Why You Should Know About 203K Renovation Loans

If you’re thinking of buying an existing lake home or cabin, you may want to consider a renovation loan.  Here’s what it is and how it can benefit you.

Although these loans have been around for decades, they’ve never been especially popular.  But in today’s market, and at today’s low interest rates, they’re a great solution for a lot of  buyers.  Suddenly, banks are talking about them more, too.

So what exactly is a renovation loan?  First, here’s what it’s not: it’s not a second mortgage, and it’s not separate add-on loan to cover the cost of renovations.  Instead, it’s a single loan that covers the purchase price and the cost of renovations—sometimes even major renovations that bring the loan amount to well over the purchase price.

The details vary, depending on whether your renovation is a Standard FHA 203(k), FHA 203 (k) Streamline, or conventional renovation loan.  But in general, here’s how it works.  You find a home or cabin you love, but it needs work.  Get a contractor involved immediately.  Plan your renovation, get an estimate, and talk with a banker.  Your appraisal will based on the home’s value after the renovation.

How you use a renovation loan is up to you.  Depending on the type of renovation loan, you can use it for “health and safety” issues, livability improvements, repairs to well and septic, structural repairs, and even luxury items.  Maximum amounts, depending on the type of loan, are $35,000, 75% of the after-improved value, or “none.”  This means qualified buyers can actually obtain a loan covering renovations that cost more than the home’s unimproved value.  And for some properties, that’s what it’s going to take.

Some loans come with restrictions.  The FHA renovation loans can only be used for owner-occupied homes (including multifamily homes of up to four units), but conventional renovation loans can also be used for second homes and for investment properties of up to four units.  If your contractor advises caution about certain variables, you can also set aside a contingency reserve.  For qualified buyers, downpayments at some banks can be as low as 10% of the total loan amount.

You could use a renovation loan for situations like these:

• You’ve found a lake cabin that’s nearly perfect.  You’re not excited, however, about the avocado appliances and the orange shag carpeting from 1972.  You could probably dig up enough cash to cover the $7,000 these minor updates would cost.  But you’d rather not.
• You’ve fallen in love with a home in the country, but an inspection reveals that its septic tank is failing.  The seller doesn’t have the $5-10,000 needed to fix it, and you don’t, either.
• You’ve found a great deal on a three-season cabin that overlooks a beautiful lake.  You know banks aren’t always eager to make loans on properties like these, and you’d also like to use the cabin for more than four months of the year.  It’s small, but maybe you could add on a bedroom and a screened-in porch.  That, plus the insulation and plumbing upgrades to make it livable year-round…  This is going to cost a few dollars.  But you’ll end up with a year-round lake home that’s big enough so you could live there after retirement.
• You’ve found a great deal on a foreclosure that’s been standing empty for three years.  At just under $100,000, it’s a steal.  But it has some major issues, and the renovations required to make it livable will very likely cost that much or more.  Your contractor also wants to build in a contingency; he says it’s possible there’s hidden damage from that winter two years ago when the plumbing froze.

So what’s the catch?  These loans sound great, but why would a bank want to offer them?  If you think about it from the bank’s point of view, these examples are part of the explanation.  Short sales and foreclosures.  Properties with dated decor, and sometimes far more serious issues.  Distressed properties that have deteriorated even further after standing empty for two or three years.  Banks are finding that for the average buyer it takes special financing to make deals like these work.  And as long as banks are confident that you’ll be able to repay the loan, they’re happy to lend you a little more.  You are, after all, paying interest.  If someone ever did default on one of these loans, the bank would at least own a home that’s nicely renovated and much easier to sell to the next buyer.

As always, you’ll want to talk with your banker and financial adviser about the details.  Renovation loans aren’t for everyone.  But for the qualified buyer, they can be a great opportunity to make needed renovations while still preserving your cashflow.  Today’s interest rates are at historic lows, and these loans may give you new options.  To talk more about how you might take advantage of those options with specific types of properties, please give me a call.

Later, when we find the home or cabin that’s right for you, it may or may not require the sort of improvements or repairs that would involve a renovation loan.  If it does, let’s be ready to call a contractor for an estimate and contact your banker to ask about a renovation loan.