Finding solutions to one of today’s biggest market challenges
Renovations and renovation loans are becoming more prevalent in our lives, especially in our entertainment options.
One television channel in particular – HGTV – is overflowing with shows about transforming a run-down property into the house of every homeowner’s dream. From Chip & Joanna Gaines to the Scott Brothers, many of us cable TV consumers have witnessed the power of home renovations and the impact they have on homeowners’ lives.
The plethora of home makeover shows is not just a fad; it’s a clear response to one of today’s longest-enduring challenges – satisfying the needs of a revitalized interest in homeownership. There is one significant obstacle in filling this need – inventory.
The inventory challenges we face vary by market but include obstacles such as:
- Lack of affordable first-time homebuyer properties (FTHB account for 36% of the market)
- Current owners are staying put, slowing the move-up market – a trend that will expand should interest rates rise (average length of homeownership tenure has declined to 8.05 years in Q1 2019 as compared to 8.17 years at the end of 2018.)
- Sellers won’t list before they have found the home they want to buy
- Equity concerns
- Continued shortage of new construction to address lack of inventory
These factors lead us to potentially making compromises in our homeownership decisions. Prospective homebuyers may need to expand their market area or recognize that purchasing a home that needs some fixing up may be a better option. Current homeowners may look to tackle the home improvement list rather than buying something new! Who would want to leave that awesome cul-de-sac anyways?
These consumer decisions open up significant opportunities for mortgage lenders looking for specialty product offerings, including renovation loans. But what are renovation loans and who can offer them?
Who Can Offer Renovation Loans
Fannie Mae and Freddie Mac both offer renovation products. For the purposes of this discussion, I will focus on Fannie Mae.
Seller/Servicers who deliver their loans post-renovation do not need to be pre-approved for the program. However, prior Fannie Mae approval is required if the loan will be delivered prior to project completion.
Fannie Mae’s approval typically requires that a lender have demonstrated renovation lending experience. Lenders must develop a mechanism for managing the distribution of funds to the builder while the renovation project is being completed. Many depositories gain this experience through portfolio product offerings.
How Renovation Loans Work
Fannie Mae renovation loans can be for purchase or refinance transactions, have minimal overlays to standard purchase or refinance transaction guidelines (not to exceed 97% LTV), and support buyers who are purchasing that fixer-upper. Renovation loans can also be suitable for current homeowners who are tackling home improvements, additions, etc.
Portfolio lenders not intending to sell their renovation loans to Fannie Mae have flexibility to structure their loan program based upon their own risk tolerance. Lenders may also add MI to a renovation loan to enhance the coverage.
Below are a few of the program highlights:
- Eligible properties are new or existing properties, 1-4 unit Primary Residence, condos and PUDS, manufactured housing (limitations apply), second home or investment property (standard LTV limits apply)
- Renovation funds shall not exceed 75% of the lesser of the purchase price plus renovation costs, or the “AS-COMPLETED” appraised value for purchase transactions; and 75% of the “as completed” appraised value for refinance transactions. (MH limited to lesser of $50,000 or 50%)
- Renovation funds may include: labor/material, soft costs (fees/permits), contingency reserve allowances, and up to 6 months PITI payments should the borrower need to vacate property for renovation
- Unused funds may be used to pay down the unpaid principal balance and/or fund additional improvements that are permanent and add value
- Contractor must be registered, licensed and reputable (documented contractor approval process should be maintained)
- DIY projects allowed: only when renovation funds do not exceed 10% of value of home, material cost only and restricted to 1-unit, owner-occupied home
|Purchase Price of Home||$100,000||$150,000|
|Cost of Renovation||$100,000||$300,000|
|Total Funds Required to Complete Project||$200,000||$450,000|
|As-Completed Value||$175,000 (max funds allowed $131,250)||$500,000 (max funds allowed $337,500)|
|Maximum Loan Amount (97% LTV)||$169,750||$485,000|
|Required borrower project contribution||$30,250 (15% contribution to project)||$15,000|
Funding and Payments
Renovation loans are 100% funded at the time of loan closing with a fully amortizing payment schedule. Upon loan closing, the lender holds the funds for renovation in an interest-bearing custodial or escrow account.
As the construction proceeds, the builder submits disbursement requests directly to the lender who verifies, through title and appraisal updates, that work is proceeding at the expected pace. New program policies allow for up to 50% of materials costs to be disbursed to builder at time of loan closing.
If you’re wondering how this is different from a construction loan, you’re not alone. You can learn more about the similarities between renovation and construction loans here.