Purchasing rental property as an investment takes planning, decisiveness, and available capital to move quickly on a great deal. However, many investors face the same issues as new homebuyers – a lack of inventory. In addition, as the market across the country has become more and more competitive, investors are looking at property opportunities that may not be so move-in ready. If that is the case, investors will likely have to find more money to cover the cost of renovations to take their fixer to fabulous. That said, investors rely on being able to purchase and renovate quickly to either have the property ready to rent or resell for profit. While this is a great strategy, it can limit your financing options. Join us below as we review common types of home improvement loans and discuss how they can help you grow your portfolio.
What Makes Home Improvement Loans Different?
Home renovation loans have a particular purpose. These loans fund the cost to remodel, renovate, or complete major repairs to an existing home. That said, there are several different types, and not all are geared towards investment properties. So, it is important to work with a reputable lender and look for a loan option that does not require the home to be owner-occupied.
Typical Qualifications for Home Improvement Loans
As with all loan applications, lenders will have specific qualifications for home improvement loans. Some of these qualifications may include, but are not limited to the following –
- Minimum credit rating ranging from 580 to 620 depending on the lender and type of loan.
- Proof of a stable source of income.
In addition, many lenders like to see that the investor has prior experience with purchasing rental units or homes to fix and flip. While credit score and income matter most, the added experience can help an investor’s credibility.
Special Considerations for Non-Owner-Occupied Properties
As an investor, the property you purchase and renovate is likely not occupied by you. So whether investors rent or resell the property, choosing the right loan is essential. When it comes to renovation loans, there are a few key points to consider.
- All property renovations must be a permanent fixture of the property.
- Any renovation needs to increase the property’s overall market value.
- Limits on the Number of Financed Properties per Borrower
Types of Home Improvement Loans
As the industry has grown, investors now have even more financing options apart from traditional banks, including online lenders specializing in investor loans. So let’s review some of the home improvement loans available for your next fixer-upper.
Hard Money Home Improvement Loans
Hard money lenders focus on the property deal and not as much on the investor themselves. Mainly because a hard money loan is secured against the real estate itself. While they still evaluate the borrower’s financial health, the goal is to make sure the property deal will create enough equity to recover the funds if the investor defaults. The idea is to purchase a property that is undervalued to create the highest profit potential.
Unlike conventional loans that can loan up to 95% of the property value, hard money loans tend to be between 50 to 80% LTV or Loan-to-Value ratio. Another big difference between conventional and hard money loans is the timeframe. In general, hard money loans focus on getting in and out of the deal quickly. So, the term can be anywhere from 6 months to 2 years.
Benefits of Hard Money Rehab Loans
- Fast and Flexible – Investors need to move on deals fast to get the best possible opportunities. Hard money lenders offer fast and flexible options that can close in as little as 3 days. Thus, providing a huge advantage for savvy investors.
- Easy Renovation Financing – Hard money loans were almost made for renovations. Their quick approvals combined with the release of funds through a series of draws make this option great for investors. Also, in some cases, these lenders will finance up to 100% of the renovation cost.
- Bad Credit? Not a Problem! – Borrowers considered higher risk have a better chance with hard money home improvement loans. However, since hard money loans focus on the viability of the property and the deal, less focus is on the individual borrower.
- Flexible Down Payment Rules – Conventional mortgages have some restrictions on where the money for a down payment comes from. Therefore, some buyers have a difficult time qualifying and making it to closing. However, this is not a concern for hard money lenders as their security comes from the real estate collateral.
- No Private Mortgage Insurance – Typically, traditional mortgages may require borrowers to have Private Mortgage Insurance, adding to their monthly payments. However, hard money lenders do not charge PMI.
Disadvantages of Hard Money Loans
- Higher Fees – Speed and convenience of financing do not come without fees. For borrowers using hard money lenders, be prepared to pay dearly for that convenience. Typically, hard money loans carry an 8 to 18% interest rate. In addition, these loans come with processing fees, administrative costs, appraisal review costs, and other financial considerations.
- Shorter Terms – Repayment terms for hard money home improvement loans are anywhere from 6 to 24 months. This quick turnaround is not the ideal option for every investor, so choose wisely.
- Harsh Penalties – There are consequences for late payments or default in any loan. However, hard money lenders follow a much more no-nonsense policy. So, if you miss a payment, expect quick and decisive action in the form of a foreclosure notice.
- A Hard Bottom Line – Renovations, especially large or complex ones, come with an inherent risk of blowing the budget. That said, hard money loans come with an even harder bottom line. Overall, hard money lenders are flexible in creating a loan to suit your needs, but borrowers have little option if something goes bad once the ink is dry.
For investors that own a property in need of renovation, a line of credit may be the right choice. These types of credit use the property’s own equity to extend needed funds for home renovation projects. Essentially, this allows investors to borrow a percentage of the property’s equity for fewer fees and interest than other loan options.
Lower fees are due to the fact the property itself secures the debt. However, keep in mind investors have up to 30 years to repay the loan, which is ample time. That said, qualifying for this requires equity, a low debt-to-income ratio, and excellent credit.
Benefits of an Investment Property LOC
- Favorable Repayment Terms (up to 30 years)
- Low-Interest Rates
- Tax Benefits on Any Interest Paid Over Time
- Pay Interest Only on Drawn Amounts
- Quick Access to Capital
Concerns Regarding Investment Property Lines of Credit
- Maximum 60% LTV Ratio
- Significant Equity Needed
- Strict Qualifications
- Some Limitations on Unit Type
Federal Housing Administration 203(k) Permanent Rehab Loans
Many buyers may be familiar with FHA 203K loans; however, these are designed for single-family, owner-occupied properties. That said, that is not the only requirement for this type of financing. However, investors must prepare themselves for added paperwork and a longer process than a conventional mortgage. In addition, the renovation costs must be a minimum of $5,000 but not exceed $35,000. Let’s break down the pros, cons, and important considerations below.
Downsides of Using an FHA 203k Loan
- The Clock is Ticking – Renovations under these types of home improvement loans must take no more than 6 months to complete after closing.
- Decisiveness Required – Plans and detailed estimates are needed to create a comprehensive plan of the work needed and associated costs. So, investors must be decisive and careful in their choices. Plus, work must commence within 30 days of closing, so it is important to have everything set and ready to go beforehand.
- It Will Get Complicated – Approval for an FHA 203k loan takes some additional paperwork and processes not every investor is prepared for. This includes getting estimates, vetting contractors, and ensuring changes meet local codes. Therefore, bringing in additional expertise or help may be necessary.
The Benefits of 203(k) Home Improvement Loans
- Favorable Down Payment – Many homebuyers don’t have the cash on hand to make a 20% down payment on a home, then pay for renovations after closing. Not only does the 203(k) loan bundle the cost of the mortgage and the cost of improvements, but it requires as little as 3.5% down.
- Great Interest Rates – With 203k loans, interest rates are typically better than short-term alternatives such as hard money loans.
- Quick Equity – Successfully purchasing an undervalued property and making strategic renovations can net immediate equity for investors. Investors can then leverage this equity to grow your portfolio or fund other ventures.
- Benefits at Tax Time – An FHA 203K loan bundles the renovation cost and mortgage into one. So, at tax time, the interest on the full amount is tax-deductible. So, always consult a qualified tax specialist to ensure you take advantage of all available deductions and programs.
Lean on Professionals to Maximize Your Investments
Financing the purchase of or securing home improvement loans for an investment property is only half the battle. When it comes to rental properties, managing the day-to-day operations requires significant commitment and time. For some investors, that is time taken away from growing their portfolio or simply enjoying their personal lives uninterrupted by tenant calls.
That is where the experts at Bay Property Management Group come in. Our experienced team of professional property managers works alongside investors to oversee daily operations and maximize investment potential. In addition to leasing, screening, maintenance, and accounting tasks, our team can help owners decide what renovations may bring the best ROI within the local market. If you are new to real estate investment or a seasoned pro looking to take a step back, give us a call today to learn the many benefits of full-service property management.