By Dian Hymer
You may get a good deal if you buy a home that needs work. But, you must be prepared to tackle the project. And, you need to find a way to finance the improvements.
One way to pay for the renovation is to use cash, either savings or cash that you generate through the purchase. There are several ways to do this.
A buyer who recently made an offer to buy a home that needed $40,000 of dry rot and foundation repairs structured the deal by using a combination of first and second mortgages. The buyers had enough cash saved to make a down payment equal to 20 percent of the purchase price. Instead of putting the full 20 percent down, they put 10 percent down and took out a second mortgage for 10 percent of the purchase price. This preserved 10 percent of the $450,000 purchase price, or $45,000, to use for repairs.
Another option would have been to obtain a mortgage for 90 percent of the purchase price. However, with a 90 percent first mortgage, the buyers often have to pay Property Mortgage Insurance (PMI) to protect the lender in case the buyers default. PMI premiums add the equivalent of an additional 1/4 to 1/2 percent to the interest rate. PMI is usually not required with 80/10/10 financing.
The above scenarios are an option for buyers who can qualify for the additional financing. Also, the buyers must be willing to pay the higher mortgage payments. This may be worth it if the fixer property has good upside potential.
Securing an equity line of credit against the property is another way to generate cash for renovations. This can be done at the time of purchase or at a later date. Some lenders permit 100 percent financing with a combination of a first mortgage and an equity line of credit.
First Time Tip: A property that looks a disaster and is cheap may not be a good fix-up project for a novice homebuyer. Contractors tackle these projects, and often make sizable profits. But, they usually have established business connections with construction lenders who finance home building and remodeling. This sort of financing is difficult to obtain if you have no track record renovating properties.
The seller of a fixer-upper may be willing to help finance the renovations, particularly if he's having difficulty selling. Recently homebuyers purchased a fixer property in the Crocker Highlands neighborhood of Oakland. They increased the purchase price they were willing to pay by $20,000 and asked the seller to credit $20,000 to them at closing.
With this financing scheme, the buyers financed a higher purchase price, which they could easily afford. But, they were short on cash. The credit generated cash to pay for repairs.
In order for this arrangement to work, the house will need to appraise for the inflated purchase price. Ask your agent to check comparable sales in the neighborhood before presenting the seller with a credit-back request.
Lenders have limits on the amount of money they will allow sellers to credit buyers at closing. Some lenders limit the credit amount to 3 percent of the purchase price; others will allow a 6 percent credit.
Many lenders won't allow a credit that exceeds the amount of the buyers' nonrecurring closing costs. These costs are paid one-time only at closing, such as title insurance and transfer taxes.
The Closing: If you're having difficulty finding financing for a fixer, check with a portfolio or private lender who will have more flexibility in their underwriting requirements. Or ask the seller to carry financing for you.
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