One way to find your dream home is to purchase a fixer-upper, find a contractor and start renovating. These custom loans can help to take on such a project. Let us introduce you to the Fannie Mae HomeStyle and FHA 203(k) construction loans that are designed to finance properties where conventional loans aren’t applicable or for homes that have been sitting for a while.
How Are These Loans Similar?
It is important to understand that a construction loan is not as simple as a conventional loan. It’s a great option for a specific set of circumstances, but if you are looking to use it for a multi-property or a DIY renovation there may be other loan options that will be a better fit. That said if you are looking to hire a contractor for your renovations an FHA 203(k) or Fannie Mae HomeStyle loan may be right for you!
Both of these construction loans follow the same guidelines as a regular mortgage. The major difference is the appraisal, which with these loans is based on the value of the property once the construction is completed. Both have money put into escrow at closing for renovations which is allocated to contractors when they meet project milestones. Both can be used as a refinance option when a renovation is involved. The borrow rate for either the Homestyle loan or FHA construction loan is about ½ percent higher than conventional loans or a standard FHA loan.
If you run into emergency issues, there is a contingency reserve that is added to the loan, about 10-15%. This can only be used for additional issues found, ie. you open up a wall and discover mold that needs to be remediated. The reserve can not be used to add on more improvements, or inspection and other closing fees.
Finding a contractor that you trust, is available and has produced a contract at a set price is essential for using a 203(k) or HomeStyle loan. They’ll need to produce proof of licensing, liability insurance, references, and to sign a contract for the work to be done, at a set price, prior to closing.
How Are They Different?
Deciding factors on which construction loan to use comes down to your finances, credit score, and what you want to accomplish in your renovation. FHA 203(k) loan is a bit more lenient with credit score and financial requirements vs the HomeStyle but it has tighter restrictions on renovations. For example, with FHA you can fix a pool but not build a pool, with the Homestyle loan you can build one. It’s important to discuss your design plans with a lender so there are no surprises about what will be approved. A Homestyle loan may pay for landscaping but excludes luxury items such as an outdoor brick fireplace, or items used exclusively for decor. Think function and permanently fixed when using a construction loan.
To utilize an FHA renovation loan, you’ll also hire a 203(k) consultant if the repairs are substantial, which is regulated by HUD ( Department of Housing and Urban Development). It's a cost that is due up-front but can be financed (aka come back to you at closing). At the consultation, the minimum repairs, as well as the ones you have in mind, will be identified. With that, the appraisal can be ordered.
Although a consultation isn’t necessary for a HomeStyle loan, many lenders recommend or even insist on this for their clients. There is a lot of preparation for a construction loan. You will need your contractor in place in order to save time and meet required deadlines that will affect your approval process. Hiring a renovation/203k consultant allows you to know what to expect and how to prepare.
Home inspections combined with a 203K or Homestyle Consultation will be discounted to $399