Expanding home-buying options with a fixer-upper mortgage

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It’s the lament of first-time homebuyers in just about every market: There aren’t enough entry-level houses that are move-in ready.

One response to this situation is to broaden your search to fixer-uppers. With a renovation mortgage, you can get a home loan to cover both a purchase price and the cost of improvements.

NOT ENOUGH AFFORDABLE HOMES

Entry-level houses, whether new or used, are scarce. The biggest increase in the stock of houses for sale has been in expensive houses, according to Realtor.com.

The decline in entry-level new construction is remarkable: 36 percent of the houses built in 2000 had less than 1,800 square feet; in 2017, 22 percent had, according to the Harvard Joint Center for Housing Studies.

As for existing properties, the number of houses that were resold for between $100,000 and $250,000 in October was 1.9 percent below what it had been in the same month a year earlier, according to the National Association of Realtors. The demand is there: Even with the decline, homes in that price range made up of 40.2 percent of all sales.

Amid a shortage of affordable homes, it makes sense to consider buying dwellings that are outdated or in need of repair.

The two main types of loans used for renovations are the FHA 203(k) loan, insured by the Federal Housing Administration, and the HomeStyle loan, guaranteed by Fannie Mae. Both cover most home improvements, whether big or small.

“Basically, every kind of repair that can be done to a property, we do it,” says Brad McMullen, vice president of renovation lending for PrimeLending, a national mortgage lender that specializes in renovation loans.

RENOVATION LOANS EXPAND OPTIONS

Both FHA 203(k) and HomeStyle can be used for structural and cosmetic renovations. With both, renovation work may begin immediately after closing.

FHA’s 203(k) loan is for primary residences only. It requires a minimum credit score of 500 and a down payment of at least 10 percent; a credit score of 580 or higher allows a down payment of 3.5 percent. These loans can’t be used for work that the FHA deems a luxury, such as installing a swimming pool.

There are two types of 203(k) loans: limited and standard. The limited type is for renovations that cost no more than $35,000 and don’t require major structural work. The standard is for projects that either cost more than $35,000 or involve major structural work.

To get a 203(k) standard loan, you have to enlist a HUD consultant, who will help you solicit and analyze bids and oversee renovation inspections. Consultants are often contractors, architects or inspectors, McMullen says.

Fannie Mae’s HomeStyle loan may be used to buy and repair a primary residence, second home or investment property. It requires a minimum credit score of 620. Its minimum down-payment requirement calls for putting down between 3 percent and 5 percent, depending on whether a home is owner-occupied and a borrower whether is a first-time home buyer or has a low to moderate income.

HomeStyle loans place few restrictions on improvements, other than requiring that they “be permanently affixed to the real property (either dwelling or land),” according to Fannie Mae guidelines. That means HomeStyle may pay for adding a swimming pool.

PITFALLS TO WATCH FOR

The most common source of trouble is neglecting to get detailed cost estimates, McMullen says. To prevent cost overruns, you should make sure estimates are specific about materials, and list costs for inspections, permits and consultant fees.

Another pitfall: over-improving. If every house on a particular block has one story and three bedrooms, it might be a bad idea to add a second story with two bedrooms. The house will no longer fit in with the neighborhood, and, because of the absence of nearby comparable houses, it will be difficult to get an accurate estimate of its likely value following a renovation.

GETTING STARTED

After finding the house you want, choose a lender, decide on a type of loan and hire a HUD consultant. Then, with the consultant’s guidance, get estimates from contractors. Your lender will need copies of the estimates.

Your renovation work may begin soon after you close on your loan.

When your improvements are complete, you’ll have your home the way you want it — sooner than you might have thought possible.

— Holden Lewis is a writer at NerdWallet, a website that provides various types of financial advice. Write to him at [email protected].