Finding the Financial Tools to Buy and Renovate a Home
David and Marilyn are set to close escrow on a new home purchase in North Hollywood this month and then begin a summer of major repair work.
The couple is buying a home that was started by a builder who ran out of money and never finished it. An out-of-state lender now owns the home, which is in need of paint, landscaping, bathrooms, a kitchen and water, sewer and gas lines.
Many buyers would consider such a project a bit too daunting. There’s also the problem of financing. Most lenders will only lend money on the appraised value of the home, not the value after it has been fixed up. David and Marilyn, however, have been able to find a way to basically get three loans in one: money to buy the property, make the needed repairs and finance the home for 30 years when the work is completed.
Finding money to fix up a home isn’t as easy as it was just a few years ago. Many homeowners simply don’t have much if any equity in their homes to spare. And, most home buyers are pretty much tapped out by the time they close escrow on a newly purchased residence.
There are, however, still quite a number of financial sources available for owners and buyers who want or need money for repairs and renovation. The hard part--as usual--is making sense of all the options.
David and Marilyn are buying their new 4,800-square-foot home for $313,500 and adding another $164,000 in repairs, renovations and finishing touches. Their lender is estimating that the property will be worth $630,000 when it is finished, and the couple is getting in the door for just $31,350 in cash. “Not many people can acquire a property that’s this valuable with so little cash,” David said.
“Until recently, borrowers haven’t had a lot of options when it comes to buying a home that’s in need of major work,” said Glen Pickren of Barron Financial Services, the Irvine-based mortgage lender that financed David and Marilyn’s deal. Barron has agreed to lend on the value of a property after it has been fixed up, thus allowing buyers to get more of a loan.
The Barron loan is similar to a program backed by the Federal Housing Administration in a loan program designed to help people buy run-down homes and rehabilitate them.
The FHA’s 203(k) program offers up to $152,350 to finance a single-family residence, $194,850 for a duplex, $235,550 for a triplex and $292,800 for a fourplex. The money can be used for a refinancing and renovation or purchase and renovation, said Pat Spear, a vice president at S & S Financial Inc. in Woodland Hills.
Speculative investors are getting back into the real estate market by financing their purchases and renovations with these FHA loans and then selling to a new buyer who assumes the loan, Spear said. Lenders are even lending to borrowers based on what they estimate will be the value of the property after it has been fixed up.
For example, Spear said, a buyer might purchase a severely earthquake-damaged home for $75,000. The borrower gets a $152,000 loan and uses it to buy the property and finance $25,000 in repairs and $2,000 in closing costs. The investor then sells the property for $175,000 and the new buyer assumes the $152,000 loan. Borrowers who plan to occupy the residence can get up to a 97% loan-to-value loan. Investors need to put 15% down.
Investors who plan to borrow based on the future value of the residence after it has been rehabilitated better be sure they know what they are doing. The extra money doesn’t get disbursed until the investor finds another buyer and, meanwhile, the investor has to pay interest on the full balance of the loan. “You need to know what you’re doing,” Spear said.
There are other options for rehabbers:
* Home equity loans are the most traditional form of renovation financing for current homeowners. Borrowers can typically mortgage up to 70% to 80% of their homes; however, many people don’t have 20% to 30% equity in their homes today. If you do have equity, most of these loans feature variable interest rates and five- to 15-year terms. The fees and expenses associated with these loans vary greatly, depending on the lender and on the borrower’s credit profile.
* Lines of credit are similar to home equity loans in that both are usually in the form of a second mortgage. A line of credit uses the home as collateral for a pool of credit that can be used in much the same way as a credit card. The monthly payment is based on a percentage of the borrower’s average outstanding balance. As the borrower repays principal, the borrower can continue to borrow up to the credit limit set by the lender. Most of these loans have relatively small upfront fees and terms of up to about 15 years.
* FHA Title 1 home improvement loans are a good option for many borrowers who have little or no equity in their homes, said David Stepp, a vice president at Union Bank in Downtown Los Angeles. These government-backed loans are made by lenders approved by the Federal Housing Administration. Borrowers can get up to $25,000 for acceptable home improvements, usually without any equity or even an appraisal.
Title 1 lenders are generally in second position--that is, behind a superior first lender. Borrowers can even get this loan the day after they buy a home. With up to five points as a fee to the lender and interest rates of up to 14.99%, these are not cheap loans. Also, FHA loans can’t be used on luxuries such as a pool. “This is for people who can’t qualify for other types of loans,” Stepp said. The points, fees and interest rates that a borrower pays all depend on how credit-worthy he is.
* Construction financing is another option for property owners planning major work on their home. These are usually one-year loans for projects costing more than $100,000. Lenders will usually insist on reviewing the plans for renovation or remodeling and funds are disbursed to contractors as work progresses. Borrowers should be prepared to pay their lenders pretty hefty fees for progress inspections and plan reviews. There is also the issue of how to permanently finance the work once it has been completed. Some lenders allow the borrower to convert a construction loan into a conventional loan. Other lenders require a whole new loan.
* Sellers can be asked to do needed work as part of a sales contract. In some cases there’s no other option but to ask the seller to perform certain work on a house. For example, most lenders won’t lend until a roof is watertight.
