the as-is value plus rehab costs and financeable fees or 110% of the home’s value once repairs are completed, whichever is less, subject to FHA loan limits.
There are two types of FHA rehabilitation loans: limited 203(k) loans and standard 203(k) loans.
- Limited 203(k) loans are for homes that need minor improvements, repairs and upgrades costing up to $75,000. Small projects may include kitchen remodeling, interior repainting or new flooring. However, a limited 203(k) loan doesn’t cover structural repairs like room additions or basement conversions.
- Standard 203(k) loans are for major repair and rehabilitation projects costing at least $5,000 and must be overseen by an FHA-approved consultant. With a standard 203(k) loan, there’s no set maximum for repair costs, so you can tackle larger improvements like structural repairs, roof replacement and plumbing work. However, the FHA won’t allow you to use the funding for luxury projects, like swimming pool construction.
As with any other FHA loan, you can get a 203(k) loan with as little as 3.5% down with a credit score of at least 580 or 10% down with a score as low as 500. You’ll also still pay the up-front mortgage insurance premium, which is 1.75% of the loan amount, as well as monthly mortgage insurance premiums, which are required until you sell, refinance or repay the loan in full.
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VA Rehab Loans
Active and retired military personnel may be eligible for a VA renovation loan that rolls the cost of necessary home improvements and repairs into the mortgage. Like a standard VA purchase loan, a VA rehab loan allows you to buy a home with 0% down, no mortgage insurance and competitive interest rates. You’ll also pay the up-front VA funding fee between 1.25% and 3.3% of the total loan amount, and there may be an additional construction fee of up to 2% if the lender pays out the majority of the loan proceeds during construction.
With a VA renovation loan, you can borrow up to 100% of the home’s estimated post-renovation value or up to 100% of the acquisition costs (which includes sales price, repairs, contingency reserve, fees and permits), whichever is less.
The funds can only be used for repairs and upgrades that are necessary to improve the safety or livability of the property, such as replacing heating, ventilation, air conditioning, electrical or plumbing systems. VA rehab loans can’t be used for major structural repairs, such as teardowns and rebuilds.
Conventional Renovation Loans
In addition to government-backed home renovation loans, there are a few conventional loan programs that include the cost of repairs in the mortgage amount: Fannie Mae HomeStyle and Freddie Mac CHOICERenovation.
Fannie Mae’s HomeStyle Renovation Loan is a conventional mortgage that includes financing for home improvements at the time of purchase or during a refinance. For homebuyers purchasing a property, the maximum renovation costs are 75% of the sum of the purchase price and rehab costs, or 75% of the property’s as-completed appraised value, whichever is less. Homeowners who refinance can borrow up to 75% of the as-completed appraised value of the property to pay for repairs. The contingency reserve is up to 15% of the loan amount.
Freddie Mac’s CHOICERenovation Mortgage is similar to Fannie Mae’s offering, with the same 75% renovation budget threshold. But Freddie Mac also offers a streamlined version of this loan, the CHOICEReno eXPress, for buyers with smaller rehab budgets. With the eXPress option, you can borrow up to 10% of the home’s value for renovation costs, or 15% if the property is located in a federally designated “Duty to Serve” high-needs area, such as a low-income or underserved rural market. A contingency reserve is not required, but if the lender chooses to establish one, it is capped at 20% of the total renovation costs.
Unlike a government-backed rehab loan, the improvement funds from Fannie Mae and Freddie Mac renovation mortgages can be used on any project, including home additions and nonessential upgrades. You can also use any licensed contractor as permitted by state law, without the need for an FHA- or VA-approved consultant.
Pros and Cons of Fixer-Upper Mortgages
Pros
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It may be possible to get a government-backed renovation mortgage with a low down payment and lenient credit requirements.
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There is typically less competition among homebuyers for a home that needs urgent repairs.
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You stand to gain equity when the work is done, even after accounting for the cost of renovations.
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You can choose the fixtures and finishes that suit your taste.
Cons
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The process can be complicated, between completing mortgage paperwork and hiring approved contractors.
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Homebuyers often have to compete with all-cash investors for fixer-upper homes.
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You may have to put aside a contingency reserve to be used if there are issues with the repair work.
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You risk taking on a more complicated project that exceeds your initial budget and construction timeline.
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The costs of permits, inspections, contractors and appraisers can add up quickly.
How to Choose the Best Renovation Financing Option
There’s no one-size-fits-all financing solution for mortgage borrowers who are buying a fixer-upper. Here are a few things to consider when choosing a fixer-upper loan:
- Consider the scope of your work. Someone buying a home that just needs minor aesthetic improvements will have much different financing needs from someone who plans to buy a home in need of major repair.
- Determine whether you meet the eligibility requirements. For example, you’ll need a Certificate of Eligibility, or COE, to qualify for a VA renovation loan. If you have a lower credit score, you might have the best luck through the FHA’s 203(k) loan program.
- Get a few estimates for the work that’s needed. Reach out to the proper contractors, such as plumbers, electricians and HVAC technicians, to find out how much each project will cost. Once you have a better idea of your total renovation budget, you should be able to narrow down your borrowing options.
- Compare borrowing costs for each product. Interest rates vary widely across mortgage types, so it’s important to consider the long-term cost of borrowing for a renovation loan. You can find the mortgage rate, monthly payment and closing costs in your loan estimate.
Another Way to Finance a Fixer-Upper
FHA 203(k) loans and other rehab loans may be the right choice for some homebuyers, but they’re not ideal for DIY renovators with relatively smaller remodeling projects. If you want to buy a fixer-upper without the limitations of a renovation loan, there’s another common strategy to consider:
- Use a traditional conventional or government-backed home loan to purchase the property and make improvements later. Understand, however, that homes with substantial damage, deferred maintenance or defects that are severe enough to affect their safety, soundness, or structural integrity will not be eligible for this type of financing.
- Take out a home improvement loan, such as an unsecured personal loan or line of credit, to pay for your renovation project.
- Refinance your original mortgage when the work is completed. This effectively allows you to tap into your home’s increased equity to pay off the rehab loan at a lower rate – and ensures your home improvement loan doesn’t have a prepayment penalty for paying it off early.
A separate loan may be a good option if you have the skills and equipment to complete the repairs yourself, or if you plan to live in the home while you renovate it. But if a property needs expensive professional repairs before you can move in, a fixer-upper mortgage may be a more favorable option.
How Much Should You Expect to Invest in a Fixer-Upper?
The amount of money you’ll spend renovating a fixer-upper will vary widely depending on the home’s condition and size, the scope of the projects, the materials used and where the property is located.
The average cost to remodel a house is $52,000, according to Angi, a home improvement services website. It also estimates that buyers could see a return on investment of 40% to 80% with a whole-house remodel. Here are the typical price ranges for projects commonly needed to restore fixer-upper homes, per Angi estimates:
- Bathroom remodel: $6,600 to $17,600
- Deck installation: $4,300 to $12,500
- Electrical rewiring: $2,000 to $12,000
- Flooring replacement: $2 to $22 per square foot
- Fence installation: $1,900 to $4,800
- Garage remodel: $7,000 to $30,000
- Kitchen remodel: $10,000 to $65,000
- Roof replacement: $5,500 to $45,000
- Siding replacement: $5,500 to $18,000
- Window replacement: $3,400 to $12,000
With a moderate fixer-upper, you may be able to negotiate the purchase price to offset the cost of more urgent repairs – but you might not have a lot of wiggle room if a home is being sold “as-is.”
Having a thorough home inspection and shopping around for quotes from contractors can help you estimate the cost to remodel a property, so you can determine if the purchase price is worth the potential ROI.
