A rehab loan is a home improvement loan you can use to buy a house that needs some fixing. These allow buyers to borrow enough money to buy a property and cover the renovations and repair expenses a fixer-upper home may need.
Buyers can use these loans to purchase houses that need work, situated in locations they otherwise couldn’t afford because properties that don’t need as much work aren’t on the market in these neighborhoods.
In this article, we explore rehab loans, how they work, the process of applying, and their advantages and disadvantages to help you decide whether this financing option will suit you.
Also known as the FHA 203k loan and FHA construction loan, a rehab loan allows you to finance both the property itself and needed repairs and renovations. A 203k rehab loan tackles a common issue when purchasing a fixer-upper house - lenders often don’t approve loans for properties that require major repairs.
However, 203k lenders track and verify repairs when using a rehab loan and are willing to approve loans on houses they wouldn’t otherwise consider. Even so, for a lender to approve financing, the property must meet some safety and livability standards determined primarily by the FHA home appraisal. And if the property is too rundown, you won’t be able to use a rehab loan.
A 203k rehab loan program can be an excellent option for buyers on a tighter budget who want to purchase an older house and fix it instead of buying a more expensive home ready for immediate use. However, even buying a fixer-upper home can involve some hidden costs.
The process for a rehab loan is similar to that of regular home buying, with some differences. First, you need to apply for a loan with a 203k-approved lender and get approved for it. Then, you need to choose a contractor and get bids (estimates for the repairs). After that, you must close the loan and complete the repairs. And once you’ve done that, you’re free to move in.
To qualify for a rehab loan, you must meet specific requirements outlined by the Department of Housing and Urban Development (HUD), including:
There are two types of FHA 203k loans, and the extent of the repair work will depend on the loan you choose.
Formerly known as the Streamline 203k, Limited 203k loan allows you to do most cosmetic repair work, such as bathrooms and kitchens. The stated cost limit is $35,000, but an FHA 203k loan requires a contingency equal to 15% of the total bids.
This contingency is a “just in case” fund to cover costs exceeded by your contractor, and if this fund isn’t used, it’s credited back to you. This means that your actual maximum expenses would be approximately $31,000.
With the Limited 203k loan, most non-luxury, non-structural items are allowed, including:
However, you can’t do anything structural like adding more rooms, moving load-bearing walls, or changing the house's footprint. Nevertheless, many buyers choose this option because more lenders offer it than the standard rehab loan, and the process is more streamlined than the standard option.
With this option, you can do almost anything you want to the property, except add luxury amenities or non-permanent changes. This includes:
Although FHA rehab loan guidelines allow a lot, some things are unacceptable, such as minor landscaping, projects that take longer than six months, or adding a luxury amenity like a swimming pool, tennis court, or barbecue area.
While people typically use a rehab loan when buying a house, it can also be used for refinancing. You can use this refinancing option if you have at least $5,000 in improvements.
The lender will order an appraisal that shows the as-is or current home value and the improved value after improvements. Your maximum refinance loan amount is subject to FHA loan limits and the lowest of the following calculations:
The lender must use the acquisition cost plus the documented rehabilitation costs for your maximum loan amount if you have owned the property for less than a year. Moreover, you don’t need an existing FHA loan to use an FHA rehab loan for refinancing
FHA rehab loans have many benefits. Here are some of them:
While rehab loans have many advantages, there are also several drawbacks that come with them, some of which are listed below:
Besides FHA-approved 203k loans, there are also conventional rehab loan options, including the HomeStyle Renovation Mortgage from Fannie Mae and the CHOICERenovation loan from Freddie Mac.
This loan’s original principal can’t exceed Fannie Mae’s maximum loan limit amount. Borrowers buying a house can’t incur rehab costs more than 75% of the lesser sum of the purchase price of the home plus repair and improvements expenses or the as-completed appraised value of the home.
These loans can also be applied to investment properties or second homes. Similar to Fannie Mae’s HomeStyle loans, this mortgage is available at a 15- or 30-year term and has a lower DTI, down payment, and credit requirements.
After reading this article, you have a good idea about whether a rehab loan would suit you. While these can be an excellent option for buyers on a budget, rehab loans may not be necessary if you’re looking to increase the value of your home to sell it for more money.
There’s a much easier way to sell your house, and you don’t have to take out a rehab loan to make any improvements to increase its value. SleeveUp Homes will buy your home as-is for top dollar. Check how much you can get for your property by requesting a no-obligation cash offer and see for yourself.
If you want to sell fast and are worried about how long the traditional process takes, and the commission and fees involved, consider working with SleeveUp Homes.