- Renovation mortgages allow you to purchase a fixer-upper and roll construction costs into the loan amount.
- Depending on the type of loan, there may be rules limiting the scope of projects you can finance – such as no luxury additions or rebuilds – and you may need to use an approved contractor.
- You'll likely need to come prepared with a contingency reserve, worth up to 15% or 20% of the home's estimated repair costs, and there may be added fees compared to a traditional purchase mortgage.
As home prices continue to rise and interest rates stay higher for longer, many of today's homebuyers are struggling to keep their monthly mortgage payments affordable. But for those who are willing to buy a lower-priced home that needs a little TLC, there's a glimmer of hope: About one in 20 homes for sale on the market could be considered a fixer-upper, with listings describing a "handyman special," "diamond in the rough" or "remodelers dream," according to research from Realtor.com.
Still, buying a fixer-upper isn't always the seamless undertaking seen on reality TV shows – especially when it comes to financing. Some mortgage programs have strict property requirements, which can pose a problem for buyers who lack the cash to make urgent repairs upfront.
For homebuyers who don't mind putting in a little sweat equity, though, there are several types of fixer-upper mortgages that roll the cost of home improvements into your total loan amount. If you've decided to buy a diamond in the rough, a renovation mortgage may be the right home financing option for your needs.
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Many fixer-uppers are sold to investors who pay in cash, renovate the home and sell it for a profit – but DIY-savvy homebuyers also have options for financing fixer-upper homes. Besides paying in cash, there are a few types of renovation mortgages that can cover the cost of urgent home repairs available through the Federal Housing Administration, the Department of Veterans Affairs and the government-sponsored enterprises, Fannie Mae and Freddie Mac.
Here's a breakdown of the different types of mortgage programs for fixer-uppers that offer a built-in repair budget.
A 203(k) loan is a type of FHA mortgage that covers the purchase of a property as well as the cost of repairs and renovations in the loan amount. You can borrow up to the as-is value plus rehab costs and financeable fees or 110% of the home's value once repairs are completed, whichever is less, subject to FHA loan limits.
There are two types of FHA rehabilitation loans: limited 203(k) loans and standard 203(k) loans.
Limited 203(k) loans are for homes that need minor improvements, repairs and upgrades costing up to $35,000. Small projects may include kitchen remodeling, interior repainting or new flooring. However, a limited 203(k) loan doesn't cover structural repairs like room additions or basement conversions.
Standard 203(k) loans are for major repair and rehabilitation projects costing at least $5,000 and must be overseen by an FHA-approved consultant. With a standard 203(k) loan, there's no set maximum for repair costs, so you can tackle larger improvements like structural repairs, roof replacement and plumbing work. However, the FHA won't let you use the funding for luxury projects, like swimming pool construction.
Like with any other FHA loan, you can get a 203(k) loan with as little as 3.5% down with a credit score of at least 580 or 10% down with a score as low as 500. You'll also still pay the upfront mortgage insurance premium, which is 1.75% of the loan amount, as well as monthly mortgage insurance premiums, which are required until you sell, refinance or repay the loan in full.
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Active and retired military personnel may be eligible for a VA renovation loan that rolls the cost of necessary home improvements and repairs into the cost of the mortgage. Like a standard VA purchase loan, a VA rehab loan allows you to buy a home with 0% down, no mortgage insurance and competitive interest rates. You'll also pay the upfront VA funding fee between 1.25% and 3.3% of the total loan amount, and there may be an additional construction fee of up to 2% if the lender pays out the majority of the loan proceeds during construction.
With a VA renovation loan, you can borrow up to 100% of the home's estimated post-renovation value or up to 100% of the acquisition costs (which includes sales price, repairs, contingency reserve, fees and permits), whichever is less.
The funds can only be used for repairs and upgrades that are necessary to improve the safety or livability of the property, such as replacing heating, ventilation, air conditioning, electrical or plumbing systems. VA rehab loans can't be used to make major structural repairs, like teardowns and rebuilds.
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In addition to government-backed home renovation loans, there are a few conventional loan programs that include the cost of repairs in the mortgage amount: Fannie Mae HomeStyle and Freddie Mac CHOICERenovation.
Fannie Mae's HomeStyle Renovation Loan is a conventional mortgage that includes financing for home improvements at the time of purchase or during a refinance. For homebuyers who are purchasing a property, the maximum renovation costs are 75% of the sum of the purchase price and rehab costs, or 75% of the as-completed appraised value of the property, whichever is less. Homeowners who refinance can borrow up to 75% of the as-completed appraised value of the property to pay for repairs. The contingency reserve is up to 15% of the loan amount.
Freddie Mac's CHOICERenovation Mortgage is similar to the offering from Fannie Mae, with the same 75% renovation budget threshold. But Freddie Mac also offers a streamlined version of this loan, the CHOICEReno eXPress, for buyers with smaller rehab budgets. With the eXPress option, you can borrow up to 15% of the home's value for renovation costs. The contingency reserve is up to 20% of the loan amount.
Unlike a government-backed rehab loan, the improvement funds from Fannie Mae and Freddie Mac renovation mortgages can be used on any project, including home additions and inessential upgrades. You can also use any licensed contractor as permitted by state law, without the need for an FHA- or VA-approved consultant.
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Pros
It may be possible to get a government-backed renovation mortgage with a low down payment and lenient credit requirements.
There is typically less competition among homebuyers for a home that needs urgent repairs.
You stand to gain equity when the work is done, even after accounting for the cost of renovations.
You can choose the fixtures and finishes that suit your taste.
Cons
The process can be complicated, between completing mortgage paperwork and hiring approved contractors.
Homebuyers often have to compete with all-cash investors for fixer-upper homes.
You may have to put aside a contingency reserve to be used if there are issues with the repair work.
You risk taking on a more complicated project that exceeds your initial budget and construction timeline.
The costs of permits, inspections, contractors and appraisers can add up quickly.
There's no one-size-fits-all financing solution for mortgage borrowers who are buying a fixer-upper. Here are a few things to consider when choosing a fixer-upper loan:
Kristen HampshireJuly 31, 2023
FHA 203(k) loans and other rehab loans may be the right choice for some homebuyers, but they're not ideal for DIY renovators with relatively smaller remodeling projects. If you want to buy a fixer-upper without the limitations of a renovation loan, there's another common strategy to consider:
A separate loan may be a good option if you have the skills and equipment needed to complete the repairs yourself, or if you plan on living in the home while you renovate it. But if a property is in dire need of expensive professional repairs done by a licensed contractor before you can move in, then a fixer-upper mortgage may be a more favorable option.
The amount of money you'll spend renovating a fixer-upper will vary widely depending on the condition and size of the home, the scope of the projects, the materials used and where the property is located.
The average cost to remodel a house can range from $15,000 to $200,000 or more, according to Angi, a home improvement services website. It also estimates that buyers could see a return-on-investment of 40% to 80% with a whole-house remodel. Here are the typical price ranges for projects commonly needed to restore fixer-upper homes:
Source: Angi. Data collected on April 12, 2024. Prices are rounded to the nearest hundred.
With a moderate fixer-upper, you may be able to negotiate the purchase price to offset the cost of more urgent repairs – but you might not have a lot of wiggle room if a home is being sold "as-is."
Having a thorough home inspection and shopping around for quotes from contractors can help you estimate the cost to remodel a property, so you can determine if the purchase price is worth the potential ROI.
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