What Is Conventional Rehab Loan? A Step-By-Step Guide

Last Updated on November 4, 2024 by Amrita Das

If you are considering buying a fixer-upper as your next home, you may be concerned about the cost of necessary repairs and upgrades. Although you may have enough money in savings to cover these expenses, it may still not be prudent to spend them all at once.

In this case, you can think about conventional rehab loans. These loans are specifically designed to help homeowners finance renovations and repairs to their homes, making them an ideal option for those looking for a more affordable way to purchase a fixer-upper.

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With a rehab loan, you won’t have to drain your savings or worry about taking out multiple loans to cover the costs. Now you may want to learn more about these loans so keep reading this guide to explore everything you need.

What Is Conventional Rehab Loans?

Conventional rehab loans are a financing option that allows borrowers to purchase homes in need of repairs, remodeling, or updates.

This type of loan combines the cost of purchasing the home with the cost of renovation, making it an ideal solution for those looking to buy a home in less-than-perfect condition.

By choosing a rehab loan, borrowers can avoid taking out additional loans or accumulating credit card debt to cover the cost of repairs.

This not only saves them from financial stress but also provides them with the opportunity to preserve their savings account for other expenses.

While this type of loan follows the guidelines of a traditional conventional mortgage, it offers a unique advantage by allowing borrowers to finance both the purchase and renovation of a home in one loan.

How Do Conventional Rehab Loans Work?

Step 1: Applying for the Loan Product

The first step in securing a rehab loan is applying for a loan product through a lender. As with any mortgage, you will need to provide documentation such as income verification, credit history, and debt-to-income ratio.

If you have been pre-approved, the lender will inform you of the specific terms for your loan, including the amount of down payment that will be required.

Step 2: Submitting Contractor Plans

After receiving approval for the loan, the next step is to obtain contractor plans for your renovation project. These plans will then need to be submitted to your lender for their review and approval.

The plans should include a detailed breakdown of the improvements that will be made and their associated costs.

Step 3: Appraisal and After-Repair Value

Once the contractor plans have been approved by the lender, they will send an appraiser to assess the property’s after-repair value (ARV). This value takes into account the improvements outlined in the contractor’s plans.

The ARV will be used to determine the total loan amount, including the cost of both the home purchase and renovations.

Step 4: Closing on the Home and Commencing Renovations

Once everything is in order, you can proceed with closing on the home and commence renovations. It is important to note that most conventional rehab loans require renovations to be completed within six months.

However, some lenders may allow for a longer timeframe of up to one year for approved projects. It is crucial to stick to this timeline as any delays could result in additional costs or even the loss of the loan.

Different Types Of Conventional Rehab Loans

There are two main types of conventional rehab loans available – the Fannie Mae HomeStyle Renovation Loan and the Freddie Mac CHOICERenovation loan.

Fannie Mae HomeStyle Renovation Loan

The Fannie Mae HomeStyle Renovation Loan is an excellent option for those looking to combine home purchase and renovation into a single, manageable mortgage.

This means you pay closing costs only once and make a single monthly payment. Here, you can choose between adjustable or fixed interest rates, typically lower than those for home equity loans or lines of credit.

Loan Limit:

Standard Markets: Borrow up to $548,250 for single-family homes.

High-Cost Markets: Borrow as much as $822,375 in pricier areas.

Multi-Unit Properties: Up to $685,400 for four-unit properties, and $1.5 million in high-priced markets.

Manufactured Homes: Limited to $50,000 or 50% of the post-renovation value.

Usage: You can fund most home improvements and cover temporary living expenses during construction (within 6-12 months of closing). However, keep in mind that you cannot use these loans for the following purposes:

Building a second property
Temporary improvements
Demolishing the current property

Flexible Loan Terms: Opt for a 15- or 30-year loan term.

Requirements:

Credit Score: Minimum score of 620.

Debt-to-Income Ratio: Ideally, no more than 45%.

Points to Consider: If you already own the home, you’ll need to refinance your existing mortgage, which could result in a higher interest rate.

Freddie Mac CHOICERenovation Loan

The Freddie Mac CHOICERenovation loan helps cover renovation costs for investment properties, second homes, and multi-unit properties. Here’s what you need to know:

Loan Amount: You can borrow up to 95% of the home’s value after renovations.

Usage: You can use this loan to renovate a property you plan to buy or one you already own. If you already own the property, you’ll need to refinance your mortgage, which might result in a higher interest rate.

Flexibility: This loan is more flexible than the Fannie Mae HomeStyle Renovation Loan. You can use it for most upgrades and also for repairs to protect the property from natural disasters.

Terms: Loan terms of 15 or 30 years are available.

Requirements:

Down Payment: At least 3.5%

Credit Score: Minimum of 660

Debt-to-Income Ratio: Should not exceed 43%

If you plan to do the renovations yourself and finish before closing, you might be eligible for a down payment credit.

Understanding the Freddie Mac CHOICERenovation loan is now simpler, making it easier for you to decide if it’s the right option for your renovation needs.

Additional Reading: What Is Caveat Loans? A Step By Step Learning

Understanding Eligibility For Conventional Rehab Loans

Considering a rehab loan for your renovation project? Let’s break down the eligibility criteria so you can see if this financing option fits your needs.

Meeting the Criteria for a Rehab Loan:

Credit Score and Financial Health

Having a solid credit score is crucial. Most lenders look for a score of 620 or higher, but some might need 660 or above. Before you apply, check your credit report and ensure your financial health is in good shape.

Down Payment and Financial Ratios

The down payment usually starts at 5%, but under certain conditions, it can be as low as 3.5%. Your DTI ratio, which compares your monthly income to your monthly debts, should ideally be no more than 43%.

These numbers are key to getting your loan approved.

Preparing Your Application:

Documentation Checklist

When you’re ready to apply for a conventional rehab loan, gather these documents:

Gathering Financial Documents

To support your application, you’ll need to provide financial statements that demonstrate your stability as a borrower. This includes bank statements and other records that showcase your assets and liabilities.

Lenders will also require income verification documents such as pay stubs, W-2 forms, and tax returns from the past two years to confirm your earnings.

Before you initiate the application process, it is important to have all necessary documents prepared.

Preparing Renovation Plans

In addition to financial documents, you’ll also need to submit detailed renovation plans and contractor estimates as part of your application.

These will outline the scope and cost of your project and provide lenders with a clear understanding of how the funds will be used.

It’s important to work closely with your contractor to ensure accurate and comprehensive renovation plans are submitted.

Property Appraisal

As with any loan, a property appraisal is required for these loans. This assessment will determine the current value of the property and project its future value after renovations.

Lenders will use this information to determine the loan amount they are willing to provide.

It’s helpful to do some research on comparable properties in the area to get an idea of the potential increase in value after renovations.

Consulting with Your Financial Institution

It’s always a good idea to consult with your financial institution before applying for any loan, especially a l rehab loan.

Each lender may have unique requirements and it’s important to understand what documents are needed and their specific criteria for approval.

By consulting with them beforehand, you can ensure a smoother and more efficient application process.

Understanding Loan Terms And Renovation Requirements

Interest Rates and Loan Terms

When considering a rehab loan, it’s crucial to understand the terms and interest rates that will affect your overall financing.

These loans typically offer 15 or 30-year terms, providing you with flexibility in managing your finances over time.

However, keep in mind that your credit score and financial health can impact the interest rate you receive. It’s essential to carefully consider all associated costs, including down payments and closing fees before committing to a loan.

Property Eligibility for Renovations

One of the significant advantages of conventional rehab loans is the broad range of eligible properties. Primary residences, second homes, and investment properties can all qualify for this type of loan.

However, it’s important to note that the property must be habitable after renovations are complete.

This means that the range of allowable renovations is extensive, encompassing everything from minor enhancements to major expansions.

In fact, luxury and energy efficiency improvements may even be approved if they add value to the home.

Contractor Qualifications and Timelines

A crucial aspect of conventional rehab loans is selecting a qualified contractor to complete the renovations.

Lenders typically require that contractors be licensed professionals who have had their renovation plans approved before releasing any funds.

It’s essential to communicate the project timelines with your contractor, as lenders expect renovations to commence within 30 days of loan closing and be completed within 6 months to a year.

As such, it is crucial to select a contractor who understands and can meet these timelines in order to avoid any potential issues with your loan.

How To Apply For A Conventional Rehab Loan?

Here are some important steps to follow when applying for a rehab loan:

Understand Your Options

The first step in getting a rehab loan is understanding what it is and how it differs from other types of loans. As I earlier discussed this loan is a type of mortgage that helps finance the purchase and renovation or repair of a property.

It differs from other types of loans in that it allows borrowers to include the costs of renovations or repairs into their mortgage, making it a one-time closing process.

Find a Lender

Once you understand your options, the next step is to find a lender who offers conventional rehab loans. It’s important to do your research and compare rates, fees, and terms from multiple lenders to ensure you get the best deal possible.

Gather Necessary Documents

Like any other loan application, you will need to provide certain documents to support your application for a rehab loan. This may include personal financial statements, tax returns, and proof of income.

Your lender will also require a detailed renovation plan from a licensed contractor.

Get Pre-Approved

Before you start looking for properties, it’s recommended to get pre-approved for a rehab loan. This is good for getting an idea of how much you can borrow and will make you a more attractive buyer.

Find the Right Property

With pre-approval in hand, you can now start looking for the perfect property. Keep in mind that the property must meet certain criteria set by your lender, such as being in need of repairs or renovations.

Submit Your Application

Once you have found a suitable property, it’s time to submit your application for this loan. This will include all the necessary documents and a detailed renovation plan.

Your lender will review your application and notify you of their decision.

Close on Your Loan

If your application is approved, the next step is to close your loan. This typically involves signing legal documents and paying any closing costs or fees.

Begin Renovations

With your funds now available, you can begin your renovations or repairs on the property. It’s important to stick to your budget and timeline outlined in your renovation plan.

How Long Does It Take To Get Approved?

The timeline for getting approved for conventional rehab loans can vary depending on different factors such as the complexity of your financial situation, the lender’s workload, and potential delays in appraisal or document submissions.

It is important to keep in mind that the mortgage process requires thorough review and verification of all financial documentation, which can take some time.

However, with proper preparation and communication with your lender, the process can be completed within 60 to 90 days on average.

It is also important to note that conditional approvals may require additional information or documentation, which can further extend the timeline for final approval.

Ultimately, the key to a smooth and timely approval process is to stay organized and responsive throughout each step of the mortgage process.

Difference Between Conventional Loan And Rehab Loan

While both conventional loans and rehab loans are used for financing the purchase of a home, there are significant differences between the two.

A conventional loan is a standard mortgage that follows strict guidelines set by private lenders, requiring a down payment of up to 20% of the home’s value.

On the other hand, a rehab loan is specifically designed to help cover not only the purchase price but also renovation costs in one single loan.

This gives borrowers more flexibility and convenience when it comes to financing their home renovations.

Additionally, qualifying for a rehab loan may be easier than for a conventional loan, making it an attractive option for those looking to purchase a fixer-upper.

It’s important to carefully evaluate your personal financial situation and the condition of the home before deciding between a conventional or rehab loan.

Benefits Of Conventional Rehab Loans

Flexibility in Financing

One of the major advantages of rehab loans is the flexibility they offer in financing.

Unlike traditional mortgages, which require separate loans for purchasing a home and making renovations, these loans allow you to combine both costs into one mortgage product.

This can save you time, effort, and potentially money by avoiding needing multiple loans or paying out of pocket for renovations.

Additionally, conventional rehab loans are not subject to the same strict rules as government-backed loans like FHA or VA loans.

This means that there may be more options available to you and less paperwork involved in the loan process.

Opportunity for Property Appreciation

Another advantage of conventional rehab loans is the potential for property appreciation. By purchasing a fixer-upper with this type of loan, you have the opportunity to increase the value of your property through renovations.

As the market and property values in your area rise, your newly renovated home may continue to appreciate in value even further.

Lower Home Ownership Costs

Using conventional rehab loans for a fixer-upper can also lead to lower overall homeownership costs. For one, you may be able to purchase the property at a lower price than a fully renovated home would cost.

Additionally, by combining both the purchase and renovation costs into one loan, you can avoid multiple loan fees, appraisals, and closing costs.

Finally, by using loan funds to address potential maintenance issues upfront, you may be able to reduce ongoing maintenance costs in the long run.

Overall, a rehab loan can make homeownership more affordable and manageable for those looking to purchase a fixer-upper property.

So, these loans provide numerous advantages that make them an attractive option for financing home renovations.

Conventional Rehab Loans Limitations

Challenges with Eligibility

One of the main disadvantages of conventional rehab loans is the stricter eligibility guidelines. This can make it difficult for some borrowers to qualify, especially those with less than perfect credit or irregular income.

This can be a major hurdle for individuals who are looking to finance their renovation projects and may limit their options for obtaining funding.

Furthermore, the requirement for a larger down payment can also pose challenges for eligible borrowers.

Not everyone has the financial means to provide a large sum upfront, which could impact their ability to take advantage of this loan option.

Limited Loan Amounts

Another drawback of conventional rehab loans is the cap on the loan amount. This means that you may not be able to secure enough funding to cover all your desired renovations.

This could lead to having to scale back your plans or seek alternative financing options, which can be a time-consuming and complicated process.

Additionally, the limited loan amounts may not be suitable for larger projects, leaving borrowers with no choice but to look for other financing options.

This can be frustrating and overwhelming for individuals who were counting on a rehab loan as their primary source of funding.

Complex Renovation Process

While renovating any property can be challenging, managing the process with a rehab loan can be even more difficult.

The detailed plans and strict budget requirements may limit your choices in terms of contractors, making it harder to find someone who meets the lender’s criteria.

Furthermore, working closely with a contractor and coordinating the renovation process can also be time-consuming and stressful. Any delays or unexpected costs could cause setbacks and possibly jeopardize the completion of your project.

This can be overwhelming for borrowers who are already juggling other responsibilities related to their renovation project.

Therefore, while conventional rehab loans offer many benefits, they do come with several disadvantages that should be carefully considered before choosing this financing option.

Learn More: True American Loan | Everything You Need To Know

Navigating The Loan Process: A Step-by-Step Learning

What You Need to Know Before Applying for a Rehab Loan

The loan process can be overwhelming, especially if you are a first-time homebuyer or looking to finance a major renovation project.

Understanding the steps involved and being prepared with the necessary documents can make the experience smoother and increase your chances of getting approved for conventional rehab loans.

First and foremost, it is important to have good or excellent credit before applying for any type of loan. Lenders rely heavily on your credit score to assess your financial responsibility and capability to repay any loans you may take out.

Additionally, having a down payment of at least five percent is typically required for conventional rehab loans.

Keep in mind that some lenders may require up to 20 percent down and any amount below 20 percent will likely require private mortgage insurance.

Furthermore, having an acceptable debt-to-income ratio is crucial when applying for rehab loans.

This ratio compares your monthly income to your monthly debts and helps lenders determine if you can afford the additional mortgage payments for the renovation costs.

The Cost Related to the Loans

When it comes to rehab loans, it is crucial to have a clear understanding of all the expenses involved.

This will not only help you make well-informed decisions but also allow you to effectively budget and manage your finances throughout the process.

Down Payment

The down payment for conventional rehab loans typically ranges from 5% to 20% of the total loan amount.

This means that you will need to have a significant amount of cash on hand before applying for this type of loan. It is important to carefully consider your financial capabilities and choose a down payment amount that works best for you.

Closing Costs

In addition to the down payment, there are also various closing costs associated with rehab loans. Some common cost associated with loan processing include origination fees, appraisal fees, and additional expenses.

It is important to carefully review these costs and factor them into your overall budget for the project.

Interest Rates

The interest rates for rehab loans can vary depending on factors such as your credit rating and the amount of the loan. Generally, a higher credit score and better financial stability can lead to lower interest rates.

It is important to shop around and compare different lenders to find the best interest rate for your specific situation.

Rehabilitation Expenses

One of the main expenses involved in rehab loans is the actual cost of renovating the property. This includes materials, labor, and any other necessary expenses to make the property habitable or more valuable.

It is important to carefully plan and budget for these costs before applying for a loan. It is also worth noting that with conventional rehab loans, a single mortgage covers both the purchase price and rehabilitation expenses.

This can be advantageous as it means you only have one monthly mortgage payment to worry about. However, it also means that you need to accurately estimate all renovation costs before finalizing your loan amount.

The Application Process

After pre-qualifying with a lender, you will need to gather all necessary documents such as tax returns, bank statements, pay stubs, credit reports, and a detailed renovation proposal.

This documentation will be used by the lender to assess your financial situation and determine if you are eligible for the loan.

Once your application is submitted and approved, an appraisal of the property is required to assess its current condition and expected value after renovations.

Finally, upon loan approval, you will attend a closing where all necessary paperwork will be signed and the funds will be disbursed for the renovation process to begin.

Therefore, understanding the loan process and being prepared can greatly increase your chances of obtaining a conventional rehab loan.

By having good credit, a down payment, and an acceptable debt-to-income ratio, as well as accurately estimating rehabilitation expenses and completing the application process thoroughly, you can successfully navigate through this financial journey.

So take the time to understand each step involved and work closely with your lender to ensure a smooth and successful loan process.

Conventional Rehab Loan Vs FHA 203(k) Loan

FHA 203(k) loans and conventional renovation loans are both great options for financing your dream home renovations. However, there are some differences between them that you should check before jumping.

One major difference is in the qualification requirements. While rehab loans typically require a minimum credit score of 620, FHA 203(k) loans have lower credit score minimums starting at 500.

This makes FHA loans a more accessible option for those with less-than-perfect credit histories or high debt loads.

Another important distinction is the type of residence that can be financed.

While FHA 203(k) loans can only be used for primary residences, conventional renovation loans offer more flexibility and can also finance second homes, rental properties, and multi-unit investment properties.

The scope of renovations allowed also differs between the two loan types. With rehab loans, almost any type of renovation is possible as long as it does not involve a total rebuild.

However, FHA 203(k) loans have more limitations and do not allow for luxury upgrades such as pools or outdoor kitchens.

It’s also worth noting that there are differences in mortgage insurance policies for each type of loan.

While conventional rehab loans allow you to eventually stop paying mortgage insurance once your equity reaches 20%, FHA 203(k) loans require you to pay it for the entire life of the loan.

In terms of timeline, conventional renovation loans provide a longer timeframe of 12 months to complete renovations, while FHA 203(k) loans only allow six months.

This may be a consideration for those who require more time to complete their renovations.

Therefore, both FHA 203(k) loans and conventional renovation loans have their own unique advantages and disadvantages.

It’s important to carefully consider your specific needs and financial situation before deciding which one is the best fit for you.

Conventional Rehab Loans Alternatives

Exploring Home Equity Loans and HELOCs as Alternatives to Conventional Rehab Loans

When considering financing for home renovations, many homeowners automatically think of conventional rehab loans. However, it’s essential to explore all available options before committing to a specific type of loan.

One alternative worth considering is leveraging the equity in your home through either a Home Equity Loan (HEL) or a Home Equity Line of Credit (HELOC).

Home Equity Loan vs. Home Equity Line of Credit

Both HELs and HELOCs allow you to borrow money against the value of your home’s equity. A HEL provides a lump sum upfront, which is repaid over a fixed term with a stable interest rate.

This offers the benefit of predictability for budgeting purposes.

On the other hand, a HELOC works more like a credit card, providing you with access to a line of credit that you can draw from as needed during the “draw period.”

This offers flexibility but comes with a variable interest rate.

Considering Individual Financial Preferences and Project Requirements

When deciding between a HEL and HELOC, it’s crucial to evaluate your financial preferences and renovation goals. For those who prefer stability and predictability in their payments, a HEL may be the better option.

However, if you anticipate needing ongoing access to funds throughout your renovation project, a HELOC may be more suitable.

VA-Backed Cash-Out Refinance Loans as an Alternative for Veterans

For veterans, there is another alternative option worth considering – a VA-backed cash-out refinance loan. This type of loan allows eligible veterans to access their home’s equity with potentially favorable terms and competitive rates.

It can be particularly advantageous for those who qualify, offering the potential for no down payment and no need for mortgage insurance.

Knowing When to Explore Alternatives

As we know, Conventional rehab loans offer a convenient solution for home buyers who want to cover both the purchase and renovation costs in one loan.

However, it’s important to note that these types of loans may not be suitable for everyone.

Some homeowners may struggle to meet the strict eligibility criteria or have difficulty coming up with a substantial down payment.

In these cases, exploring alternative financing routes, such as VA-backed loans or Home Equity Loans/HELOCs, can be beneficial.

Consulting with Experts and Exploring Options

Ultimately, the decision on which financing option is best for your renovation project depends on your individual circumstances and goals.

It’s crucial to carefully assess the terms and benefits of each option and consult with a lending expert for guidance.

Additional Reading: Blue Wave Loan Review: The Smart Choice For Your Financial Needs

Planning Your Renovation Budget With Conventional Rehab Loans

When considering a rehab loan for your home renovation project, it’s important to have a clear understanding of the financial considerations involved.

This includes not only the down payment and closing costs but also the loan caps and how they may impact your renovation budgeting.

Understanding Down Payment and Closing Costs Requirements

The down payment requirement for conventional rehab loans typically ranges from 5% to 20% of the loan amount. However, this can vary depending on factors such as creditworthiness and lender expectations.

It’s important to carefully consider your down payment amount as it can affect your loan terms and overall budget planning.

In addition to the down payment, borrowers should also account for closing costs when budgeting for their renovation project.

These one-time fees can include things like loan origination and appraisal fees and can have a significant impact on the total cost of the loan.

It’s important to carefully review these costs with your lender to ensure you have a full understanding of what is required.

Loan Caps and Renovation Budget Considerations

Most markets have a cap on how much you can borrow through rehab loans, usually set at $548,250 for single-family homes.

This limitation may require you to adjust your renovation plans or seek additional financing options for larger projects.

It’s also important to consider the loan-to-value ratio, as different loan programs may have varying LTV and CLTV limits.

By understanding these financial limitations, you can align your renovation goals with the available funding and make informed decisions about your budget.

Remember, every homeowner’s needs are different, so it’s crucial to carefully consider all financial aspects before committing to a rehab loan.

Why A Conventional Rehab Loan Is A Viable Option?

Conventional rehab loans can be a smart choice for those who want to invest in a property that needs some work but don’t want to deplete their savings or take out another loan.

This type of loan allows you to preserve your cash and use it for other purposes while still being able to make necessary improvements to the property.

It’s also a great option for borrowers who prefer not to have multiple payments, as taking out a second mortgage or using credit cards can result in juggling different due dates and interest rates.

A rehab loan eliminates these hassles by providing one manageable payment with lower interest rates compared to other financing options.

Ultimately, a rehab loan can be the perfect solution for those looking to make necessary renovations and investments without disrupting their financial stability and managing multiple payments.

So, it is a wise choice to opt for a rehab loan when considering options for financing property improvements.

Final Thoughts

A conventional rehab loan is an excellent option for those looking to purchase and renovate a home all at once.

With flexible use of funds, a lower down payment, and the potential for increased property value, this type of loan offers numerous benefits for homebuyers.

If you are considering purchasing a fixer-upper or a home in need of significant improvements, be sure to research this loans as an option for financing your dream home.

So, it is worth exploring the various types of conventional rehab loans available and finding one that best fits your needs and financial situation.

Additionally, it is crucial to carefully plan and budget for the renovations to ensure a successful and stress-free home buying experience.

Remember to consult with a trusted lender or mortgage professional for more information on this type of loans and how they can help you achieve your dream of homeownership while also transforming a property into your perfect home.