Rehabilitation mortgages are used to purchase homes that need major or minor repairs before the home is suitable to occupation. Right now, homes in New Orleans that were damaged in Hurricane Katrina are great examples of rehab mortgage loans. Some areas of New Orleans still sit vacant and are perfect areas for renovations.
In areas where homes are in short demand, rehab loans can help purchasers buy homes that need updating or major renovations. Once you have fixed up the home, you can sell it and recoup your money, rent it out or you can opt to live in the home yourself. You must verify restrictions with your lender because some will require you to live in the home for a period of time before you can use it for another purpose.
With a rehabilitation mortgage, you are borrowing the money needed to purchase the home plus the money needed to pay for repairs. If you take out a rehabilitation mortgage, make sure you spend your money wisely. It is common for people to take out loans and then use the extra to pay off debt and suddenly find themselves stuck in an awkward position because they have no funding to repair necessary items.
For a home to qualify for a rehab mortgage, it must meet certain criteria:
- Three-quarters of the walls must be structurally sound.
- The home is for one to four families.
- Cannot be a condo or mobile home.
- Repairs must meet the lender's limits.
To come up with a mortgage value for a rehab loan, you must find out how much the repairs will total. To this amount, add an additional amount for unexpected costs. You also need to find out how much similar homes in the area are selling for. If you pay too for your rehab mortgage, you will end up taking a loss when the home sells. Imagine purchasing a rehab home for $140,000 and then putting in $60,000 in repairs. If you take out a rehab mortgage for $200,000 and then try to sell the home down the road, the market may not be as strong and you will wind up losing money.
Experts suggest taking the average amount other homes have sold for and multiplying it by 65 percent. To this sum subtract the expected cost of repairs. Round up the repair estimate so that you have a little extra money just in case. Never take out a mortgage for more than the 65 percent figure minus the repair costs. This leaves you a cushion in case home prices decline.
FHA (Section 203k) rehab loans are the most popular because of the low interest rates. However, you must purchase a one-family home and must promise to live in it for a set amount of time. Other restrictions usually include not renting it to others and the home has to be more than a year old.
Loan terms are usually 30 years and fees are generally 1.5 percent. Homeowners must pay for up to five inspections, the title, credit check fees and appraisal fees. Most banks will require paperwork showing the renovations that will be made and a final estimate that lists all costs and repairs. Not all banks will add the closing costs into your loan, so make sure you verify this before closing.
It is also important to check with your state. With the Internet, people are doing their banking and searching for mortgages online to get competitive rates. Many online rehab mortgage firms are not allowed to offer rehab loans in Alaska, California, Hawaii, Louisiana and Vermont. Shopping online for the best rates can be tricky in these states.