Lately I have encountered more houses that NEED work and more people who WANT to do work. On that note, I asked loan officer Mark Anderson of Paramount Bank to write a post regarding some construction loan options.
You should know that the low price of a house that needs work reflects the simple economic principle of supply and demand – with a twist. On the supply side, there are tons of houses that need everything from ‘a little work’ to ‘a full rehab’. With a large supply, we also see a large demand. However, the pool of folks that want to purchase these properties is much larger than the group that can. Out of the group that can there is an even smaller set that decides to follow through once they’ve examined their options. If you fall into this last category, you are part of a small group with a huge inventory to choose from.
If you have the cash on hand to purchase a fixer-upper and to do the work needed to spruce the place up, by all means get out there and stimulate our economy. If you need a mortgage, let’s take a look at your options so you can decide if purchasing a fixer-upper will work for you.
Both first time and repeat home buyers can take advantage of FHA loans. The advantages are the low down payment of 3.5% and the looser credit guidelines when compared to conventional financing. If you are looking to purchase a house that needs work, you need to know up front that FHA has strict standards when it comes to the condition of the house you buy. I’ve seen FHA appraisers require sellers to scrape peeling paint, fix broken windowpanes and install handrails. This makes a standard FHA loan not compatible with the house in sub-standard condition.
If you were considering FHA but you determine the property you want will not meet FHA guidelines, you will want to check with your lender to see if a conventional loan with 5% down is a viable alternative. It is fair to say that a conventional appraisal is not ‘nit-picky’ in the way that FHA can be over certain property conditions. However, this does not mean that anything goes. In order for a property to be considered suitable for financing, it must be in ‘livable’ condition at closing. The definition of ‘livable’ is interpreted by the individual appraiser who views the property. In general, the property must have a useable kitchen, functional bathrooms and working systems including electric and plumbing. It is important to point out that if the property has had copper pipes stolen, attached light fixtures not in place or holes in the wall that you may require a rehabilitation loan in order to purchase the property.
In many ways, the 203k cousin to the standard FHA loan looks similar – 3.5% down, looser credit guidelines, etc. However, the 203k product allows you to purchase a property in rough shape and also finance the necessary repairs. The closing costs can be double what you would normally pay, given the extra work involved for the bank and title company. In addition to the cost, the amount of time and energy you will need to put into the process can make taking on a 203k loan quite stressful. You need to be prepared to select a contractor, specify exactly what work will be done and provide the lender more paperwork than on a normal loan. Underwriting will take longer, so you should avoid offering the sellers a quick closing. If you were planning on doing some of the work yourself, the 203k guidelines will not allow it. All materials and labor associated with the loan must be tied to an approved contractor.
203k loans come in two varieties – “Streamline” and “Full”. I have had better luck with the streamline program, which is for smaller projects with a total cost under $35,000. The larger scale, full 203k loans are much more difficult to work with, but if you are prepared for a tough process and the property needs a lot of work, it may be the best option.
The Best Option for “Light” Fixer-Uppers
As I joked earlier, the best way to buy a house that needs work is to pay cash. It’s unrealistic for most of us, so an option a lot of my clients choose is to simply put less money down than they were planning on. This will only work for a property that qualifies for either normal FHA or Conventional financing, but it is great if you planned to put 20% down or more. There are ways to put as little as 5% down and still avoid PMI, so take the path of least resistance if possible. Without a renovation loan in place, you’ll be able to call the shots and do what you want, when you want with your property.
Finally, I wanted to address one of the most common questions I hear from new clients regarding ‘getting a little extra’ (from the bank or home seller) for minor home improvements. Five years ago, when I first got started in the mortgage business, we had programs called 110% and 105% loans. Not only did the borrower not need to put any money down, but they got cash on top at closing. These were some of the programs that hurt the housing market the most. Getting a little extra is just not possible anymore because, with very few exceptions, zero money down is a thing of the past. Lenders these days consider the value of your property to be the lesser of your purchase price or your appraised value, so that tosses out the idea of ‘instant equity’ as well. The only way to finance repairs is to take specialized loans that, as we’ve seen, require additional fees and some extra work on your part as the borrower. If you are prepared and ready to learn more about these options and others, please give me a call or visit my website.