On a traditional transaction, one of the first steps is hiring an appraiser to evaluate the property. On a renovation loan, before an appraiser is assigned, a contractor and a renovation consultant must do some work. The contractor will work with you to come up with plans for the property. The consultant will work with you and the contractor to make sure the plans meet the lending guidelines. Once plans for the work are finished, the appraiser comes to evaluate the home. Traditional appraisals value and comment on the home’s current state. Renovation loan appraisals value and comment on the current and future condition based on the proposed renovation plan.
Once the renovation plans have been completed and the future value is determined, the loan closes as normal. The only main difference is that during the underwriting (approval of the loan) process, the underwriter approves things based on a future value and the future work to be done. When the loan funds, the lender sends the entire amount needed—the amount to make the purchase happen AND the amount needed for renovations.
Construction starts after the closing date, and the home is officially yours. The title company holds on to the renovation funds and disperses them (through the consultant) at various times throughout the build. Once the construction is done, the appraiser performs a final inspection. He/she simply makes sure that the work was done per the contractor’s original specs. Assuming that all goes smoothly, the loan entirety of the transaction officially closes and you have a beautiful newly renovated home!
Types of Renovation Loans
FHA 203k – As mentioned in the title, this is an FHA loan, but it carries additional features. These loans are designed for owner-occupied (not for investment) borrowers with a minimum credit score of 640, at least 3.5% down, and a maximum loan amount of $279,450 (for Maricopa County). Also, this loan is only for homes that are completed. The home must have a “certificate of occupancy.” As a whole, this is the loan type you choose when the property you want to purchase has structural issues, or you wish to add square footage. This loan does not allow for most landscaping or luxury items.
FANNIE MAE HOMESTYLE – This is a conventional loan. Like FHA 203k, this loan is for owner-occupied borrowers. However, the requirements are different. You must have at least a 680-credit score, and put 5% down, but you can get a loan as high as $453,100 (in most AZ counties). This is the loan you want if you want to do more than rehab the property. Along with renovations, HomeStyle loans allow for extensive landscaping, pool installment/repair, and other cosmetic/luxury items.
Renovation loans can be great if you’re interested in purchasing a home to pour some money into before you move in. Just know that the loan process is more complicated than a typical purchase.
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