What Is a Rehab Loan for a House?
Discover how a rehab loan lets you finance both a home's purchase/refinance and its renovation with a single loan.
A rehab loan for a house is a specialized financial product that combines the cost of purchasing or refinancing a home with the expense of its renovation or repair. This type of loan helps individuals acquire properties that require substantial work or enables current homeowners to improve existing residences, especially those that might not qualify for traditional mortgages due to their condition. It streamlines the financing process by allowing a single loan to cover both the property acquisition and necessary improvements.
Understanding Rehab Loans
A rehab loan fundamentally differs from a traditional mortgage because it finances both the property’s purchase or refinance and the estimated cost of renovations under a single loan. Unlike a standard home loan that provides a lump sum for the property’s immediate value, rehab loan funds for renovations are typically disbursed in stages, known as draws. These draws are released as work progresses and is verified through inspections, ensuring funds are used appropriately and renovation work aligns with the approved plan.
Rehab loans cover a wide array of projects, ranging from structural repairs like foundation work to major interior renovations such as kitchen and bathroom remodels. They can also finance essential upgrades to meet safety or livability standards, or energy efficiency improvements. A core concept governing these loans is the “as-completed” value, meaning the loan amount is based on the home’s projected market value after renovations are finished, rather than its current “as-is” condition. This valuation allows borrowers to finance improvements that significantly increase the property’s worth.
Key Types of Rehab Loans
Several types of rehab loans are available, each with distinct features. The Federal Housing Administration (FHA) offers the 203(k) loan, which is government-insured and designed for purchasing or refinancing a home needing rehabilitation. This program has two main variations: the Standard 203(k) and the Limited 203(k). The Standard 203(k) is suitable for major structural repairs and renovations typically costing a minimum of $5,000. It must remain within FHA mortgage limits for the area and often requires a HUD-approved consultant to oversee the project.
The Limited 203(k) loan is for less extensive repairs, generally capped at $35,000 to $75,000, and covers non-structural work like cosmetic upgrades, new roofing, or appliance installation. FHA 203(k) loans typically feature more lenient credit requirements, often allowing for a lower down payment of 3.5%. However, they require both an Upfront Mortgage Insurance Premium (UFMIP) of 1.75% of the loan amount and an annual Mortgage Insurance Premium (MIP), which can be required for the life of the loan depending on the down payment.
The Fannie Mae HomeStyle Renovation Loan is another popular option, a conventional loan product offering greater flexibility in allowed renovations, including luxury items not typically covered by FHA 203(k) loans, provided they are permanently affixed. This loan can be used for various property types, including single-family homes, condos, and multi-unit properties. While it generally requires higher credit scores, often a minimum of 620, and a down payment of at least 5%, it avoids FHA mortgage insurance premiums. VA Renovation Loans are also available for eligible veterans and active-duty service members, allowing them to finance both home purchase and necessary improvements with benefits like no down payment and competitive interest rates, though structural repairs may not be allowed with some VA renovation options.
Eligibility and Property Requirements
Qualifying for a rehab loan involves meeting specific borrower and property criteria. Borrower eligibility typically includes minimum credit scores, ranging from 580 for FHA 203(k) loans to 620 or higher for Fannie Mae HomeStyle loans. Lenders also assess debt-to-income (DTI) ratios, generally preferring them below 50%, and require proof of stable income to ensure repayment capacity. Most rehab loans are intended for owner-occupied properties, meaning the borrower must reside in the home as their primary residence.
Property requirements dictate that the home must be improved to meet livability, safety, and structural standards after renovation. Eligible property types often include single-family homes, two-to-four unit properties, townhomes, and condominium units. The appraisal process evaluates both the property’s current “as-is” value and its projected “after-repair” value (ARV) once renovations are complete. This ARV assessment determines the maximum loan amount.
The Rehab Loan Process
Obtaining a rehab loan begins with finding a lender experienced in these specialized products, as not all lenders offer them. Once a suitable lender is identified, the application and pre-approval process follows, involving a credit check and assessment of income to determine the borrower’s potential loan amount. This initial step provides a clear understanding of the financial parameters for the renovation project.
A detailed renovation proposal is then required, including a comprehensive scope of work and itemized bids from qualified contractors. It is important to select licensed and insured contractors to ensure the work meets professional standards and lender requirements. The lender will order an appraisal that estimates the home’s value based on its condition after the proposed renovations are completed. This “as-completed” appraisal helps finalize the loan amount.
After underwriting, the loan closes. Funds for the property purchase are disbursed, but renovation funds are typically held in an escrow account. These funds are then released through a draw schedule as work progresses, tied to inspections conducted by the lender or, for FHA 203(k) loans, a HUD consultant. These inspections verify that work milestones are met before subsequent draws are released, ensuring adherence to the project plan and budget. The process concludes with a final inspection and the release of any remaining funds upon successful completion of all approved renovations.