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How to Get a Mortgage for a Fixer-Upper

How to Get a Mortgage for a Fixer-Upper
Financing a fixer-upper property can be challenging because lenders are reluctant to offer you a mortgage based on the post-renovation value of the property.  In addition, getting a construction loan to finance property renovations and then another permanent mortgage to pay-off the construction loan after the renovations are completed can be costly and time-consuming.  Below, we outline multiple mortgage programs and options to help home buyers purchase and renovate fixer-uppers.  The construction to permanent (C2P), FHA 203(k) home loan and Fannie Mae HomeStyle Renovation mortgage programs covered below allow a fixer-upper buyer to finance renovation and remodeling costs without taking out a separate construction loan, which is a huge benefit to the borrower.  We also review additional approaches a borrower can use to get a mortgage on a fixer-upper.  We also provide a summary of fixer-upper mortgage programs on FREEandCLEAR.

Consider a Construction to Permanent (C2P) Loan

A construction to permanent loan, or C2P loan, enables a borrower to finance the cost of building a new home or significant renovations, including for a tear-down or fixer upper, with a single mortgage

A construction to permanent loan is a potentially attractive alternative to a borrower arranging two separate loans to build or renovate a home: one short-term construction loan to finance property renovations and a second, permanent mortgage that replaces the construction loan when the project is completed

Using a construction to permanent loan enables the borrower to have one mortgage closing instead of two, reduce closing costs, arrange a permanent mortgage long before completing property construction and lock-in the interest rate for the permanent mortgage six months to a year in advance of completing the project

Not all lenders offer construction to permanent loans but many do.  The best lenders for construction loans include regional banks, credit unions and banks where you have an existing relationship

Click INTEREST RATES to view lenders in your area and contact them to determine if they offer the construction to permanent (C2P) loans


FHA 203(k) or Fannie Mae HomeStyle Renovation Home Loan Programs

The FHA 203(k) and Fannie Mae HomeStyle Renovation Home Loan Programs enable home buyers to finance the purchase of a home as well as the cost of significant remodeling and repairs to the home with one mortgage

Both programs allow borrowers to finance the cost of fixing up a property without having to obtain a separate construction loan which can be costly, complicated and time-consuming to arrange

Both mortgage programs work well for home buyers looking to purchase a "fixer-upper"

With the FHA 203(k) Home Loan Program, the value of the property is determined by either the value of the property before the remodeling or rehabilitation project plus the cost of the project; or, 110% of the appraised value of the property after the remodeling project, whichever is less

The FHA 203(k) Program requires additional up-front and ongoing borrower fees

With the Fannie Mae HomeStyle Renovation Program, the value of the property is the lesser of the purchase price plus the cost of the renovations or the appraised as-completed value of the property

The FHA 203(k) Home Loan Program applies only to owner-occupied properties while the Fannie Mae HomeStyle Renovation Program applies to both owner-occupied and investment properties

These mortgage programs are offered through any approved lender. Not all lenders offer these programs but many do. Click INTEREST RATES to view lenders in your area and contact them to determine if they offer the programs


Purchase the Home for its Current Fair Market Value

If you decide to not use the construction to permanent (C2P), FHA 203(k) or Fannie Mae HomeStyle Renovation Home Loan Programs, the first step to getting a mortgage for a fixer-upper is to buy the property based on its current fair market value, before any remodeling or improvements are factored in

Without using one of the fixer-upper mortgage programs outlined above, most banks will not offer borrowers a mortgage that includes the cost of improvements. For example if you want to buy a fixer-upper that is worth $200,000 and make $50,000 worth of improvements, the bank will most likely only give you a mortgage based on the $200,000 value of the property before improvements

It is important that you only pay for the property based on what is worth today even though it will be worth more after you fix it up, because this is the way the bank thinks about your mortgage



Get a Construction Loan

After you purchase the property at its fair market value you can obtain a construction loan to finance the remodeling and improvements you want to do

A construction loan is typically a six-to-twelve month loan that charges a higher interest rate than your mortgage

Not all banks offer construction loans but many do and the bank that you use for the mortgage on the property may provide construction loans

A borrower must qualify for both the mortgage to purchase the property as well as the construction loan based on the borrower’s income and debt so it is important to understand what size mortgage and construction loan you qualify for before you start the home purchase process -- the last thing you want to do is buy a fixer-upper and then not have the ability to finance the remodeling

Buyers should have the construction loan lined-up and ready to go before he or she buys the property so that they can begin remodeling immediately after the purchase closes and there are no issues financing the renovations



Get a Take-Out Mortgage When the Remodeling is Completed

After your remodeling is completed, the borrower should get a take-out loan to pay-off the construction loan and refinance the original mortgage used to purchase the property

The lender for the take-out mortgage will use a new appraisal that factors in any home improvements to determine the value of the property

The more valuable the property, the larger the mortgage the lender will be willing to offer, assuming the borrower qualifies for the larger mortgage

With a take-out loan in place, the borrower will have paid of the construction loan and have a new mortgage based on the improved value of the property

It is important to highlight the risks to financing a fixer-upper through a construction loan and take-out mortgage

First if the borrower’s financial profile changes significantly during the course of remodeling the property, such a job loss or drop in credit score, he or she may not be able to obtain the take-out mortgage

Second, there is no guarantee that the remodeling will result in the increase in property value expected by the borrower, which could hinder the borrower’s ability to obtain the take-out mortgage. For example the appraisal may show a property value less than the original purchase price of the property plus the cost of the improvements

It is important to work with potential take-out lenders in advance of buying the fixer-upper to limit potential disagreements about the value of the property after the remodeling

In many cases a construction loan lender will not fund the loan until a borrower has arranged a permanent take-out mortgage



Consider Making a Lower Down Payment

If a borrower is concerned about obtaining a construction loan and take-out mortgage he or she may want to make a lower down payment and pay for the remodeling out of pocket

For example, instead of making a 20% down payment, the borrower makes a 5% down payment and uses the difference in down payments to pay for all or part of the property improvements

This would minimize the need for the borrower to obtain a construction loan and take-out mortgage

It is important to understand that if you make a down payment of less than 20% lenders typically require that you pay private mortgage insurance (PMI), which is an additional monthly cost on top of your mortgage payment, or the lender may charge you a higher interest rate

In this scenario, the borrower could refinance his or her mortgage after the remodeling is done and assuming the value of the property has increased and the borrower’s equity in the property has increased, the borrower may not be required to pay PMI or the lender would offer a lower interest rate


Consider a Hard Money Mortgage

If you cannot arrange a mortgage for a fixer upper through a traditional lender you may be able to get a mortgage through a hard money lender, also known as a private lender 

Borrowers can use a short-term hard money mortgage, also known as a bridge loan, to finance the purchase and renovation of a property and then refinance the hard money mortgage with a traditional mortgage with a lower interest rate after the property is remodeled

Hard money mortgages typically charge an interest rate that is 4.0% - 7.0% higher than a traditional mortgage plus much higher lender fees.  Additionally, a hard money mortgage may require a lower loan-to-value ratio which means that the borrower must make a greater down payment or equity contribution

Although a hard money mortgage is much more expensive than a traditional mortgage it is another alternative for a buyer seeking to finance a fixer-upper

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