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before and after of a house that needs renovation

How to finance a fixer-upper

By Liz Keuler

April 2021

When the inventory of homes available for purchase is low but demand is high – like right now! – buying a fixer-upper can help first-time homebuyers get a foot in the door (literally). But if a house needs more than just some cosmetic touches, you may wonder how you can afford to buy a house and fix it up. 

The true cost of a fixer-upper

For the most part, houses that need some work are priced accordingly. That means you might be able to find a fixer-upper and have some room in your overall home budget to renovate. But it could require a lot of cash on hand to cover a down payment, closing costs and other fees, plus the cost of (possibly major) home improvements. Even if you’re handy and think you could do some or all of the work yourself, the cost of materials might stretch your budget.

Let’s say you’ve been preapproved for a mortgage loan of up to $250,000, but you aren’t seeing many move-in-ready homes in your area in that price range. You find a home with “great bones,” absolutely no curb appeal, and some serious issues listed at $150,000. Your real estate agent estimates that it needs about $75,000 worth of work. The combined $225,000 is within your overall budget – but you don’t have $75,000 (plus a down payment and closing costs) sitting in the bank! That’s where renovation loan programs come in.

Can you add renovation costs to a mortgage?

You sure can! Many lenders offer programs that allow you to roll the cost of repairs or home improvement into the loan amount, as long as you are able to qualify for a total loan amount that covers the purchase price plus renovations.

You’ll qualify for a renovation loan just like you would any other mortgage loan. Your lender will look at your income, debts, and credit history to assess your ability to repay and determine how much they would be willing to lend you. Renovation loans don’t automatically come with higher interest rates. Your interest rate will be determined by the “usual” factors, including your credit score, debt-to-income ratio, and what’s going on in the housing market.

Lenders may be approved for specific federal programs created to help revitalize aging home inventory while making homebuying more affordable, like Fannie Mae HomeStyle® Renovation or Freddie Mac CHOICERenovation® (more on those below) or FHA 203(k). Lenders may also have their own renovation programs. Not all lenders offer renovation loans, so make sure to ask lenders what home improvement programs may be available to you, and how those programs work.

Fannie Mae HomeStyle Renovation and Freddie Mac CHOICERenovation

Fannie Mae and Freddie Mac both offer a renovation loan program that will allow you to base the amount you borrow on what the home will be worth after you improve it. 

While Fannie Mae HomeStyle Renovation and Freddie Mac CHOICERenovation programs have a few differences, they’re similar in many respects:

  • You can include the following in the loan amount: closing costs, fees and prepaid items, labor, materials, architect fees, permits, licenses, contingency reserves, and up to 6 months’ mortgage payments (since you’ll most likely be paying to live elsewhere during the renovations) 
  • You’re in charge of finding a qualified, experienced contractor and negotiating the cost of your proposed renovations – but your lender will have to approve the contractor and their plans, specifications and contracts
  • Renovations must be completed within 12 months of closing the loan

Forbes offers more detailed descriptions of both Homestyle Renovation and CHOICERenovation.

How much of a down payment do you need for a renovation loan?

If your lender has their own renovation loan program, they’ll set their own down payment requirements. 

For both HomeStyle Renovation and CHOICERenovation loans, down payment requirements are based on either the property’s post-renovation value or the purchase price plus renovation cost. For a one-unit primary residence, you’ll need to put down a minimum of 5%. The down payment minimum drops to 3% if you qualify for the matching affordability program by Fannie Mae or Freddie Mac – HomeReady® or Home Possible®, respectively. Other requirements apply for second home, multi-unit properties or investment properties.

As with any conventional home loan, if you do put less than 20% down, your lender will require mortgage insurance – which can be canceled when you reach 20% equity in your home, through making payments on your loan and/or home price appreciation. 

You may also be eligible for down payment assistance to help defray those costs, so make sure to research possible programs and check with your lender! 

Can I save money by doing the work myself? 

You may be able to save a little money on labor by doing some of the renovation work yourself, depending on the terms of the renovation loan program. That’s one area where the national renovation programs I covered above differ.

With a Fannie Mae HomeStyle Renovation loan for a one-unit property, DIY improvements can make up to 10% of the post-renovation value, as long as you have your lender’s approval. This allows you to save money on labor and finance just the cost of the materials, along with contingency funds in case you need to hire someone to finish the work. You can’t include funds to “pay yourself” for your labor. If you have money left in your financed amount after completing the work, you can apply it to the balance of your loan or make more improvements.

The Freddie Mac CHOICERenovation program allows you to do some work yourself as long as your loan is also part of the Freddie Mac Home Possible affordability program. In this case, the work you do – also known as “sweat equity” – will count toward your down payment and closing costs. The value of your sweat equity must be estimated by an appraiser before you begin renovations, and your DIY work must be inspected and certified by an appraiser when complete.

Any renovation loan program that allows DIY work may include restrictions on exactly what types of DIY work is allowed. Your program may allow you to paint the interior of the house, for example, but require all electrical work to be done by a licensed electrician.

The upshot? If you’re handy and/or willing to put in the time and effort involved with working with a contractor and managing the paperwork, a renovation loan might just make the difference for you in terms of finding and affording a home! 

 

HomeStyle® and HomeReady® are registered trademarks of Fannie Mae. CHOICERenovation® and Home Possible® are registered trademarks of Freddie Mac.

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Liz Keuler is the editor of Readynest. She spent a decade meandering through radio, nonprofits and the corporate world before convincing MGIC to hire her based on her staunch grammatical convictions. She lives in a charming 100-year-old bungalow on Milwaukee’s East Side. Her interests include old Ernst Lubitsch films, new action movies, 60s girl pop, Regency romance novels, word games, sewing and shallots.
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