Conventional Rehab Loan

What Is Conventional Rehab Loan? Read Step By Step

by Amrita

Last Updated on February 21, 2024 by Amrita

If you’re in the market for a home that needs some fixing up and you want to get it done with an affordable renovation loan, you may want to consider a conventional rehab loan. This loan is ideal for those looking to buy a fixer-upper home or renovate their existing property.

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Rehab Loans

Introduction To Conventional Rehab Loans

A conventional rehab loan, also known as a renovation loan or improvement mortgage, is a type of financing designed for individuals looking to purchase and renovates a home. It combines the cost of purchasing a property with the funds needed for repairs or renovations into one convenient loan.

While traditional mortgages typically only cover the cost of the home itself, a conventional rehab loan offers borrowers the opportunity to finance both the purchase and renovation of a home in one loan. This type of financing is especially useful for those looking to purchase fixer-upper properties or homes that require significant improvements.

How Does It Work?

Down Payment: When using this type of loan, the first step is to make a down payment. The amount required may vary depending on your lender and individual situation, but it’s important to keep in mind that a higher down payment can often result in better terms for your loan.

Lender and Contractor Collaboration: Once you have made your down payment, your lender and contractor will work together to come up with a plan for the renovations. This plan will then be submitted to the lender for approval, as they want to ensure that the proposed renovations will increase the value of the home.

Appraisal Process: After the plans have been approved, an appraiser will evaluate the home based on the potential after-repaired value. This value will then be used to determine the loan amount.

Qualifying Documents: In order to obtain a conventional renovation loan, you must provide all the necessary qualifying documents. This may include proof of income, assets, and credit qualifications. The process of gathering these documents and getting pre-approved can take 60 to 90 days.

Private Mortgage Insurance: If your down payment is less than 20%, you may be required to pay private mortgage insurance. The amount of PMI will depend on factors such as your down payment, home value, and credit score.

Time Limit for Completion: It’s important to note that all work must be completed within six months after the loan closes. If you require more time, it is possible to get an extension of up to one year, but this would require approval from your lender.

Funding and Disbursement: Unlike a traditional home loan, work on the property cannot begin until the loan has closed. The lender will pay the seller and put any remaining funds into escrow.

These funds will be disbursed according to an agreed upon schedule with the contractor and after each completed phase has been inspected. This ensures that all renovations are completed satisfactorily before releasing additional funds.

Conventional Rehab Loan Benefits

  • One loan, one payment: With a conventional rehab loan, borrowers only have to make one monthly mortgage payment instead of multiple payments for the purchase and renovation costs.
  • Flexible use of funds: The funds from a conventional rehab loan can be used for a variety of purposes, including structural repairs, cosmetic upgrades, or even energy-efficient improvements.
  • Lower down payment: Conventional rehab loans may offer a lower down payment option compared to traditional mortgages, making it more accessible for first-time homebuyers.
  • Increased property value: By using the loan funds for renovations or repairs, borrowers can increase the value of their property and potentially see a higher return on investment when they decide to sell.

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How To Apply For A Conventional Rehab Loan?

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

  1. Understand Your Options: The first step in getting a conventional rehab loan is understanding what it is and how it differs from other types of loans. As I earlier discussed a conventional rehab 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.
  2. 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.
  3. Gather Necessary Documents: Like any other loan application, you will need to provide certain documents to support your application for a conventional 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.
  4. Get Pre-Approved: Before you start looking for properties, it’s recommended to get pre-approved for a conventional rehab loan. This is good for getting an idea of how much you can borrow and will make you a more attractive buyer.
  5. 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.
  6. Submit Your Application: Once you have found a suitable property, it’s time to submit your application for a conventional rehab 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.
  7. Close on Your Loan: If your application is approved, the next step is to close on your conventional rehab loan. This typically involves signing legal documents and paying any closing costs or fees.
  8. 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.

Conventional Rehab Loan Eligibility Requirements

To qualify for a conventional rehab loan, borrowers must meet certain eligibility requirements set by the lender. These may include:

#Credit Score and Down Payment Requirements

One of the most important factors in securing a conventional loan is having a good credit score. The minimum requirement for most lenders is 620, but borrowers with scores over 720 are more likely to get favorable interest rates. It’s also a common misconception that buyers need to put down a hefty 20% for a down payment.

In reality, standard conventional loans require just 5% down, and there are even specialized programs that allow for as little as 3% down. However, it’s important to note that a lower down payment will result in the need for private mortgage insurance (PMI) until you have built at least 20% equity in your home.

#Income and Debt-to-Income Ratio Requirements

To qualify for a conventional loan, lenders will require proof of stable and consistent income for at least two years. This can come in the form of salary or hourly wages, bonuses, overtime, commission, part-time income, self-employment or contract work.

Lenders also have the ability to consider additional sources of income such as retirement income, alimony, child support, and social security payments.

However, all income sources must be properly documented and the borrower must show a debt-to-income ratio (DTI) under 36%. Some lenders may allow for DTIs up to 43% with compensating factors such as a high credit score or significant cash reserves.

#Property Requirements

Conventional loans also have specific property requirements that must be met in order to secure financing. The property must be a single-family home or multi-unit residence (up to four units) and cannot be used for commercial purposes.

It must also pass an appraisal to ensure that the purchase price does not exceed the true value of the property. For condos, at least 51% of units must be owner-occupied or second homes. These requirements help to protect both the lender and borrower by ensuring the property is structurally sound and free of any claims or liens.

Overall, understanding and meeting these requirements is essential in successfully securing a conventional loan for your dream home. With proper documentation, stable income, and a good credit score, you can increase your chances of approval and secure favorable interest rates.

Different Types Of Conventional Rehab Loans

Types of Conventional Reh

There are two main types of  this loans to choose from: the Fannie Mae HomeStyle Renovation Loan and the Freddie Mac CHOICERenovation loan. Each loan has its own set of qualifications, benefits, and limitations.

1. Fannie Mae HomeStyle Renovation Loan

The Fannie Mae HomeStyle Renovation Loan is a popular choice for homebuyers looking to finance their renovation costs. With this loan, borrowers can roll the purchase price and renovation expenses into one mortgage product, simplifying the process and avoiding the need for multiple loans.

Additionally, borrowers may be able to secure a lower interest rate with this loan compared to other financing options, such as a home equity loan or line of credit. However, it’s essential to note that refinancing an existing mortgage with this loan may result in a higher interest rate.

#Loan Limits and Qualifications

The Fannie Mae HomeStyle Renovation Loan has limits on the amount you can borrow, depending on the property type and location. In most markets, borrowers can receive up to $548,250 for single-family properties, up to $685,400 for four-unit properties, and up to $1.5 million in high-priced real estate markets. However, these limits can vary based on location and are subject to change.

To qualify for this loan, borrowers typically need a minimum credit score of 620 and a debt-to-income ratio of 45 percent or less. This means that your total monthly debt payments should not exceed 45 percent of your gross monthly income.

2. Freddie Mac CHOICERenovation Loan

The Freddie Mac CHOICERenovation loan is another popular option for financing home renovations. Unlike the Fannie Mae HomeStyle Renovation Loan, this loan can be used on investment properties, second homes, and multi-unit properties.

This provides borrowers with more flexibility when it comes to financing their renovations. However, refinancing an existing mortgage with this loan may result in a higher interest rate.

#Loan Limits and Qualifications

The Freddie Mac CHOICERenovation Loan allows borrowers to borrow up to 95 percent of the home’s after renovation value. This means that borrowers can receive a higher loan amount compared to the Fannie Mae HomeStyle Renovation Loan.

However, to qualify for this loan, borrowers typically need a credit score of 660 or higher and a debt-to-income ratio of 43 percent or less.

Both the Fannie Mae HomeStyle Renovation Loan and the Freddie Mac CHOICERenovation loan offer homebuyers the opportunity to finance their renovation costs. However, it’s essential to carefully consider the loan limits and qualifications for each option before deciding which one is right for you.

How Long Does It Take To Get Approved?

The timeline for getting approved for a conventional rehab loan 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.

Alternatives Loans Options To Conventional Rehab Loans

There are several alternatives to conventional rehab loans that offer a different approach to financing your home renovations. One option is RenoFi, an online lending platform that connects homeowners with credit unions for renovation projects.

With loan amounts ranging from $20,000 to $500,000 and the ability to borrow up to 90% of the after-renovation value of your home, RenoFi offers flexibility and competitive interest rates.

Their unique loan options include a home equity line of credit or traditional home equity loan with a 10-year draw period, as well as a fixed-rate mortgage product up to $2,000,000 with a repayment period of up to 30 years (available in select states).

What sets RenoFi apart is their streamlined process without the need for inspections or draws, and the ability for contractors to be paid quickly. With a loan calculator available to see potential borrowing power, RenoFi offers a convenient and efficient solution for your home renovation financing needs.

So, if you are considering purchasing a fixer-upper or looking to refinance with renovation costs included in the mortgage, it’s worth exploring alternatives like RenoFi that may better suit your needs and preferences.

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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 conventional renovation 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 conventional 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.

In conclusion, 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.

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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.

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