Potential home buyers and current homeowners have a choice when it comes to renovation loans. One program is backed by the federal government while the other is offered through one of the largest mortgage providers in the country. Both products have their advantages and we will outline both products below to help you choose the right one for you.
Take a look at the following article to learn what renovation loan options you have and to see a comparison of the FHA 203k and Fannie Mae HomeStyle loans.
FHA 203K Loan
What is an FHA 203k Loan?
The FHA 203k loan is a mortgage guaranteed by the Federal Housing Authority aka FHA. This means that if a borrower is not able to make the payments on the loan and the lender must foreclose on the home, the federal government will step in and pay off a portion of the loan to the lender.
The 203k loan allows a borrower to do 2 things with one simple loan
- Buy a home
- Make necessary repairs and/or renovations to the home.
Essentially, this is a way for a person to buy a fixer-upper and get the funds for the repairs all at the same time.
Here are the basic steps to getting the FHA 203k loan
- Get pre-qualified with an FHA lender
- Find a home
- Find a licensed contractor to submit a bid to do the work
- Get the bid along with purchase loan approved and closed
- Allow the contractor to complete the work
- Move into your home
What is Allowed
The lender will assign an appraiser to review the home and determine the current shape of the house. If there are any issues that affect the safety, soundness, or structural integrity of the home, those items will be required to be fixed before closing the loan. Items like faulty wiring or a leak in the roof would be an example.
After all necessary repairs are considered, you can then look at improvements to the home. Items like newer appliances, new floor coverings, and better cabinets would be examples of improvements.
In general terms, FHA will allow borrowers to make most any type of change or improvement to the home except for luxury items or any project that will require more than a 6-month time frame. A new swimming pool or a tennis court would be an example of a luxury item.
In order to approve the repairs and/or improvements, you must use a licensed contractor to perform the work. FHA wants to make sure that you are protected against scam artists and they also want to protect their investment, thus the need for a certified contractor.
Who Can Qualify for FHA 203k
The FHA 203k loan follows the same lending guidelines as an FHA purchase loan. This means that FHA does not offer the loan directly to borrowers. Instead, it authorizes mortgage lenders across the country to offer the loan.
The same credit rules and debt-to-income ratios offered for a regular FHA loan are also used for the FHA 203k loan. This opens the door to many people who may not have perfect credit but have worked to re-establish their credit rating over the past year or two.
For the debt to income rules, the proposed new mortgage payment should not be over 28% of the borrower’s monthly gross income. The mortgage payment plus all other debt should not be more than 43% of the borrower’s monthly gross income.
The borrower(s) must plan to live in the home as their main residence. Investment properties and vacation homes are not allowed under the FHA 203k loan.
The FHA 203k rules also state that borrowers may acquire a loan up to 110% of the home’s future market value once the repairs have been finished or the home’s current value plus the amount to make repairs, whichever is less.
For example, if a person wants to buy a home for $150,000 and has a contractor bid for $60,000 to do repairs and improvements, the total of those two amounts would be $210,000. If the proposed value of the home after repairs is $215,000 then the borrower could get a loan for $210,000 which is lower than the proposed value. The borrower will need to make a 3.5% down payment of the $210,000 which would be $7,350
There are many pros and cons of the FHA 203k loan, which I encourage you to ask a knowledgeable Mortgage Loan Officer about.
HomeStyle Renovation Loan
The Homestyle Renovation loan is offered by Fannie Mae. Like FHA, Fannie Mae does not lend directly to borrowers. Instead, authorized lenders who prepare a loan according to Fannie Mae’s rules can offer the loan
Since Fannie Mae deals with conventional mortgages, the credit requirements for this loan will be slightly more restrictive compared to the FHA 203k loan.
The Homestyle loan does allow borrowers to get a loan up to 97% of the future appraised value.
The Homestyle Renovation loan will allow borrowers to make necessary repairs, like the FHA 203k loan, related to safety, soundness, or structural integrity. It also will allow most improvements, like the FHA 203k loan.
Where the Homestyle loan differs is the ability to use the money to build an accessory unit. An accessory unit could be a guest house built at the rear of your property or it could be a single apartment built above the garage.
This can be a boost for 2 different groups of people. First and foremost are families that may have an elderly relative coming to live with them but still wants to keep their privacy. This could be an excellent way to have your grandmother or uncle or any other relative living on your property but still have a private place to call their own.
The other group of people that can benefit from the accessory unit would-be entrepreneurs who wish to use the extra space to generate revenue. Whether it is through a room sharing site like Airbnb or a local ad that appeals to tourists, this is a great way to get involved in real estate investing on a small scale.
FHA 203k vs. Fannie Mae HomeStyle Loan Comparison
Here is a simple chart that highlights some of the major points of each type of loan
|HomeStyle Renovation||FHA 203K|
|Is Private Mortgage Insurance Required?||It will be required if the loan amount is over 80% of the appraised value. Private mortgage insurance will drop off when loan balance drops below 80%||Yes, for the duration of the loan|
|Single unit investment property||Is allowed, with restrictions on loan to value and renovation amounts||Not allowed|
|Loan type allowed||Purchase existing property or refinance an existing property||Purchase existing property or refinance an existing property|
|Down Payment requirement||3% of future value||3.5% of future value|
|The maximum amount that can be used for repairs and or improvements||The amount for repairs and/or improvements may not be over 50% of the proposed new value||No restrictions on the amount used for improvements and/or repairs. The only restriction is on the total loan amount|
Final Thoughts On Renovation Loan Options
Keep in mind that with either of these loans, the overall process will take longer than a typical mortgage. There is more paperwork involved, and there are more people involved since a contractor will be handling the improvements and repairs. However, either mortgage is a terrific way to buy a house and get enough money to fix up the place and make it your ideal home.
Additional Renovation Resources:
How Do Renovation Loans Work via MaxRealEstateExposure
Renovation Mistakes To Avoid by Anita Clark
Renovations For Maximum Value by Kevin Vitali
Setting A Remodeling Budget by John Cunningham
About the author: This article on the “Renovation Loan Options: FHA 203k And Fannie Mae HomeStyle Compared” was written by Luke Skar of www.MadisonMortgageGuys.com. As the Social Media Strategist, his role is to provide original content for all of his social media profiles as well as generating new leads from his website.
MadisonMortgageGuys.com and team provide award-winning customer service to clients who need to purchase a home or refinance an existing mortgage. Our branch currently serves 47 states. Take a look at our newest state-specific page for information on Wisconsin VA Loans.