Can You Buy a House That Needs Work With a Conventional Loan?

Acquiring a home is a significant financial undertaking. While conventional loans are widely used for home purchases, properties needing extensive repairs can present complexities. This article explores how conventional loans can be adapted to facilitate the purchase and renovation of such homes. It outlines standard property expectations, details specialized renovation loan programs, clarifies eligibility criteria, and explains the procedural steps involved.

Conventional Loan Property Standards

Standard conventional loans are designed for homes ready for immediate occupancy. Lenders prefer properties that meet specific criteria related to safety, structural soundness, and marketability. An appraisal is a required component of the conventional loan process, where an appraiser evaluates the property’s current market value and ensures it meets these standards. The appraiser’s primary role is to protect the lender by confirming the home’s value aligns with the loan amount, and this assessment also benefits the buyer by preventing overpayment.

Properties with significant deferred maintenance or structural issues might not satisfy these “move-in ready” requirements for a standard conventional mortgage. Such conditions can lead to a lower appraised value or even a property being deemed ineligible for traditional financing. If an appraisal identifies major necessary repairs, a standard conventional loan may not be approved without those repairs being completed beforehand, which can be challenging for a buyer. This highlights the need for alternative conventional financing solutions when a home requires substantial work.

Key Conventional Renovation Loan Programs

For properties needing significant improvements, specialized conventional loan programs integrate renovation costs into the mortgage. The Fannie Mae HomeStyle Renovation Loan and the Freddie Mac CHOICERenovation Loan are two options. These programs allow borrowers to finance both the purchase or refinance of a home and its renovation through a single loan with one monthly payment. This structure avoids the need for separate loans or higher-interest financing for repairs.

The Fannie Mae HomeStyle Renovation Loan offers flexibility, covering repairs from minor cosmetic updates to major structural changes, energy efficiency improvements, and even accessory dwelling units. It permits financing based on the property’s “After-Repaired Value” (ARV), which is the estimated value of the home once all planned renovations are completed. The Freddie Mac CHOICERenovation Loan also bases the loan amount on the ARV, providing increased borrowing capacity for extensive projects. This program is versatile, accommodating structural or non-structural repairs, and can even be used for luxury installations.

Both programs allow for financing up to a certain percentage of the ARV, often up to 95% for primary residences, within conforming loan limits. An appraiser determines the ARV by reviewing proposed renovation plans and comparing the property to similar recently sold homes, factoring in the added value of improvements. This estimated future value dictates the maximum loan amount available, enabling borrowers to undertake projects that enhance the home’s worth.

Eligibility for Conventional Renovation Loans

Qualifying for conventional renovation loans involves meeting specific criteria for both the borrower and the property. Borrowers need a minimum credit score of 620, though a higher score, such as 700 or 740, can lead to better interest rates and more favorable loan terms. Lenders review the borrower’s debt-to-income (DTI) ratio, which should not exceed 45% to 50%, to ensure the borrower can manage the new mortgage payments. Consistent employment and a stable income history are important factors in the approval process.

Down payment requirements for these loans are as low as 3% for fixed-rate conventional loans, particularly for first-time homebuyers or when combined with programs like HomeReady or Home Possible. For multi-unit primary residences, second homes, or investment properties, the down payment expectation can increase, ranging from 10% to 25% depending on the property type and specific loan terms. If a down payment is less than 20%, private mortgage insurance (PMI) will be required, adding to the monthly payment.

Property eligibility extends to various types, including one-to-four-unit primary residences, single-unit second homes, and single-unit investment properties. Manufactured homes, condos, and planned unit developments (PUDs) are also eligible, though some restrictions or lower loan limits may apply. For the renovation work itself, licensed and insured contractors are required.

The Renovation Loan Process

The process of obtaining a conventional renovation loan begins with finding a lender experienced in these specialized products. Once a property is identified, the borrower works with a contractor to develop renovation plans and cost estimates. These plans, along with the borrower’s financial documentation, are submitted to the lender for review.

A specialized appraisal assesses the “as-completed” value of the home, which is its estimated value after all renovations are finished. The appraiser considers the proposed improvements and compares them to similar properties, providing a basis for the loan amount. After the loan is approved and closes, the renovation funds are held in a renovation escrow account.

Disbursement of funds from the escrow account to the contractor occurs through a draw schedule, tied to the completion of specific renovation phases. Inspections are required before each draw to ensure the work is progressing as planned and meets quality standards. A contingency reserve, 10% to 20% of the renovation costs, may be required within the escrow to cover unforeseen expenses. Upon final completion, a final inspection is conducted, and any remaining funds in the escrow account are applied to reduce the loan’s principal balance.