To understand the country’s obsession with home renovation, turn on HGTV. The cable television channel features series such as “Property Brothers: Buying and Selling,” “Love It or List It,” “Fixer Upper,” “Rehab Addict” and even “A Very Brady Renovation,” in which reality TV stars show viewers that their dream home is right in front of their eyes. It’s just hidden behind the unattractive house they’re staring at.
The broad appeal of these shows mirrors the collective mindset of current and prospective homeowners. It also works well with the dynamics of today’s housing market.
Inventory is tight, affordability is challenging and the homes for sale are often older, less-than-ideal properties. So, buying and renovating makes sense for a variety of consumers: first-time and move-up homebuyers, those who are aging in place and even households that are downsizing.
Nationwide, renovation projects remain strong. Harvard University’s Joint Center for Housing Studies projected record spending of $331 billion in 2019. With this groundswell of interest, the one element that is largely lacking from these well-watched TV series is that none really get down to the nitty-gritty of financing (or refinancing) options available to borrowers.
This lack of understanding extends to real estate agents and mortgage originators. These professionals often steer borrowers away from renovation loans because they don’t have experience with the available products.
The knock on renovation loans is that they are complex, require a lot of paperwork and are difficult to get approved. Although there may have been some truth to this in the past, government entities have been streamlining their programs, making them flexible and useful in many more situations.
Today, Freddie Mac and Fannie Mae, as well as the U.S. Department of Veterans Affairs (VA) and Federal Housing Administration (FHA), have significantly enhanced their renovation offerings. One of the latest examples is Freddie Mac’s CHOICERenovation program. Announced this past summer as part of Freddie’s All For Home initiative, it provides homebuyers with a flexible choice to purchase a home and finance renovation costs with a single-close mortgage.
The CHOICERenovation mortgage also may be used to renovate or repair a property that has been damaged in a natural disaster, or for renovations designed to prevent damage from a future disaster, such as storm-surge barriers, foundation retrofits or retaining walls. The loan has two components: The first finances the purchase price or the outstanding balance of an existing loan. The second finances the renovation costs which, as the project meets certain milestones, assures additional balances are funded until the project is complete.
This program is similar in many respects to Fannie Mae’s HomeStyle Renovation program. The biggest differences appear to be the base-product underwriting guidelines and the use of different automated underwriting systems — Freddie Mac’s Loan Product Advisor and Fannie Mae’s Desktop Underwriter. There are more specific differences, too.
- Freddie’s CHOICERenovation has a higher loan-to-value (LTV) ratio for three- and four-unit properties (80% vs. 75%).
- CHOICERenovation has a higher LTV on rate-and-term refinances for investment properties (85% vs. 75%).
- CHOICERenovation allows a contingency reserve of up to 20%, compared to 15% for Fannie’s HomeStyle loan.
One aspect of the programs from the government- sponsored enterprises (GSEs) that is often overlooked is their flexibility when it comes to financing luxury items. So, adding a pool or a patio as part of a purchase or renovation is an option with the GSEs’ programs.
Another program that is frequently misunderstood and, as a result, is often overlooked, is the VA renovation program. Both the VA and FHA have minimum property standards. With an aging housing stock, deferred maintenance is an issue for many properties.
The low end of the market has been advantageous to sellers for some time, so many sellers have been resistant to making repairs and instead tell their Realtors that they won’t accept VA financing. This is unfortunate because it limits their pool of buyers and disadvantages veterans, who can qualify for 100% financing of the purchase and the needed improvements.
Qualifying for these loans doesn’t require too much extra effort. The major difference between a VA renovation loan and a standard VA or FHA loan is that the buyer has to get his or her contractor vetted, which is a fairly simple process. The buyer fills out a questionnaire and the lender conducts its due diligence to make sure the contractor is licensed and insured. The contractor also provides the lender with a bid for the repairs. This goes to the appraiser, who then calculates the property value based on the completion of the renovations or repairs.
Why should a borrower use a renovation loan over other options, such as refinancing or a home equity line of credit (HELOC)? Renovation loans usually have fixed rates and include longer terms than a HELOC. When you look at the pricing and the monthly payments, a renovation loan may be equivalent or better.
Also, refinances and HELOCs usually limit the LTV to 80% to 90%, based on the current value of the property. With a renovation loan, the appraisal is based on the higher, after-completed value and the standard LTV guidelines can go up to 95% or higher.
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The largest obstacle to broader adoption of available renovation products is the lack of knowledge among consumers and mortgage brokers. A recent Fannie Mae report, for example, stated that homebuyers believe mortgage and renovation financing are two separate steps. “They have no knowledge of the opportunity to combine the mortgage payments with the renovation financing, much less the financial and tax benefits that come from combining the two steps,” the report stated.
The study concluded that conventional loans maintain a comfort level for everyone in the process, including the buyer, Realtor and lender. And, interestingly, Fannie Mae found that buyers would have considered a different property, or even refinanced their current property, if they had known they could finance renovations with one loan. So, take the lead from HGTV and consider riding the renovation wave.