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A guide to finance options for buying and renovating a fixer-upper

Ericka S. and Anthonio Black stand in front of their house. Ericka bought this house while she was still in college. She paid $100,000 in 2009. After doing about $50,000 in renovations, she estimates the house is now worth $600,000. (Amanda Andrade-Rhoades for The Washington Post)
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The Freddie Mac CHOICEReno eXPress loan program was inadvertently omitted from an earlier version of this article. The story has been updated.

Ericka S. Black, a real estate agent with Coldwell Banker Realty in D.C., bought her first fixer-upper when she was still in college and didn’t have any experience renovating a home.

“I know it can feel overwhelming to see a house that needs work, especially if you’re a first-time buyer,” says Black. “But look at the benefit. I bought that place in 2009 for $100,000 and put in about $50,000 and now it’s worth $600,000.”

“Too many buyers look for HGTV perfection for their homes,” she adds, “instead of creating what they want through renovation.”

Many home buyers express a preference for a move-in ready home. But the limited number of homes for sale and rapidly rising prices mean a home in need of renovation is sometimes the only option for buyers on a limited budget, says Amy Marie Dirazonian, a renovation loan specialist with Mortgage Network in Auburn, Mass.

“If you find a property that someone else has purchased and renovated, you’ll likely find the price is not conducive to many first-time home buyer’s budgets,” says Dirazonian. “First-time buyers can often get a renovation loan to complete necessary repairs and possibly some cosmetic upgrades and turn a not-so-pretty fixer-upper into a house they truly love and want to call home.”

Fixer-uppers are an affordable option, if you are up for the work

Renovation loans can be used to finance both the purchase of the house and the associated improvement costs in one package.

Rather than borrowing to buy the house and then paying cash, using credit, or taking out a home-equity loan to make repairs after the purchase, the projects can be financed and completed before moving day, says Megan Eppard, a special programs manager for Cherry Creek Mortgage in Greenwood Village, Colo.

Buyers who can afford to borrow often avoid a fixer-upper, which can reduce the competition for a less-than-perfect house, says Dirazonian. However, buyers of fixer-uppers may be competing with investors.

Here’s what you need to know about buying a fixer-upper:

Be cautious

Fixer-uppers are not without risk, especially for first-time buyers.

“First-time buyers are more inexperienced with the home-buying process in general, so they may benefit from purchasing a home that needs fewer or minor repairs compared to a home that needs extensive or major work,” says Eppard.

Renovation loans can take at least two weeks longer to complete than a traditional loan, which can be a disadvantage for buyers, says Tom Trott, a branch manager for Embrace Home Loans in Frederick, Md. The loan closing is contingent on getting a detailed construction bid and an appraisal based on the “as-completed” value of the property, he says.

“Home sellers in today’s market often have multiple offers, so they are more likely to accept one that settles quickly,” says Trott.

Another challenge for buyers can be managing the renovation.

“Finding licensed and insured contractors who are available and willing to do the project within a specified time frame according to the contract can be challenging,” says Trott.

Financing options

● Both FHA (Federal Housing Administration) and conventional renovation loan programs are available. Generally, conventional renovation loans have lower fees and monthly payments than FHA loans, especially if you make a 20 percent down payment and therefore are not required to pay mortgage insurance, says Trott. FHA loans require upfront and monthly mortgage insurance regardless of the down payment amount.

● The FHA 203(k) renovation loan requires a minimum credit score of 620 and a down payment of 3.5 percent. The property must be the borrower’s primary residence, says Dirazonian.

“FHA loans have two appraisals, including an ‘as-is’ appraisal and a ‘subject to’ appraisal after completion of all proposed repairs and improvements,” says Eppard. “The FHA sets loan limits for renovation loans by county and by property type, such as a single-family home or a multiunit property.”

The standard FHA 203(k) loan requires a minimum of $5,000 in repair costs and the assistance of an FHA-licensed consultant with the Housing and Urban Development Department, says Dirazonian.

“There’s not much you can’t do under the FHA 203(k) standard program,” says Dirazonian. “For example, you can convert a one-level property to a two-story, do a full remodel of the interior, build a garage or convert it into an in-law unit as long as the local municipality allows it. However, renovations the FHA calls luxury items, such as installing a swimming pool or a deck, are not allowed. But you can repair those items if they’re already on the property.”

The limited FHA 203(k) loan has no minimum renovation costs but has a maximum of $35,000 and does not allow structural renovations. That program is designed for smaller cosmetic repairs, Dirazonian says.

In the market for a home in D.C. but don’t have a mint? Hello, fixer-upper.

“Except for condominiums, FHA will lend up to 110 percent of the market value of a renovated property, which is a huge benefit for buyers,” she says.

Fannie Mae HomeStyle Renovation, Freddie Mac ChoiceRenovation and ChoiceReno eXPRESS offer other options. Conventional renovation loan options also require a credit score of 620 and loan limits are also set by county and property type. The HomeStyle loan is available to investors and second-home buyers, says Dirazonian.

The appraisal process for these conventional loans is similar to the FHA 203(k) loan program, but borrowers can only finance up to the after-improved value. If that appraisal is below the total of the sales price and renovation costs, the buyers may need to pay cash, ask for a price reduction or scale back their home improvement plans, Dirazonian says.

“Improvements with a Fannie Mae loan must be permanently affixed to the property, with the exception of some appliances,” says Eppard. “Appliances can be purchased with the Fannie Mae loan if they’re part of a substantial kitchen or utility room remodel.”

Fannie Mae’s loan can also be used for outdoor structures if allowed by zoning, such as a swimming pool, accessory dwelling unit, garage and recreation rooms, Eppard says.

“Freddie Mac’s [ChoiceReno eXPRESS] loan allows minor repairs and cosmetic fixes, such as new flooring, furnace, roof, countertops, windows, kitchen and bathroom upgrades, paint, and carpet,” Eppard says. “All improvements must be fixed to the property and add value. Improvements can’t alter the foundation and must be nonstructural.”

Find a contractor first

The key to a successful renovation, says Black, is finding experienced contractors.

“Some lenders have a list of potential contractors,” Black says. “Not every contractor will work with a renovation loan because the lenders have strict requirements, so it’s best to find someone who has already done work with a 203(k) loan.”

Black recommends establishing a relationship with contractors before making an offer on a home, since the lender will need information about the contractor before approving a mortgage.

“Do the legwork upfront by researching online and getting recommendations and references from your real estate agent,” says Black. “Then you can have your contractor come with you to inspect the home before you even make an offer.”