While Housing Brothers and similar shows have excited viewers with the prospect of affording more home for their money, buying and immediately renovating a home is not as easy and affordable a prospect as it seems. That model works best when home buyers have a significant amount of cash to use toward the purchase and renovations.
Important Details to Consider
Where will you live during the renovations?
Will you be able to live in the home during the renovation process? If so, what concessions will you need to make? Will you require a makeshift kitchen while the main kitchen is being renovated? What will it cost you to do that and/or eat out more often?
Will your family be able to safely live in the home during renovations? If you have young children or pets, that could be especially difficult and dangerous.
If you cannot live in the home during the renovations, will you continue renting until the renovations are completed? If so, you’ll have to budget for that living expense, as well as the costs associated with your new home.
Is the home insurable?
Depending on the condition of the home, it may not be insurable. Homeowner’s insurance companies have requirements that must be met in order to insure a home, so some homes are not insurable until the work is completed. Not only does that put your investment at risk, but traditional lenders do not write mortgages on homes that cannot be covered by insurance, so depending on your funding source, an uninsurable home might not be an option.
Some homes are insurable with enough money held in escrow to complete required repairs within a certain time frame. For example, enough money (cash out of your pocket unless it’s a construction loan) held in escrow to repair the roof may be required in order for the insurance company to cover the home during the renovation process, thus allowing the buyer to purchase the property with a loan.
Can the home be purchased using a loan?
Lenders are strict about their lending. They do not want to assume too much risk, so in addition to approving you based on your credit, they must also approve of the condition of the home. Homes requiring substantial work are not eligible for basic conventional or FHA loans. FHA guidelines are the most strict, so they’re least likely to suit this kind of sale. Conventional loans are much more lenient, but they also have requirements on home condition. Something as simple as bare floors from torn up carpet will make a home ineligible for a basic conventional mortgage, so you’ll need to communicate carefully with your lender during the offer process.
Homes requiring substantial work more often require a construction loan like an FHA 203k or a conventional construction loan, cash or a hard money loan. More on those below. Furthermore, some sellers and agents of homes like these will only accept cash or hard money.
Basic Options for Covering Purchase and Remodeling Costs
Cash
Cash is preferable. Remodels and repairs are already expensive, so tacking on interest adds an additional, and often substantial, cost. In the best case scenario, the buyers have enough cash available to cover their down payment (between 5-20% for a conventional loan), their closing costs and prepaids (between about 3-5%), and then enough to complete the renovations.
Construction Loans
203k Loans
The most common construction loan for prospective homeowners who plan to complete renovations upon closing is the FHA 203k. Basically, the loan amount is calculated by including the actual purchase price plus the estimated cost of approved repairs. These can be very helpful loans in the right circumstances, but they are also challenging loans with very strict guidelines. The successful ones typically limit repair escrows to the most important, basic items like replacing the roof, updating the electric and buying an appliance package. These loans carry higher closing costs and interest rates than typical purchase loans.
All repairs using a 203K must be done by the book with licensed, registered contractors and include all permits. In other words, you will not be able to complete this work over a few weekends with your cousin Vinny using materials you found on Craigslist.
Conventional Construction Loans
These function in a similar basic framework as 203K loans, except that the repair/remodel money is distributed using much looser guidelines and far less supervision, so you could potentially complete some of this work on weekends with Craigslist supplies and the help of your cousin, Vinny.
Approval for these loans is more difficult than for a 203k; borrowers require a higher credit score, larger down payment and lower debt-to-income ratio in order to be approved.
Revitalization Loans and Grants
Various local areas have loans and grants available for restoration. Each has its own requirements, so these scenarios vary greatly. Many are attached to especially blighted areas and others are tied to historic homes that must be restored using specific guidelines.
Loans and grants like these can present great opportunities under the right circumstances, but they require a good deal of research and preparation and they apply to very distinct situations only. Start your research and due diligence early.
More Complicated Than it Appears
Buying a fixer upper can present a great opportunity, but it’s complicated and more expensive than many people consider. If you’re considering this route, your first order of business is to carefully evaluate your finances, including potential loan options and cash available. Be certain to apply for and get estimates on the costs of any loans you’re considering and compare them before deciding on a plan.
Once you’ve mapped out a funding plan (loan, cash out of pocket, etc.), you can move forward with finding a fixer upper in your price range. Be sure that an adequate inspection period is included in your offer. Once your offer is accepted, you’ll have to work quickly to get strong estimates on the work required during that period to be certain that the house and costs fit within your budget.
Under the right circumstances, renovating a fixer-upper can yield a very exciting home well-suited to your personal tastes. Early preparation and strong cost estimates are key in doing that successfully.
Other Options
What if, like many buyers, your financial resources are not optimal for an immediate remodel of a fixer upper? What other options might you consider?
Buying a renovated home
Home buyers can still find renovated homes at affordable prices here in the Tampa area. Compare the cost of purchasing a home with a low down payment and low interest rate with your monthly obligation if you choose to complete renovations yourself.
Buy a Starter Home
Another option to consider, especially for first time home buyers in a strong housing market, is to purchase a starter home – a home you intend to live in for a few years using the best loan product available.
The money earned from the sale of that starter home, together with savings made possible by a significantly lower monthly cost and annual tax deductions, can help home owners achieve the kind of savings required to upgrade on their next home.
Updating One Project at a Time
A less exciting, but much more realistic, option is to purchase a livable fixer-upper and tackle one renovation project at a time. Savings over time, tax incentives for home ownership and even equity lines of credit (much more affordable than a 203k loan) can all be sources of funding you can use to remodel your home over time.
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