Whether you want to buy a fixer-upper to flip, or maintain as a long-term rental, you will need cash. In addition to purchasing the property, these types of homes often need work that takes both time and money. Getting the right type of loan—and for the right amount—will help ensure that you have the resources you need to improve the property. A residential rehab loan can help you kick-start your real estate investment dreams, but it’s important to work with the right lender.

Types of Residential Rehab Loans

Fortunately, if you’re in the market for a residential rehab loan, you have choices. 

FHA 203(k)

The Federal Housing Administration offers two types of residential rehab loans. The Limited 203(k) loan is only for homes that don't need structural repairs, with a maximum of $35,000 allowed for repairs. Standard 203(k) loans are for homes that need structural repairs and room additions. There is no limit on the cost of repairs with a Standard 203(k), but the total mortgage must fall within the FHA's regional mortgage lending limits.

You must meet minimum requirements to qualify for any type of FHA mortgage, including:

  • Minimum credit score required but could be as low as 580
  • Minimum 3.5 percent down payment
  • Regional loan limits

An FHA residential rehab loan offers many advantages, but there are also some drawbacks. For example, it is often harder to close than a standard mortgage because estimates are required from contractors. Funds for repairs are held in escrow and released as the work is completed, and you must start work within 30 days of closing and complete it within six months. Mortgage insurance is also required if the down payment is less than 10 percent.

Fannie Mae HomeStyle Renovation Loan

Similar to the FHA program, the Fannie Mae HomeStyle Renovation loan is provided for residential rehab projects. Borrowers must meet all of the minimum requirements to get any other type of Fannie Mae loan, and the contractor must be approved before the loan is finalized. Borrowers must also submit rehab plans created by a contractor, renovation consultant, or architect, including an estimate of the costs and estimated start and end dates.

Private Lender

If you don’t meet the requirements for an FHA or Fannie Mae loan, you have another option. Private lenders are backed by investors and have more freedom than government lenders, so you may be able to secure financing even if you have been rejected previously. Private lending decisions are based on equity and the property, not your credit score or financial history. Because of this, private lenders are able to close much more quickly—sometimes in just one week—than the alternatives. 

Considerations for Residential Rehab Loans

Estimating the cost of repairs can be challenging—especially for inexperienced investors—so build in a buffer for the unknowns to make sure you have enough cash to complete the project. For example, if you plan to flip or hold the property as a rental, factor in the cost of the unoccupied property while the repairs are underway, including loan payments, utilities, and so on.

Additionally, if you’re working with a traditional lender, be prepared to provide details about appraisals (including the value both before and after), estimates from contractors, information from inspectors, and any other documentation the lender requires. 

7 Questions to Ask Lenders 

If you’re in the market for a residential rehab loan, it’s a good idea to evaluate multiple lenders. Ask these questions when making your decision:

1. Do you require a minimum credit score?

Conventional lenders require minimum credit scores, while private lenders typically do not. If your credit score has been impacted by your financial history but you have equity and enough cash for a down payment, you may be able to get a private loan. 

2. What documents are required?

Depending on the type of lender, you might need to provide tax returns, pay stubs, or other proof of income. If your tax returns don’t show a certain income level, it could be difficult to get a conventional loan. However, because private lenders are equity-driven,  your financials usually don't matter.

3. How much can I borrow for repairs?

Conventional loans have maximums or require detailed paperwork that outlines the estimated costs. Private lenders make decisions based on individual properties and usually cover 70-100 percent of the cost of repairs. 

4. Can I get a loan for an investment property?

Most conventional lenders require you to use the property as your primary residence to get a residential rehab loan. If you’re looking for a residential rehab loan for an investment property, an FHA or Fannie Mae loan might not be possible. Look to a hard money lender or get a HELOC if that’s an option.

5. How long will it take to fund the loan?

Conventional loans can take months to close, especially if you have to wait for appraisals, contractor estimates, and so on. With a hard money lender, you can close in a matter of days, which gives you an edge in a competitive market.

6. Can I do the repair work myself? 

Find out if you are required to use a licensed contractor or if you are allowed to do some or all of the work yourself. The more you can do on your own, the more profit you can make. However, conventional loans require you to work with a licensed contractor, which can impact your overall budget.  

7. Is there a prepayment penalty for this loan?

This is an especially important question if you plan to flip the house and can impact your potential profit. Ask the lenders you are considering if there are prepayment penalties and build this into your calculations.  

Financing with Socotra Capital

If a conventional loan isn’t an option for you, private lending could be. However, not all private lenders are the same, so it's important to do your research. Look for a direct lender with a proven track record. To learn more about private lending and what to look for, read The Borrower's Guide: Fix-and-Flip Hard Money Loans.