Conventional Rehab Loan: What It Is and How It Works

A conventional rehab loan is a type of mortgage that lets homeowners finance both the purchase of a home and the costs of renovating it in a single loan. It’s designed for buyers who want to purchase a fixer-upper. This loan is also perfect for current homeowners who need funds for major home improvements.

While conventional rehab loans can be beneficial, they’re not always the best choice, especially if you are seeking a more straightforward, flexible, and cost-effective way to finance your home improvements. 

If you’re considering a conventional rehab loan, a RenoFi loan lets you borrow on average 11x more money than traditional loan options by using your after renovation home value without refinancing your current mortgage or dealing with lengthy inspections.

Understanding Conventional Rehab Loans

Sometimes referred to as a renovation loan, a conventional rehab loan combines the cost of purchasing a home with the expenses needed for renovations. This makes it an excellent option for individuals looking to buy a fixer-upper or renovate their existing property without taking out multiple loans or tapping into personal savings.

How Does a Conventional Rehab Loan Work?

With a conventional rehab loan, the lender estimates what your home will be worth once the planned renovations are finished. The lender then bases the loan amount on this projected value, which is generally higher than the current appraised value. This enables homeowners to secure financing for the purchase of the home and the renovation costs in one mortgage.

There are two main types of conventional rehab loans:

• Fannie Mae HomeStyle Renovation Loan: This type of loan is a great choice if you are looking to make significant renovations. Through this loan, borrowers can finance almost any home improvement, provided the renovations are permanently attached to the property and add value.
• Freddie Mac CHOICERenovation Loan: The CHOICERenovation loan is similar to the HomeStyle loan but gives you even more options. You can use the loan for major renovations, disaster repairs, or even to add an extra living space to your property. 

Benefits of a Conventional Rehab Loan

• Higher Borrowing Power: These loans allow you to borrow more than you would through a standard mortgage because the loan is based on the after-renovation value.
• Single Loan: A conventional rehab loan simplifies the process by combining the cost of the home and the renovations into one mortgage.
• Fixed-Rate Options: If you prefer predictable monthly payments, rehab loans are a good option, as they usually have fixed interest rates.
• Flexibility in Renovations: Unlike other renovation loans, conventional rehab loans allow for a wide range of home improvements, from minor repairs to major structural changes.

Eligible Property Types for Conventional Rehab Loans

Conventional rehab loans can be used for a variety of property types, including:

• Single-family homes
• Multi-family properties (up to four units)
• Condominiums
• Planned unit developments (PUDs)

Remember that you’ll qualify for a rehab loan if the renovations are permanent and increase the property’s value.

Key Considerations Before Applying

If you’re interested in a conventional rehab loan, it’s important to be aware of the following:

1. Credit Requirements: To qualify for these loans, you’ll likely need a higher credit score than government-backed options. Many lenders prefer a score of 620 or above.
2. Down Payment: While the down payment for a conventional rehab loan can be as low as 3.5%, your credit score and the loan amount will factor in. Larger renovations may require a higher down payment.
3. Mortgage Insurance: If your down payment is less than 20%, you’ll likely need to pay for private mortgage insurance (PMI). Unfortunately, this will increase your monthly payments.
4. Approved Contractors: To get a rehab loan, you’ll usually need to use licensed contractors and provide a detailed renovation plan with cost estimates and a timeline.
5. Appraisal and Inspections: As part of the loan process, your lender will appraise the property to estimate its value after the renovations are complete. They may also inspect the work at different stages to make sure it’s being done as planned.

Common Renovation Projects for Conventional Rehab Loans

Conventional rehab loans can be used for a wide variety of home improvements, including:

• Kitchen and bathroom remodels
• Roof and siding replacement
• Room additions
• Energy efficiency upgrades 

The Drawbacks of Conventional Rehab Loans

While conventional rehab loans offer a viable option for homeowners looking to finance significant renovations, they come with challenges.

One of the major drawbacks is the requirement to refinance your current mortgage or apply for a new one. This could cause you to lose a low interest rate on your existing loan. 

Additionally, the step-by-step disbursement process can be burdensome, slowing down progress on your renovation.  

The strict draw schedules, milestone-based fund disbursements, and multiple inspections at each stage to ensure compliance on these loans also mean a lot of back-and-forth between the contractor and the homeowner. 

Multiple steps, approvals, and checks are involved to ensure that both financial and construction milestones are met. This can be very time-consuming and may involve more paperwork and higher fees compared to other financing options. 

RenoFi Loans as an Alternative

Let’s imagine a scenario where you want to spend $150,000 to renovate your new home and increase the value of your home by $150,000 and you are considering using a home equity loan:

Scenario 1 (New Home Purchase): 

• Home price: $600,000
• Downpayment (20%): $120,000
• Current Mortgage Amount: $480,000

Example Home Equity Loan Amount: 

• $600,000 * 80% = $480,000 (80% of Total Home Value)
• $480,000 - $480,000 (Current Mortgage Balance) = $0 (Home Equity Loan Amount)

Example RenoFi Home Equity Loan Amount:

• Assuming that your renovation project will add $150,000 to your home value

• After Renovation Value of Your Home: $750,000

• RenoFi Loan Amount: 

  • $750,000 * 90% = $675,000 (90% of Total Home Value)
  • $675,000 - $480,000 = $195,000 (RenoFi Home Equity Loan Amount)

Using a RenoFi Home Equity Loan you have increased your loan amount from $0 to $195,000. Not only are you now able to borrow the $150,000 you wanted to renovate your home, but you can now borrow up to $195,000 because the RenoFi loan is written against your ARV (After Renovation Value).

Without RenoFi loans, you would not have been able to borrow the $150,000 needed to add the renovations that would increase the value of your home by $150,000. Now, with RenoFi loans, you are now able to get the loan you need to add the renovations you want to your home.

Scenario 2 (Recent Home Purchase): Assuming that you have now paid 10% of your mortgage:

• Home price: $600,000
• Current Mortgage Amount: $420,000

Example Home Equity Loan Amount: 

• Example Home Equity Loan % of Home Price: 80%

• Example Home Equity Loan Amount: 

  • $600,000 * 80% = $480,000 (80% of Total Home Value)
  • $480,000 - $420,000 (Current Mortgage Balance) = $60,000 (Home Equity Loan Amount)

Example RenoFi Home Equity Loan Amount:

• Assuming that your renovation project will add $150,000 to your home value

• After Renovation Value of Your Home: $750,000

• RenoFi Loan Amount: 

  • $750,000 * 90% = $675,000 (90% of Total Home Value)
  • $675,000 - $420,000 = $255,000 (RenoFi Home Equity Loan Amount)

Using a RenoFi Home Equity Loan you have increased your loan amount from $60,000 to $255,000 (4.25x more). Not only are you now able to borrow the $150,000 you wanted to renovate your home, but you can now borrow up to $255,000 because the RenoFi loan is written against your ARV (After Renovation Value). 

Here’s a summary of the difference between traditional and RenoFi home loans in table form: 

In addition to letting you borrow more money for your home renovations, RenoFi loans also offer:

• No draw periods
• No inspections
• No need to give up your original loan
• Higher borrowing limits

RenoFi loans are funded on the day the loan is closed and that is it. Take out the $195k and you get $195k in your bank and you have 20 years to pay off in equal monthly payments with interest and principal, just like a standard mortgage.

Get started with your RenoFi loan here 

RenoFi Loans vs. Conventional Rehab Loans: Which Is Right for You?

Whether a RenoFi or a traditional rehab loan is right for you depends on your financial situation and what you hope to achieve with your renovation.

A conventional rehab loan might be right for you if:

• You’re purchasing a new home that needs significant renovations
• You’re willing to refinance your current mortgage and possibly lose your current interest rate
• You have a high credit score and can meet the loan requirements

You can consider a RenoFi loan if:

• You’re planning to renovate your current home and don’t want to refinance
• You need more borrowing power based on the after-renovation value
• You want to keep your existing mortgage rate and terms

Conclusion

If you’re planning a significant home renovation, a conventional rehab loan might be the perfect solution. This loan provides flexibility and access to higher loan amounts based on the projected after-renovation value of your home. However, if you’re looking for a more efficient way to finance your home renovation without refinancing, RenoFi loans might be a better fit.

RenoFi loans are a game-changer for home renovations. Unlike traditional loans, which are based on your current home value or require you to refinance your primary mortgage and give up your low rate, RenoFi loans are based on the after-renovation value of your home. This allows you to borrow, on average, 11x more, get a low monthly payment, and keep your low rate on your first mortgage.

Ready to explore your renovation financing options? Get started with your RenoFi loan.