Rehab Loan: What It Is, How It Works and Alternatives

Rehab loans, fix-and-flip, or home improvement loans, help homeowners or investors buy and renovate houses under one mortgage. These short-term loans include: 

• Government-backed FHA 203(k) loan: Limited and Standard
• Conventional options: Freddie Mac CHOICERenovation and Fannie Mae HomeStyle
• Hard money rehab loans

How Do Rehab Loans Work?

A rehab loan empowers a buyer to invest in a home that has potential, but needs some work. The acquisition process begins with assessing the renovation needs of a property. After defining the scope of work, a mortgage professional helps you secure the loan. 

The total loan amount encompasses the estimated repair costs and the property purchase price. By combining the full cost, a rehab loan eliminates the need for multiple credit lines or loans. The loan is customized to suit specific repairs, such as kitchen and bathroom remodels or major structural repairs. 

Rehab Loan Process

The process involved in obtaining a rehab loan compares to that of traditional loans. It comprises the following:

• You make your application through an FHA-approved lender. 
• Experts evaluate your financial situation and the feasibility of your project. 
• After the loan approval, you need to pick a qualified contractor to perform the renovations. The contractor provides bids that help assess your project’s budget constraints. 
• You finalize the paperwork and financial aspects, which include signing the loan documents. 
• After closing the loan, you can begin executing your repairs and renovations. 

How to Get a Rehab Loan

The United States Department of Housing and Urban Development (HUD) outlines various rehab loan requirements. Key financing eligibility criteria include:

• Your credit score must be above 500 to show that you can manage debt responsibly. 
• The HUD sets a debt-to-income ratio of below 43% for FHA 203(k) loan payment income requirements. 
• Your property must meet HUD’s standards on liveability and other conditions during on-site inspections.
• You must provide repair cost estimates and renovation plans for the project. 
• The project must be handled by qualified and licensed contractors. 
• An FHA 203(K) borrower must purchase mortgage insurance to protect the lender in case of default. 

Types of Rehab Loans

Different types of rehab loans are available, each serving various needs. Common types include:

1. Government Backed FHA 203(k) Loans

An FHA 203(k) loan is backed by the Federal Housing Administration. It is ideal for an individual who wants to refinance or purchase a home requiring substantial repairs. It combines the renovation and purchase price of a property into one conventional loan, but comes with draws and inspections. FHA 203(k) loans are of two subtypes based on the work scope, renovation type and location. 

There are 2 subtypes: 

• Limited 203(k): Non-structural repairs like flooring, plumbing, appliances, electrical, kitchen, and bathroom renovations under $35,000. Total costs are capped based on specific locations.
• Standard 203(k): More expensive repairs, including foundation damage from natural disasters. These loans cover the lesser of purchase and renovation costs or 110% of the completed value. 

Pros:

• Smaller downpayment: 3.5% downpayments are possible which are significantly less than typical loans.
• More Profit: Fixer-uppers typically have higher ROI and can have a purchase price. Note that renovation loans are typically based on appraised, expected, and post renovation property values.
• Easier loan qualifications: FHA 203(k) loans offer less strict requirements on credit histories, higher loan limits, and higher debt to income ratios
• Personalization: Limited 203(k) loans allow you to borrow money to customize your house, including paint colors, flooring, cabinetry, countertops, and others.

Cons:

• Only certain upgrades are covered: All repairs and improvements must be outlined and itemized before approval.
• 4-unit purchase limit: 203(k) mortgages only allow buyers to purchase multi family homes that do not exceed 4 units
• Extra fees: With the low downpayment, you may for example have to provide 1% upfront guarantees or 0.35% of the remaining principal

If you are looking for help with a FHA 203(k) loan, the Renofi Marketplace offers 203k loans through lending partners to help you find lenders for your property.

2. Conventional Rehab Loans

Fannie Mae Homestyle

There are many requirements associated with the Fannie Mae Homestyle loan. While the money is given out to pay for the home purchase at closing, the renovation funds are held until an approved contractor submits plans to the bank for the draw to get paid. Note that for a purchase transaction the borrowers cannot have rehab costs more than 75% of the lesser of:

• Purchase price + renovation Costs
• As Completed appraised value of the property

Pros

• Fixed and Adjustable Rate Mortgages (ARM) available
• Can be combined with other Fannie Mae products like HomePath or RefiNow

Cons

• Complete rebuilds, teardowns, or foundation reconstructions are not allowed
• Lots of additional paperwork including work proposal, standard renovation loan agreements, consumer renovation information, and more
• Renovations must finished within 12 months of the closing date

If you are looking for help with a Home Style loan, the Renofi Marketplace offers Home Style loan through lending partners to help you find lenders for your property.

Freddie Mac CHOICERenovation

CHOICERenovation loans can be used for single-family, multi-unit houses, second homes, or investment properties. Typically these loans allow borrowers to finance up to 75% of the home’s value after the improvements have been made.

Pros

• Lower down payments (3.5%)
• Lower credit scores can still get loans
• Useful for single-family homes and investment properties

Cons

• Requires additional time for more approvals
• Borrowers cannot have a personal or professional relationship with the home’s builder, developer, or seller.

3. Hard Money Rehab Loans

Private companies provide hard money rehab loans to borrowers who fail to qualify for traditional loans due to their income or credit limitations. These types of loans are considered “hard” because they are backed by actual assets like real estate. The approval process is quick, and the funds are available for urgent renovation projects and based on the property’s future value after repairs. 

Repayment of a Rehab Loan

Rehab loan repayment terms vary depending on the loan program or lender. Common repayment options include balloon payments and monthly installments. For a balloon payment, the borrower is required to pay a large portion of the loan at the end of the term.

Planning the renovation project beforehand helps you remain on track with loan repayments. Budgeting allows you to organize your monthly obligations and other renovation expenses. 

An emergency fund can cater to unexpected expenses arising during the project duration. You can refinance a rehab loan once your financial circumstances improve. You can refinance it at a lower interest rate or by extending the repayment period. 

Advantages of a Rehab Loan

Getting a rehab loan offers you the following benefits:

• Repairs and upgrades can increase the value of your home and increase your return on investment. 
• A limited 203(k) loan allows you to personalize your new home with value-added non-structural changes. Customization options include flooring, countertops, cabinetry, and paint colors. 
• The qualifications for a rehab loan are lenient regarding loan limits, debt-to-income ratios, and credit histories. 
• An FHA 203(k) loan requires a low down payment of 3.5% and leaves you with more cash for moving expenses and furniture. 
• You can streamline your monthly payments until you pay the loan fully. This is possible since you do not use all the funds at once during the project. 

Conclusion

Choosing the right home renovation loan can make or break your project. While traditional loans like HELOCs, personal, and FHA 203(k) loans have their place, they often come with limitations that can restrict your renovation plans. But RenoFi loans give homeowners a unique and flexible alternative. Here’s why more people are turning to RenoFi:

• Increased Borrowing Power: Traditional loans often limit you to borrowing up to 80% of your current home value. Alternatively, RenoFi allows you to borrow up to 125% of your home’s current value or 90% of its future value, whichever is lower. This means more money for your renovation project without the need to refinance.
• No Need to Refinance: With RenoFi loans, you can keep your existing mortgage and its low rate intact while accessing funds for your renovation. This is a huge benefit if you’re locked into a favorable rate and don’t want to refinance.
• Streamlined Process: Unlike other loans, RenoFi loans don’t require complicated draw schedules and inspections. This makes it easier to start and complete your project on time.

By leveraging your home’s after-renovation value, RenoFi allows you to borrow more without the need to refinance your existing mortgage or deal with complex draw schedules and inspections.

Unlike traditional loans, which are based on your current home value or require you to refinance, 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.

Explore your RenoFi loan options here.