Sep 17, 2017

I get it.  You want to buy an inexpensive house that needs a little love.  You know your way around power tools and you're willing to put in a little elbow grease to get a good deal.  That may be possible.  But there is a fine line between a home that needs a little work and a home that is not financeable.

Before loaning you money, your mortgage lender will want to make sure the house you are buying (their collateral) is safe, livable, and structurally sound.  If the home you're considering has orange shag carpet, goldenrod appliances, and pink tile in the bathroom, that's fine.  If the roof is leaking, rodents are nesting in the basement, and the only heat source is a wood stove, that's not OK.

As part of the process, you will probably have a home inspection.  The home inspection is for you.  Unless something has gone very wrong, your lender should never see your home inspection.  The home inspector is very, very thorough.  He will give you a list of every teeny tiny thing that could possibly be wrong with the house.  He'll mention the kitchen cabinet that hangs wonky, the drippy faucet in the bathroom, and the garage door that gets stuck halfway.

Your lender will order an appraiser.  The primary purpose of the appraisal is to ascertain the value of the home.  But the appraiser also acts as a mini home inspector.  If he sees areas of concern, he can require repairs or suggest that an additional, more thorough inspection be obtained.

The appraiser isn't nearly as thorough as the home inspector.  For instance, the inspector will probably climb up onto your roof and let you know that a few roofing tiles blew off in the last wind storm and the flashing is missing around the chimney. 

The appraiser will observe your roof from the ground.  He's probably not going to notice a few missing tiles.  He will notice rotten fascia or soffits, extensive moss, and a tarp on the roof.  He could require those items be repaired.  Or he could require further inspection of the roof by a licensed professional.

Roof Repair
Please, no tarps on the roof when the appraiser arrives!

The appraisal process is also somewhat subjective.  One appraiser might require a broken window be repaired.  Another might not.  I've had appraisers require the replacement of windows with broken seals.  Other appraisers don't mention them.  While every appraiser is different, this is a list of the types of repairs appraisers are likely to require.

So how do people buy fixer uppers?

1.  They pay cash.

2.  They get escrow holdbacks.

An escrow holdback is sometimes allowed for inexpensive/minor repairs.  To snag an escrow holdback, a cost estimate is obtained for the required repairs.  Then the buyer or seller (or a combination of the two) deposits 150% of the estimated amount into an escrow account at closing.  The buyer then has a couple weeks to make the repairs.  After the repairs are finished, the appraiser comes back and re-inspects.  When the appraiser certifies the work is complete, escrow releases the money back to the relevant parties.

This works for minor repairs.  If a deck needs to be rebuilt, that's a good candidate for an escrow holdback.  I've done escrow holdbacks for a new furnace, a roof replacement, appliances, and exterior paint.  A home that needs $50,000 of repairs from the foundation to the roof is not a good candidate for an escrow holdback.

Warning:  Some lenders do not allow escrow holdbacks.

3.  Renovation loans.

Renovation loans (or "rehab" loans) allow a borrower to finance the cost of repairs along with the cost of the property.  Renovation loans are a beautiful thing.  There are conventional, FHA, and VA renovation loans.  Guidelines and qualifying requirements are similar to their non-renovation counterparts.  I could devote an entire blog post to renovation loans.

Renovation loans can be used for repairs or for remodeling a home.  Maybe you really want three bathrooms but the house you fell in love with only has two.  Get a renovation loan and add another bathroom!

Renovation Loans

What's the down side of renovation loans?

  • They're expensive.  Interest rates and closing costs are higher than non-renovation loans.
  • You have to qualify for enough to buy the house and make all the repairs/renovations.  (Hint:  It's going to cost more than you think.)
  • You probably can't do your own renovations.  Unless you are a licensed, bonded contractor by trade who renovates homes for a living, you will need to hire a professional.
  • They're a lot of work.  Before you can close on the loan, every repair must be planned in excruciating detail.  You have to know what kind of flooring, cabinets, and trim will be installed and the cost of each.  Your contractor will be vetted by your lender.  And permits may be required before closing.

If the home is financeable, you have the minimum required down payment, and you have enough money to make the repairs/renovations on your own, you can skip the renovation loan and save yourself all the hassle.

Otherwise, if you really want that fixer upper, a renovation loan might be the only way to go.

But what about bank owned properties?

Lots of people think they're going to get some smashing deal by purchasing a foreclosure.  I'm sorry to report, those days are over.  Lenders who own homes know how much they're worth.  They are probably not going to sell you a $300,000 home for $250,000.

Furthermore, many bank owned properties are in really rough condition.  And banks generally will not make any repairs.  If you are considering a foreclosure, pay close attention to the condition of the property.  And have a plan in place for making any necessary repairs.