Buying A Fixer-Upper: Mortgage Options

Purchasing a home with the intent of fixing it up in order to quickly resell it can be a very profitable adventure or it can be a money pit that drains your soul. That is why experienced property investors use the phrase “you make your money when you buy, not when you sell.” In other words, picking a home with the potential for profit is critical. Here are some tips on how to buy a fixer-upper and totally remodel it.

Advantages to Buying the Right Fixer-Upper

Buying an investment property with the intent of reselling it over the next 90 days (or 6 months) has some inherent advantages. Here are some of the most prominent reasons to buy a fixer-upper:

  • The ability to sell at a profit can be huge
  • Price of the home should be considerably cheaper than other homes in the area
  • Less competition from other buyers (only a few people will ever be interested in a home needing repair)
  • You will gain valuable knowledge about maintaining your own home

Keep in mind, all of this is contingent upon buying a home at a significant discount that allows you to make the repairs and still have equity in the home when you sell it.

The Ideal Fixer-Upper

Here are some guidelines to help you find a property that will potentially have strong profit potential.

Property Goals

  • Location – this single point cannot be overemphasized. The location of a home will impact its price more than any other factor. Avoid homes that are close to a manufacturing plant, or right along a busy road. If the overall neighborhood is considered unkept or impoverished, avoid that area as well. Ideally, you are searching for a home in a good neighborhood that demands a lot of attention from buyers.
  • Design of the home – take notes when you inspect the home. Are there walls in the way that prevents a nice feel or flow to the home? While it is possible to remove some walls and construct new walls in different places, that can be costly as well as structurally weaken the home.Is it tough to get from one bedroom to another? Is the master bedroom upstairs? Are the bedrooms at opposite ends of the home? All of these things will make it harder to sell once you have completed the repairs.
  • Match the home to the area – It is infinitely easier to sell a home that matches the majority of the homes in a particular area. If you find a 2-bedroom home for sale in an area that is filled with 3 and 4-bedroom homes, then it will be a tough sell. Likewise, if the property has a tiny yard and all the other homes around it have an acre or more of space on the lot, it will also be difficult to find a buyer.
  • Existing shape of the home – Some people that are experienced with multiple repairs and various parts of a home may be willing to buy almost any property and do the necessary work. However, for someone that is looking to buy their first fixer-upper, it may be a smart plan to seek out a property that only needs cosmetic repairs in order to make it saleable.

Types of Repairs

While each home will be different, the type of fixes necessary to get the home ready for its next owner will either be a simple and inexpensive fix or a more costly project. Here are some examples of inexpensive repairs:

  • Replacing carpet, adding tile or refinishing hardwood floors
  • Replacing the interior doors leading to bedrooms and bathrooms
  • Replacing glass panes in broken windows
  • Repainting walls or removing wallpaper
  • Installing new light switches and replacing worn out electrical outlets
  • Adding ceiling fan and/or adding overhead lights
  • Fixing a bathroom subfloor due to past leaks
  • Refacing existing cabinets in the kitchen and bathrooms
  • Painting the outside walls
  • Replace old baseboards

The above items can usually be completed by a person that is a bit handy and does not mind a bit of physical labor. The following items are a bit more costly and in some cases, may require the services of a licensed professional

  • Removing the existing roof and adding new decking, felt and roof shingles
  • Replacing the existing windows with complete new window frames
  • Replacing the entire heating and air conditioning system
  • Remodel a bathroom or kitchen
  • Replacing the electrical system
  • Replacing the plumbing system
  • Reinforcing or repairing foundation issues
  • Adding concrete walkway or driveway

Getting the Proper Inspections

It is a good idea to write out a contract to purchase a home that has contingencies based on various home inspections. This allows you the opportunity to have a professional view a home before you purchase to make sure that the home can be easily repaired.

Here are some of the most common inspections and what is covered. Keep in mind that some of these inspections may require upfront payment.

  • Sewer Inspection – With an older home, everything wears out, even the sewer pipes. This inspection determines the current shape of the pipes and their future viability.
  • Roof inspection – determines the current condition of the roof and provides an estimate for how long the roof should last before needing replacement.
  • Pest Inspection – This is always a good idea. The pest inspector will look for signs of an infestation from a number of different insects. You don’t want to buy a home that looks great on the outside but is actually in danger of crumbling apart due to bugs.
  • Home Inspection – Look for an experienced home inspector with a solid reputation. The inspector can walk through the entire home and point out any major problems that may exist.

Obtaining the Money to Buy a Fixer-Upper

One obstacle that prevents some people from investing in real estate is the financing. Getting a mortgage on a home that is in good shape and in need of little to no repairs is fairly easy. However, getting a loan of $245,000 for a property that is currently only worth $150,000 is much more difficult. The lender wants collateral that will be sufficient to cover the loan in the event the borrower cannot repay the mortgage.

Thankfully, there are 2 types of mortgages that can help a borrower to buy a fixer-upper AND totally remodel it.

How To Buy A Fixer-Upper: FHA 203k Option

FHA 203k Mortgage: How To Buy A Fixer-Upper

FHA 203k Mortgage: How To Buy A Fixer-Upper

FHA has a loan program referred to as the 203(k) loan. This loan will allow people to borrow money for the purchase of a home and also get additional funds for repairs and/or improvements.

The loan is offered in two ways. The first type of loan is the limited 203(k). As the name implies, there are restrictions on the loan. In laymen’s terms, FHA will allow a person to borrow enough money above the purchase price to make minor repairs, usually cosmetic in nature.

The most that a person can get for the repairs is $35,000 over the asking price of the home.

Common repairs that are made with the limited 203(k) are:

  • Replace or repair the patio, porch or deck
  • Repair or even replace exterior doors, the siding on the outside walls, or windows
  • Repair plumbing problems
  • Repair electrical problems
  • Repair or replace the roof along with the gutters
  • Repair minor floor problems

If the above issues do not use up the $35,000 it is also possible to remodel the kitchen and purchase all appliances for a kitchen.

The Standard 203(k) is much more expansive in the work that is allowed and the funds that can be borrowed.

In order to use this loan, the total amount of all necessary repairs and improvements must be higher than $5,000. A consultant approved by FHA must be used to review the home and the planned improvements. The consultant will perform an inspection of the home prior to purchase and review the estimate for work to be performed. The consultant will also oversee the home repairs until completion.

Borrowers can get 110% of the home’s value based on what the appraiser determines the home’s worth after the proposed work will be done. The most that a person can borrow for an FHA loan is $271,050 for a single-family home in most areas (view current FHA loan limits for your area and lookup multi-unit loan limits which will differ from single-family loan limits).

This is contingent upon the borrower being able to qualify for the full loan amount based on credit history, income, and debt ratios.

There are also some restrictions concerning the occupancy of the property. FHA expressly states that borrowers must intend to live in the home as their primary residence. However, FHA will also allow qualifying borrowers to purchase a 2-4 unit home.  The guidelines state the borrower has to live at one of the units and use it for their main dwelling. The homeowner is free to rent out the remaining units. This is a great way to start an investment portfolio since the loan limits are higher on multi-unit properties.

The loan will allow almost any type of repair, including adding on a room or demolishing the property and rebuilding.

Getting approved for the 203(k) standard and a limited loan is exactly the same as getting approved for a regular FHA purchase loan. Borrowers are asked to pay 3.5%* of the home’s sale price as a down payment. The down payment can be a gift from a relative. The borrower will need to meet the credit requirements, debt to ratio rules and also pay the FHA mortgage insurance fees.

How To Buy A Fixer-Upper: Fannie Mae HomeStyle Option

Fannie Mae HomeStyle Mortgage: How To Buy A Fixer-Upper

Fannie Mae HomeStyle Mortgage: How To Buy A Fixer-Upper

To compete with the FHA 203(k) loans, Fannie Mae offers the Homestyle Renovation loan.

This loan asks that borrowers pay at least 5% down of the home’s selling price. Certain credit restrictions will apply based on the down payment amount.

The Fannie Mae loan will allow borrowers a full 12 months from the closing to make all the necessary repairs and improvements. The loan does not impose a minimum to spend on repairs.

Borrowers are free to use the money for any type of work. The home can be repaired, improved, remodeled or even add energy improvements like better windows, seals around the doors, or energy saving appliances.

Borrowers are allowed to get a loan equal to 95% of the lower amount between the following:

  • The purchase price added to the repair/renovation amount, which is considered a cost basis
  • The appraised value of the home, allowing for the intended improvement

The HomeStyle Renovation loan will allow borrowers to receive as much as 50% of the home’s expected value for the repair and renovation work. Here is a hypothetical example to help you see how much a person can borrow.

Current asking price of the home $180,000
Maximum allowed for repairs $90,000 (50% of asking price)
Appraiser’s estimate of home after repairs $305,000
Combined repair plus asking price $270,000
Required 5% down payment $13,500
Total Loan amount $256,500
Potential profit if home sells for $305,000 $48,500

This does not take in to account any fees that may be paid to a real estate agent to assist with marketing the property nor any concessions that could be made to the borrower to help close the deal.

The funds used for the renovation will need to cover materials, labor, and any necessary inspection that is needed to meet with local, state and federal guidelines.

If you intend to pay the minimum 5% down you should be aware that private mortgage insurance will be assessed on the loan and need to be paid monthly until the property is sold.

The HomeStyle Renovation loan is also open to people that wish to live in the home, buy a vacation home or purchase an investment property. The investment property can be a single-family home or if you want to buy a multi-unit property up to 4 units, you can owner-occupy one unit and rent the others. This makes the loan very friendly to property investors looking for a way to start their portfolio.

Summing Up How To Buy A Fixer-Upper

If you are considering the purchase of a fixer-upper, it is vital to chat with a real estate agent and mortgage lender experienced with these types of projects. The real estate agent can help you find a potential property in a good area that should be easy to re-sell once the repairs are made. Likewise, the mortgage lender can help you get the best funding for your situation.

Between these two professionals, you should be able to locate and buy a fixer-upper that has a better than average chance of turning a profit at the final sale.

Additional Helpful Resources:
Costs to Fix Up and Repair a House via Mark Ferguson
Upgrades That Give Your Home the Most Value via Maria Mastrolonardo
Guide To Cracks In The Foundation via Joy Bender

Important Disclosure

*3.5% down payment on $193,000, 4.125% / 5.713% APR, 640 FICO, 30-year fixed rate mortgage. Mortgage insurance is required. Rates subject to change. Subject to credit approval.

 

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Filed under: Conventional Loans, FHA Loans, Home Buyers

Luke Skar

Luke Skar is the web developer and content strategist for Inlanta Mortgage in Madison, serving Wisconsin, Illinois, Minnesota and Florida. Guided by his 12-plus years of various mortgage marketing experience, Luke provides top-quality SEO services, effective social media management, and web development and maintenance. Luke’s career in the mortgage industry began back in 2001, as a loan processor. After becoming a loan officer for a number of years, Luke is now the sole owner/operator of madisonmortgageguys.com. To ensure that all the information he posts is fresh, accurate, and up-to-date, Luke relies on the knowledge which his years of dedication to keeping up with the constant change that the mortgage industry provides.

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