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For many prospective homebuyers, choosing a home that needs a little (or a lot) of repair is more than a romantic notion. A fixer upper can help you edge into a home—or a neighborhood—you might not otherwise be able to afford. You can choose your own design, pick your favorite finishes and enjoy the satisfaction of knowing you contributed to the transformation.
Getting a mortgage for a fixer upper requires a few extra steps. You'll need to understand your home's value and the scope and costs of needed repairs. You'll need a plan for getting those repairs made. And you'll need to find and qualify for the right financing. As always, your credit score and history will play a role in whether you can successfully finance the home of your dreams—as well as the repairs that will make it dreamy. But your credit score is only one factor lenders will consider to determine your eligibility, and only one element that may help you decide which financing is right for you.
Mortgage Loan Options for a Fixer Upper
Buying a fixer upper creates special financing challenges. A conventional mortgage is often not the ideal choice. If your fixer upper doesn't have working utilities or is otherwise uninhabitable, for example, a regular bank or finance company may balk at extending a loan. Also, conventional mortgages don't typically include an allowance for significant repairs. If you want a conventional loan, you'll usually need to find other sources of funds for repairs, such as using some of the cash you'd planned for your down payment; using interim acquisition and improvement financing; or finding separate financing, such as personal loans, to cover renovations.
Alternatively, there are mortgage programs designed specifically for fixer-upper properties. These are generally backed by the government and offered through private lenders such as banks and credit unions. With a renovation loan, you can add a repair budget to your purchase price and finance the entire project with a single loan. The lending process can be a bit more complex, requiring pre- and post-renovation appraisals, contractor estimates, multiple inspections and special escrow accounts for renovation funds. But the benefits are clear: You'll have the funding you need to complete repairs and upgrades—and may have built-in reserves for unexpected expenses. You also may be able to fold in the cost of renting a place to live during renovations into the loan and may even get help qualifying for a loan with less-than-perfect credit.
Here are four renovation loan programs to consider:
FHA 203(k) Loans
The Federal Housing Administration insures loans for homebuyers, including FHA 203(k) loans that include renovation financing. FHA backing can be an excellent alternative for homebuyers with low to moderate incomes and less-than-stellar credit. On the downside, these loans have limits on how much you can borrow. You'll need at least a 3.5% down payment and must pay for mortgage insurance over the life of the loan.
VA Renovation Loans
The U.S. Department of Veterans Affairs guarantees loans for veterans and qualifying family members. You'll need a stable source of income, adequate credit (typically "good" or better) and a Certificate of Eligibility to qualify. If you do qualify, your interest rate may be lower than what you'd pay on a traditional mortgage with no mortgage insurance and no down payment required.
Fannie Mae HomeStyle Renovation
Fannie Mae HomeStyle® Renovation loans let you fund a variety of repairs and upgrades, including roof repairs and landscaping, along with your home purchase. Paired with Fannie Mae Community Seconds® financing, a HomeStyle Renovation mortgage can finance up to 105% combined loan-to-value on your fixer-upper.
Freddie Mac CHOICERenovation
Freddie Mac also offers CHOICERenovation® loan guarantees that work with a range of Freddie Mac fixed-rate and adjustable-rate mortgages. You can add up to 75% of your home's projected post-renovation value for repairs and upgrades.
How Your Credit Impacts Getting a Mortgage
Generally speaking, the higher your credit score, the better your choices will be when shopping for a home loan. A higher credit score is more likely to win you a loan approval; it also typically earns you a lower interest rate.
That being said, the minimum credit score requirements for the government-backed renovation loans listed above are not astronomical. Some are even designed for homebuyers who might not have the credit score to qualify for a traditional mortgage. For instance, with a 10% down payment, the minimum credit score for an FHA loan is 500—or 580 if your down payment is less than 10%. Credit score requirements for VA loans vary by lender, but typically a "good" score of 670 is a reasonable starting place. Fannie Mae and Freddie Mac loans have a minimum credit score of 620, but higher scores make it easier to qualify and are all but essential if your down payment is below 20% to 25%. Check with your individual lender for their requirements.
Having a sufficient credit score is only one factor in getting your home loan approved. Lenders will also look at your debt-to-income ratio to make sure your income is adequate to cover your outstanding payments. Although 100% financing may be available for your fixer upper, having a down payment will open the door to more funding options. A larger down payment of 20% or more will not only make it easier to qualify for a loan, but may also lower your interest rate. Finally, lenders also want to know that you have resources to fall back on if your income is disrupted, so savings and investments are a help.
Just as lenders will evaluate your application, you'll need to evaluate which loan works best for you. Renovation loans come with a host of restrictions and requirements. Because of the complexity and additional risk that a fixer upper represents, it may help to work with a knowledgeable mortgage broker or loan officer who can help guide you through the financing process.
How to Prepare Your Credit for a Mortgage Application
Your mortgage is likely to be the largest loan you'll ever finance—the highest dollar amount and the longest loan term. For that reason, even a small difference in your interest rate can translate into dramatic savings over the life of your loan. To illustrate: A 30-year, $500,000 mortgage at 3.25% costs about $283,000 in total interest. If your interest rate jumps just 1.25%, the total interest over 30 years tops $412,000, or $129,000 more.
Sometimes the difference between a more affordable loan and an unaffordable loan is just a few points on your credit score. If you're planning to buy a home in the near future, it may pay to prepare your credit for getting a mortgage.
- Check your credit score and report. You want to know your credit score and credit history in advance so you can figure out which loans might work for you. You also want to make sure your credit report doesn't contain any inaccuracies you should dispute.
- Look for quick ways to boost your credit score. While you probably can't do a complete makeover on your credit in just a short time, you may be able to optimize it a bit by paying down credit card debt.
- Don't apply for new credit. This is not the time to apply for that rewards card you've been eyeing or take out a new car loan. Hard inquiries on your credit can temporarily lower your score. Having additional revolving debt will raise your credit utilization, and more debt overall drags down your debt-to-income ratio. Save the new credit applications for after your mortgage closes.
- Pay every bill on time every time. While you can't go back and fix your payment history, you can make sure you pay all your bills on time starting now. Your payment history is the single greatest factor in determining your credit score.
Is a Fixer Upper in Your Future?
Choosing a home in need of renovation takes courage. But the additional risk—and hard work—can pay off. Though the financing process for fixer uppers is a bit more complicated, financing options do exist, even for buyers with a few credit challenges.