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As I speak to clients looking to purchase a home or small income apartment building, they often report not finding any appealing properties for sale in areas where they are looking. I have read Realtors are expressing similar sentiments in that in many markets the newest, most updated homes will generate more interest and may go under contract very quickly. This situation can also result in multiple offers for the most appealing properties, which can compel Buyers to bid higher than the list prices.

One of the reasons there may be low inventory across many areas of the country is due to low mortgage rates available in 2020 and 2021. There may be owners who prefer to hold onto their properties and the low mortgage rate they have rather than sell and move up to a different home. Selling and buying a different property may result in a higher mortgage rate than one from 2020 or 2021, meaning a higher housing expense. That situation can reduce the supply of homes coming into the market for sale anywhere in the country.

I’m writing from where I live in Chicago. The housing stock locally can be older in many neighborhoods, dating back to the late 19th century and early 20th century. There is also some amount of newer construction locally but in an older city like Chicago there may not be much land that has not been built on already. The same can be said for older, close in suburbs.

Today I want to offer a potential solution for the low housing inventory circumstances you may encounter in many markets. The solution can be to buy the worst house in your preferred location other buyers have passed on, using one of the several types of renovation mortgages available. What I’m saying is, if you are competing with others for a limited supply of move in ready homes for sale in the area you want to live, where most of the move in ready homes sell very quickly, or even may sell for over list price, consider purchasing an old, outdated, or even damaged home and improving it with a renovation mortgage. This type of mortgage allows a Buyer to close on a home that may not even be inhabitable if all deficiencies and damage will be repaired by the renovation mortgage after closing. Doing this can be helpful to a Seller who does not wish or cannot afford to repair a property to sell it. I have seen estate sales for example, where the heirs are anxious to sell the property without spending dollars to make it more appealing or even to make it functional again. Estate sale homes are perfect candidates for a renovation mortgage.

A renovation mortgage is very similar to a typical 30-year term mortgage you might use to buy any home except it allows you to add in the cost of updates and repairs into that same 30-year term mortgage. The result is one first lien mortgage, with one monthly payment, one fixed interest rate, that gives you all the funds needed for repairs, updates, restoration, etc. The costs of repairs are financed across all 30 years of the mortgage which make it more affordable on a monthly basis to do the rehab work at purchase time and enjoy the improvements now. Not to mention any potential increase in value with improvements.

The reason why a renovation mortgage can work for you is because the loan approval is based not on what you may pay for a home, but instead on its After Renovated Value or ARV. In this way the renovation mortgage will close and allow you to buy a home in unappealing, outdated, degraded or even unlivable condition, all based on its as to be completed or finished value or ARV. The repair work begins after loan approval and closing on the property using the funds added to the mortgage for all renovations. The Seller is not responsible for repairing anything with a renovation mortgage no matter what condition the property may be in or how scary it looks.

This approach may work well in areas where there are few homes for sale and those that remain on the market are old or unappealing to today’s buyers. This allows a Buyer to consider a less appealing home but be in the area they wish to live, then remake that home into exactly what they would prefer it to be after closing on it with a renovation loan. It may be an older home, that buyers find unappealing, and may even sell at a discount due to its poor condition in a given area.

The renovation mortgage process is, after a home is identified, an offer accepted by the Seller and put under contract, the Buyer visits the property with their General Contractor who writes up the renovation cost and detailed rehab proposal. Once we have that renovation proposal with all costs documented we know the dollars to be added into the mortgage in addition to the purchase price, minus down payment, for a loan application to be done and approval process begins. As part of that loan approval process, we submit the General Contractor proposal to an Appraiser. This is the unique aspect of a renovation mortgage. The Appraiser will search for area sales comparables of similar sized properties that already have been rehabbed and arrive at an appropriate After Renovated Value. Ideally the ARV will be more than the sale price and renovation costs combined and the Buyer will have created additional equity by doing the renovation at purchase time.

Before I present a renovation purchase example, I want to review the various types of renovation mortgages available today-

  • VA Renovation for Veterans and Active Duty Military- can be 100% financing
  • FHA 203K for 1 to 4 unit owner occupied properties – minimum 3.50% down payment
  • Conventional Choice or HomeStyle for 1 to 4 unit properties- minimum 5% down payment for owner occupied single family; minimum 15% down payment for Investor rental single family homes; minimum 15% down payment for owner occupied 2 units or duplex properties; minimum 20% down payment for 3 or 4 unit owner occupied triplex or quad properties; single unit vacation homes minimum 10% down payment – (1 unit properties can include approved condominiums or townhouses)
  • Jumbo Renovation for larger than Conventional loan limit renovation mortgages on single family owner occupied homes – minimum 20% down payment; interest only payments first 12 to 24 months

Here is an example of what the circumstances can be for an unappealing single family home still for sale in a Buyers preferred location, where all the other homes have already sold due to lack of inventory-

Sale Price$300,000(whatever condition property is in)
Renovation dollars added$75,000(new kitchen, new baths, new flooring, etc.)
Total Buyer cost$375,000(one cost with renovation + sale price)
Minimum 5% down payment$18,750(Conventional Choice or HomeStyle
Renovation loan is used; 5% of $375,000)
Mortgage Amount$356,250(95% of sale price is financed +
renovation costs or 95% of $375,000)
30 Year Mortgage Rate6.50%APR 7.497%
Term30 Years
Monthly Principal & Interest$2251.74Taxes, Insur. & Private Mort. Insur. excluded
After Renovated Value$395,000(based on similar sized homes already updated)

In this example the Buyer has realized additional or hidden equity by adding into the transaction cost the $75,000 of renovation to the sale price of $300,000 but has an ARV beyond that by $20,000 with the as to be completed value appraised to be $395,000.

Note the 5% down payment is calculated off the total of sale price + renovation dollars. That is how a first lien renovation mortgage works. In this way the purchase price, minus the downpayment plus the renovation cost are financed into one 30 year term mortgage.

A first lien renovation mortgage is a very efficient way of adding dollars for renovation at purchase time, completing the work perhaps before even occupying a property and realizing the hidden equity, now, as well as enjoying the improvements to the house now, rather than waiting to do the rehab in the future with funds from some other source.

The owner occupied renovation mortgages above also allow an owner occupied Buyer to add in up to 6 months of total mortgage payment funds into the loan as well. In this way if the property cannot be lived in for up to 6 months, the payments are included and automatically made each month so a Buyer does not have the expense of living elsewhere while also paying the mortgage on a house under construction that cannot yet be occupied.

None of the renovation mortgages above have a pre-payment penalty. That means should interest rates drop after the renovation is completed, the owner may refinance into a new mortgage, pay off the renovation loan and have a potentially lower housing cost in the future.

A renovation mortgage used with a home purchase can be one solution for the challenge of a low supply of homes for sale by allowing a Buyer to consider old, outdated, dilapidated, unappealing properties that are left on the market. Plus, the Buyer may realize additional equity with an ARV over what the renovation costs and sale price paid for the home total out to have been.

Most any market around the country may have a home listed for sale for a long time or one that has been under contract but then fallen out of contract. That may be a hint there is a defect that is scaring buyers away who do not know about renovation mortgages. Or just look for the ugliest, scariest home in the area you prefer that is not selling. That home may be a perfect solution for low supply by using a renovation mortgage to make it as appealing as the homes that are selling more quickly or selling for over list price in the area.

Perry Farella NMLS ID: 755943

Loan approval and terms are dependent upon borrower’s credit, documented ability to repay, acceptability of collateral property, and underwriting criteria. The payment example provided only includes principal and interest. Additional fees and closing costs apply. All information based on a 704 credit score as of April 13th, 2023. Rates and terms subject to change without notice.

FCM NMLS ID 629700