If you’re a landlord — or want to become one — you should be aware of renovation loans. Renovation loans give you money both for the purchase of the property and for (limited) renovations, but they do come with some caveats. A renovation loan makes it possible to purchase a property that could be run-down or uninhabitable and make it a great property for tenants (or even to live in), letting you capitalize on a great opportunity.
What is a Renovation Loan?
A renovation loan gives you a certain amount (usually a percentage) of the property’s value to renovate it. For instance, you might have a property you want to buy for $120,000 that needs $60,000 in renovations. The renovation loan may be willing to give you a loan for the property ($120,000) and up to 50 percent of the property’s value ($60,000). That’s a total of $180,000, less any down payment that is required.
Renovation loans are extremely valuable because they give you property and money to repair and rehab it. There may be a property that you want to purchase, but it’s not in a condition that anyone would give you a mortgage for it. With most conventional mortgages, the property has to be move-in ready. But a renovation loan lets you purchase a home as long as you can realistically renovate it. And that gives you more options, especially if you’re looking to renovate a rental.
There are many different renovation loans. Some are government-backed and easier to get, others are personal loans that might be more challenging to get; it depends on the property involved.
It should be noted that many renovation loans are open specifically to homebuyers who are intending on living in their home — residential homebuyers rather than investors. So, it’s important to look for a renovation loan specifically for investors.
Why is a Renovation Loan a Good Choice for Landlords?
It can be worth it for landlords to renovate their properties. For instance, you may be able to find a property for $100,000 that can be renovated for an additional $20,000 — that would ordinarily cost $160,000 to buy. For landlords, margins are extremely important. The less money you spend on a property, the more you’ll make when you’re renting it out. But that also means that the renovations need to be affordable, too.
Apart from this, there are some other benefits:
- A landlord can renovate the property with tenants in mind. There are certain renovations that landlords find important, such as durable flooring, or neutral paint colors. Landlords can renovate their properties to suit their goals, even if those goals might require splitting up a duplex or performing a similarly extensive rehab. Altogether, this provides additional flexibility for the landlord.
- Landlords may be able to purchase properties at a steal. Many properties are off the market because they aren’t suitable to be lived in. These properties could be old, falling apart, or just not generally desirable. Landlords can purchase these properties and rehab them, which also helps the community by adding more properties to the market. This also prevents older homes from getting condemned.
- A landlord may be able to save some money on their renovations. Some percentage of the work can be done by the landlord themselves, which can save money. The landlord won’t need to pay for labor that way, though they can’t do all the work themselves.
These benefits make renovation loans a good choice for landlords compared to many other types of loans. But that doesn’t mean it’s always the best choice; there are many loan options available, as well as other investment options.
What Are the Challenges of a Renovation Loan?
While renovation loans are often an excellent option, there are challenges as well. Most renovation loans do require that professionals be hired to complete the renovations, so landlords aren’t able to save that much money doing things on their own, though they can still handle some minor things (such as painting). Furthermore, the renovation can cost more than you expected, which could mean that you need to dip into your own coffers.
Because a renovation loan usually offers a percentage of the property’s future value for renovations, you may not be able to do extensive renovations. For instance, if there’s a property for $30,000 that will need $60,000 of renovations, you may not be able to get that loan. Otherwise, you might need to prove that the property would be worth $90,000 (or more) after the renovations have been completed.
During a renovation loan, you do need to get quotes for the renovation as well as an appraisal of both what the property is worth now and what the property will be worth in the future. That means that it takes longer to get this type of loan than it might take to get other types of loan — which can be another hurdle to cross. But if you’re well-prepared and have your documentation in order, this type of loan is still extremely valuable.
What Are the Alternatives to a Renovation Loan?
Let’s say you’re a landlord and you have a property that you want to both buy and renovate. What are alternatives to a renovation loan? The challenge is, for the most part, that most banks won’t lend you money to purchase a home that isn’t livable.
If the property can be live in and is essentially move-in ready, but you just want to do some updates, you can get a conventional mortgage loan and get a personal loan to complete the renovations (or fund it yourself). The disadvantage is the personal loan will usually be on shorter terms; while a mortgage rehab loan would be 30-years long, the personal loan might only be 5-years long. So, you’ll need to spend more faster, which could affect cash flow.
Another option is a hard money loan, which is a cash loan from investors. Investors will give you the money for the renovation rather than going through a bank. Hard money loans can be hard to initially secure unless you already have relationships with investors, but once you do secure them, they can have favorable terms. The downside is that though they are often more flexible they also often are high interest.
Finally, you may be able to get a line of credit. An investment line of credit will give you something like a credit card that you can use to pay for renovations. LOCs are often preferred to loans because you can use as much of the line of credit as you need and you can pull money out as desired, rather than having to take out a single loan upfront.
Your options are primarily going to be determined by how much rehab the property needs. If the property needs a lot of rehab, it’s going to be a lot more work, and consequently a lot more money. Most banks don’t like giving out loans for properties that need extensive renovation because they worry the property won’t be completely rehabilitated and will therefore not be in live-in condition. It’s difficult for a bank to sell a property like that, should the owner give up.
What Are the Qualifications for a Renovation Loan?
Like other types of loans, you should have a good credit score as well as a stable income. For most renovation loans, including FHA loans, you will need at least a credit score of 580. But most investor loans are going to require 640 or more. Your income should be able to cover the property. And often you should have prior real estate experience because this will assure the mortgage lender that you know what you’re doing and that you’re investing wisely.
But other than this, qualifications for the loan will vary by the bank. If you have an existing relationship with the bank, you’re more likely to be able to get a loan, and they’re more likely to be flexible about it.
How Do You Find Renovation Loans?
Most of the popular renovation loans such as FHA 203k loans are targeted at resident owners. If you’re looking for popular investment renovation loans, you will usually be dealing with private mortgage companies, of which there are many. A few things that you should look at include:
- How much will it cover? The loan will not only have a maximum amount but also tell you how much you can spend on the renovation itself. You’ll need to find a loan that gives you everything you need to complete the renovation, as otherwise, you could end up in a situation where you run out of funds.
- What are the requirements? Debt requirements and credit requirements can vary significantly from lender to lender. Find out what the requirements are before moving forward with a renovation loan and don’t forget that you can submit an application for multiple loans at once without it hurting your credit.
- Will it cover closing costs? Most renovation loans will not. But government-backed loans usually will. You will want to know exactly how much of a down payment you need as well as the closing costs; otherwise, you may run into unexpected expenses.
- Is there a pre-payment or exit fee? Because a lot of renovation loans are taken out by house flippers, investors may take them out intending to pay them back the second the house sells. Because of this, there are often pre-payment or exit fees that need to be paid if the loan is paid off early.
- How long will the loan last? Some renovation loans are very short-term because they expect that the property is going to be flipped. As a landlord, you’re going to want a longer-term renovation loan, unless you want to be paying more upfront.
Altogether, a renovation loan can be challenging to get. But they’re also very desirable. A renovation loan, when acquired, can give a landlord everything they need to start investing in a property immediately.
How Can You Get Started?
There are specific programs for renovation loans and not all banks offer them. If you’re interested in a renovation loan, you may need to do some legwork. Start by taking a look at the renovation loans available to you and applicable to the properties you’re interested in. From there, you’ll be able to find banks that provide that type of loan. Walking in and talking to a mortgage officer is often the best way to get information, though there are renovation loans that you can acquire entirely online.
Renovation loans aren’t the only choice, of course. There are other options, such as purchasing a home with a mortgage and then getting a separate loan for renovation — or funding the renovations yourself. What option is best for you is going to depend on your financial goals and your goals for the property.