If you don’t have the money to pay for the renovation your home needs, you might think you are out of luck. Unless you want to slap it on a credit card or take out a personal loan, your options seem limited. However, there are several mortgage programs that help you renovate and/or rehab your home.
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Learn the benefits of each program below so you can decide which one is right for you.
Perhaps the most popular home renovation loan is the FHA 203K loan. Just like its FHA loan counterpart, it has
flexible underwriting guidelines and low down payment requirements. The FHA offers two options under this program:
- 203K Streamline – This is for renovations that cost $35,000 or less and are not structural. Qualifying is simple and the paperwork is short for this program. The lender will pay the contractor half of their cost up front and the other half upon completion of the project. You can inspect the work yourself, but the appraiser must confirm that the work is done satisfactorily and that it increases the value of the home.
- Full 203K – This is for renovations over $35,000 or that affect the structure of the home (adding a room, etc.). The full 203K requires more paperwork and inspections before the lender will move forward with the financing. The lender will pay the contractors in pre-determined installments as per the contract the lender and contractor create. You will also have to use a loan consultant, which is a 3rd party that helps you deal with the contractors, bank, and any other interested parties. The final inspection is done by the loan consultant and/or bank before the final funds are disbursed.
Either FHA 203K loan requires only a 3.5% down payment and a 580 credit score. The down payment is determined by totaling the cost of the home (refinance) plus the cost of the work to be done. You then pay 3.5% of the total amount. The FHA allows borrowers to take out up to 110% of the proposed value of the home after rehab, which is why working with a knowledgeable lender and appraiser is so important. In most cases, lenders also let you have up to a 43% debt ratio.
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Keep in mind, the above requirements are the FHA’s requirements. Each lender can make the requirements stricter if they so choose. For example, a lender may not be willing to lend to someone with a 580 credit score, but would for someone with a 620 or 640 credit score.
Fannie Mae HomeStyle Loan
Fannie Mae HomeStyle Loan is the conforming version of the home renovation loan. As is the case for most conforming loans, it requires a higher credit score of 620 versus the FHA’s 580. The Fannie Mae loan offers the same ability to purchase or refinance a home and include the renovation costs all in one loan. For primary residence properties, you can borrow up to 95% of the as-completed value of the home, which means just a 5% down payment. However, keep in mind, a down payment less than 20% means you’ll pay PMI.
Where the HomeStyle loan offers more benefits than the FHA loan is regarding what you can do with the funds. However, the FHA 203K loan has less stringent guidelines. With the Fannie Mae loan, you can remodel an entire room, add a room, upgrade any area of your home, or make cosmetic changes. You can even use the funds for what lenders consider ‘luxury upgrades’, which is not something the FHA loan allows.
Cash Out Refinance
If you already own a home and have equity in it, you can tap into that equity with a cash out refinance. This cuts the red tape out of the loan process. Lenders don’t usually ask what you will do with the cash when you take it out of your home. As long as you qualify for the loan based on your credit score and debt ratio, the lender can rest assured that you’ll pay the loan back.
The cash out refinance requirements vary by program. Most of the major loan programs, including Fannie Mae, FHA, and VA allow borrowers to tap into the home’s equity. Generally, you can take up to 80% of your home’s value. For example, if your home is worth $300,000 and you have an outstanding balance on your first mortgage of $150,000, you have an additional $90,000 you can take out for home renovations.
Home Equity Loan
Another option that doesn’t require you to deal with the lender helping you choose your contractor and inspect the work done is a home equity loan. Each lender has their own requirements for these programs. In general, though, you can borrow up to 85% of the current value of your property. The lender does not take into consideration any improvements you may make or the value of the home after the improvements.
The type of loan you should choose depends on your renovation needs. Do you need more than 80-85% of your home’s value? If so, you’ll rule out the cash out refinance and home equity loan. From there, you can decide if you qualify for the Fannie Mae program as you pay less in mortgage insurance if you need it. FHA mortgage insurance rates are generally higher. However, if you don’t think you can qualify for the Fannie Mae program, which requires higher credit scores and lower debt ratios, the FHA program may suit you just fine.
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