Rehab loans help new and experienced real estate investors fund the purchase and renovation of residential properties. Rehab loans are used by short-term investors looking to fix-and-flip a property as well as long-term investors looking for renovation financing for rentals. Rehab loans combine a house purchase and rehab costs into a single, short term loan with quick funding times and interest-only payments.
In this article, we’ll discuss:
- Types of Rehab Loans
- Rehab Loan Costs, Terms, and Qualifications
- Rehab Loan Application Requirements
- Who Can Benefit from a Rehab Loan?
- Example: 6 Steps of Successful Rehab Project
A special thanks to LendingHome for sponsoring this article. LendingHome is one of the nation’s largest hard money rehab lenders and offers rehab loans up to 75% of ARV. Interest rates start as low as 7.5%; get pre-qualified online for a rehab loan in minutes.
Types of Rehab Loans
There are two types of rehab loans available to real estate investors:
- Permanent Mortgage for Rehabs – Offered by Fannie Mae, HomeStyle Renovation (HSR) fund owner-occupied renovations as well as one single-unit investment property. They’re similar to the FHA’s 203(k) mortgages, and have very specific, limited uses and strict borrower requirements.
- Hard Money Rehab Loans – Hard money rehab loans are offered by private lenders and help investors purchase and renovate investment properties. Hard money rehab loans fund single-family houses as well as multi-unit properties and there are no limits to the number of properties an investor can finance. This makes them the most common of the two.
Permanent Mortgage for Rehabs
The HomeStyle Renovation (HSR) mortgage is a permanent mortgage offered by Fannie Mae. It lets you finance an owner-occupied renovation or the purchase and renovation of a one-unit investment property.
HSR mortgages have a 30-year term, interest rates between 4% and 6%, and are issued based on a percentage of a house’s purchase price, also known as the loan-to-value (LTV) ratio.
HSR mortgages are less common when it comes to rehab loans because of their limited use. For example, you can only finance the purchase and renovation of one investment property at a time. Further, the investment property can only be a single unit. In this article, we’ll stick to covering the more common hard money rehab loans. If you’d like to learn more about HSR mortgages, you can read more here.
Hard Money Rehab Loans
A hard money rehab loan is a financing option used by both short-term and long-term investors to purchase and renovate investment properties. Rehab loans are issued as a percentage of a property’s expected after-repair-value (ARV). A property’s ARV is equal to the expected amount the property will sell for after all renovations are made.
For example, if a house is listed for sale at $100k but you determine that with $50k in renovations that the home would be worth $200k, the ARV is $200k. In this example, a rehab lender would finance up to 75% – 80% of the $200k ARV, or about $150k – $160k. We talk more about ARV in the section below.
Rehab loans usually have a quick approval process, one-year financing terms, and high-interest rates and lender fees. Further, they fund the purchase and renovation of both single-family homes and multi-unit properties, as well as offer interest-only payments, making it a good option for rehab investors.
Rehab Loan Rates, Terms, and Qualifications
A wide variety of lenders offer rehab loans. Smaller, local hard money lenders will typically offer a wider range of rates, fees, terms, and qualifications because they’re able to work with atypical projects and borrowers.
National lenders on the other hand, typically have standardized costs, terms, and qualifications. For these reasons, we’re going to focus on the national lender LendingHome to give you a good example of a general rehab loan at work.
Hard Money Rehab Loan Rates, Terms, & Qualifications
|Maximum Loan Amount||75% of ARV|
|Interest Rates||7.5% - 12%
(interest-only payments, not fully amortized)
|Points (Lender Fees)||>2.5|
|Loan Term||12 months|
|Property Type||Single family home, multi-unit property|
|Pre-qualification||As little as 3 minutes|
|Time to Funding||As quick as 10 - 15 days|
|Where to Apply?||Visit LendingHome|
Rehab loans combine a property’s initial purchase and rehab budget as a single loan. Hard money lenders typically set a maximum loan amount using a property’s loan-to-value (LTV) ratio or an after-repair-value (ARV) ratio. The LTV ratio represents a percentage of a property’s initial purchase price, and the ARV ratio equals a percentage of a property’s expected fair market value (FMV) after renovations have been made.
When you’re purchasing a property in good condition, lenders typically issue a loan based on the property’s LTV, usually up to 90% of the initial purchase price. Conversely, when you’re investing in a property that needs renovations, hard money lenders most commonly issue a loan based on a percentage of a property’s expected ARV, so we’ll focus on that.
In general, the largest rehab loan amount offered by private money lenders is equal to 80% ARV, with many offering less. The more experienced you are with rehabs and better your credit profile, the higher the ARV will be. LendingHome, for example, offers borrowers an ARV rate up to 75%, meaning that they’ll finance up to 75% of the expected value of a property after renovations are complete.
This means that investors looking to finance with a rehab loan should expect to cover up to 20% or more of a property’s ARV with their own cash. Additionally, some lenders, such as LendingHome, also require that investors pay for renovation costs up front, after which the lender reimburses the investor for the rehab. This ensures that investors have enough “skin in the game,” thus protecting the lenders from default.
Rehab Loan Rates, Fees, and Terms
Rehab loans rates, fees, and terms typically reflect the following:
- Interest Rates: 7.5% – 12%
- Points: 1 – 10 (equal to 1% – 10% of loan amount)
- Loan Term: 12 Months – 3 Years
Interest rates on rehab loans generally run between 7.5% – 12%. While this is higher than conventional mortgages, it reflects the additional risk inherent in a rehab project and the short period of time during which interest will be charged. Keep in mind, in almost all cases you’ll be making interest-only payments (so no principal will be part of your monthly payments).
Points on a rehab loan are typically considered “upfront costs” and will come out of the loan itself. LendingHome, for example, charges up to 2.5 points.
Rehab Loans generally have repayment terms of 12 – 36 months. This time frame is usually enough for investors to complete their renovations and execute their exit strategy. For those looking to make money flipping houses the exit strategy will be listing and selling the renovated property. For investors looking to be landlords, that will be finding renters, seasoning the property, and refinancing with a permanent mortgage.
Most hard money lenders also require specific homeowner’s insurance, such as title insurance, closing / escrow insurance, and disaster insurance where it applies.
Rehab Loan Application Process
Rehab loan applications are typically broken down into two steps:
- Pre-qualification: Provide lender with estimated project information and basic borrower information.
- Closing: Provide lender with sale contract and contractor quotes to finalize loan.
1. Pre-qualifying for Rehab Loans
Hard money lenders usually have a pre-qualification process that helps investors determine an expected ARV ratio, costs, fees, and other terms. The pre-qualification process is quick, non-binding, and allows real estate investors to move forward with confidence that financing for their project is available.
In general, you can expect to provide the below information during pre-qualification:
- Personal Bank Statements: 2-3 Months of Personal Bank Statements
- Personal Credit Score: 550+ (check your credit here for free)
- Basic Questions: A few questions about you and the potential property, like the desired property’s address, the expected offer amount, and your name and tax ID (either a person or entity).
With an online rehab loan provider, like LendingHome, prequalifying will take just a few minutes and you’ll be presented with several loan options. While the loan terms aren’t set in stone, these prequalified rates and terms allow you to know whether financing is likely to fit your project parameters. And, so long as things don’t change during closing, you can expect your final loan to be in line with this estimate.
2. Closing Rehab Loans
Closing takes the estimated numbers used during prequalification and uses more in-depth information to finalize the loan amount, cost, fees, and terms. During this stage, you’re approved for the loan and receive the funds so you can close the deal and move forward with renovations.
LendingHome, for example, uses this step to collect the remaining loan application documents, approve the loan, underwrite it, and issue the funds for the initial purchase of the property.
Specifically, you should expect to provide the following during the closing phase:
List of Past Projects
One of the most important things a hard money lender uses to assess rehab loan applications is an investor’s past rehab experience.
If you expect to complete your renovations yourself, a rule of thumb is that lenders like to see investors with at least 2-3 projects under their belt. To prove your past projects, lenders often require prior purchase agreements, rehab invoices, and a receipt of sale or proof of refinance for each project.
If you’re a new investor looking for a hard money rehab loan and aren’t going to make the improvements yourself, you can work with a licensed contractor in lieu of experience. In this case, hard money lenders will want additional information on the contractor, which includes the company name, license number, scope of rehab work, overall bid, and timeline for completion.
LendingHome makes getting them the right information easy by providing a past project template for you to use and a portal for contractor information.
Scope of Rehab Work
The scope of a rehab should detail what renovations you plan to do. A property’s expected scope of rehab work is important because it helps determine its ARV. The scope of rehab work can either be determined by yourself if you’re an experienced rehabber or by a contractor if you’re inexperienced. Lenders will typically require a contractor perform the work if it’s a complex rehab project but let you do your own renovations if the project’s simple.
If you’re using a contractor, the scope of rehab work is typically included in his or her bid. If you’re doing the rehab yourself, you can prove the scope of work with materials estimates as well as a time for completion.
LendingHome provides you with a scope of work template document during the loan application process.
For inexperienced rehabbers and fix-and-flippers, lenders will require contractor bids as part of the scope of rehab work. This helps determine the cost of the expected rehab, which, when coupled with the scope of work and timeline (also provided by a contractor), is used to calculate a property’s ARV in the ARV appraisal.
For experienced rehabbers doing their own work, the scope of work and expected budget suffices. There’s no need to engage contractors in this case.
Most hard money lenders, including LendingHome, typically have an approved list of appraisal companies or in-house appraisers. When completing your application, the lender usually conducts two appraisals as part of their due diligence: an “as-is appraisal” and an “ARV appraisal.”
These two appraisals will tell a lender current fair market value of a house as well as the expected value after all renovations have been made. Lenders use these appraisals to verify the price listed in the purchase contract from pre-qualification as well as the ARV and loan percentage.
Appraisals are typically paid for by the borrower as part of a property’s closing costs but are sometimes included as part of the lender’s application fee.
Purchase contracts are standard documents that hard money lenders will want to see. It will state the agreed final sale price and the terms of the purchase between the buyer and seller. In most cases the agreement will be signed and usually stipulates that the purchase is contingent “on lender approval.”
Fees & Upfront Costs
As part of a hard money rehab loan, private lenders often charge a loan application fee. LendingHome, for example, charges a fee of $199 at the start of the application. After finalizing the application and agreeing on a loan amount, investors should be prepared to cover the following lender fees from the proceeds of the loan:
- 2.5 points: Loans between $120,000 – $249,999
- 2 points: Loans between $250,000 – $499,999
- 1.5 points: Loans $500,000+
For loans below $120,000, LendingHome has a minimum floor of $3,000 for lender fees.
These lender fees typically come straight out of the loan and reduce your total loan amount.
Additionally, some lenders like LendingHome hold back rehab funds until renovations are completed, ensuring an investor has extra skin in the game. In most cases, the pre-qualification process will tell you how much to expect in terms of ARV percentage, lender fees, and interest rate.
Rehab investors should expect to cover closing costs between 2% – 5% as well as make monthly interest-only payments throughout the life of the loan.
Who are Rehab Loans Good For?
Rehab loans are common tools for fix-and-flippers and long-term investors looking to renovate a new rental property. Let’s take a minute to discuss the reasons why rehab loans are good for each.
1. Fix & Flippers
Short-term investors looking to fix-and-flip a house quickly are great candidates for rehab loans. This is because the investment objective of the short-term investor matches the positive attributes of a hard money rehab loan.
The most important benefit is that rehab loans can finance the purchase and renovation of underpriced assets in poor condition (such as foreclosures). In fact, rehab loans lump together the initial purchase and the associated renovations as a single loan. This is in contrast to conventional mortgages that don’t fund renovations and require that houses are in good condition prior to purchasing.
A second benefit is that the life of a hard money rehab loan is typically 12 months or less. This is perfect for short-term fix-and-flippers looking to renovate and sell an investment property quickly. Many of the houses purchased at auction, for example, are financed with a short-term rehab loan.
The third benefit is that many rehab loans offer interest-only payments and payment of the principle in full at the end of the loan’s life. This means that while rehab loans have higher interest rates when compared to conventional mortgages, the monthly payments might actually be lower, saving an investor money.
2. Long-Term Real Estate Investors
Long-term real estate investors who want to purchase, renovate, and then rent a property, also find hard money rehab loans to be good tools. That’s because rehab loans can finance the purchase and renovation of homes in poor condition, while most conventional mortgages can’t.
So, if a long-term investor wants to buy an underpriced property, renovate it, and then rent it out rather than selling it, the best financing option is often a rehab loan. After the house is fully renovated, the investor can refinance it with a conventional 15 – 30 year mortgage and pay off the hard money rehab loan.
Example: 6 Steps of a Successful Rehab Project
Let’s take a look at an example of a rehab loan at work. This should give you a good understanding regarding what to expect during the hard money rehab loan process. There are six steps when it comes to a rehab loan at work:
The rehab financing process starts with pre-qualification. This allows an investor to get a likely ARV percentage, interest rate, and lender points based on estimated info the investor provides. But nothing’s set in stone yet.
Let’s use the example of Bob. Bob has a good credit score and strong finances. He’s also completed two rehab projects before. For Bob’s next project, he’s pretty sure he wants to purchase a single-family home for $120,000.
To see what he might expect for financing, Bob enters in his pre-qualification info with a rehab lender, like LendingHome. The lender then gives Bob a likely ARV percentage, interest rate, and points. In this case, Bob sees he is prequalified for an ARV percentage of 75%, interest rate of 10%, and lender fees equal to 2.5 points. Pretty good! Bob now has the information he needs to move forward and identify a rehab property to purchase.
2. Rehab Loan Approval
Searching for local properties in affluent neighborhoods, Bob finds a house in poor condition selling for $130,000. Since Bob has past rehab experience, he estimates that if he invests $25,000 in renovations, the after-rehab-value (ARV) on this home should be $210,000. Through negotiations, Bob’s actually able to talk the seller down to $120,000.
With the right property in his sights, Bob’s ready to finalize the loan and get the project funded. Bob pays LendingHome’s application fee of $199. He then provides LendingHome with a purchase contract stipulating the $120,000 purchase price, a renovation scope of work that includes the cost estimate of $25,000, as well as a list of his past rehab projects.
LendingHome then conducts its own appraisal to determine the property’s current fair market value (FMV) as well as its expected ARV. It turns out that LendingHome’s appraisers think that with the renovations Bob has outlined, the ARV will be more like $200,000. LendingHome finalizes Bob’s loan with this ARV and makes an offer.
Based on Bob’s actual loan application (rather than his pre-qualification estimates), LendingHome revised its offer to a 65% ARV, a 10% interest rate, and lender fees equal to 2.5 points. That’s the rehab loan offered to Bob.
Bob now has to decide whether to accept the rehab loan or not. He sees that LendingHome is willing to fund a total of $130,000 for the purchase and renovations, derived as:
($200,000 ARV) x (65%) = $130,000
However, Bob knows he won’t receive the full $130,000 if he accepts. Instead, LendingHome will hold back the rehab budget and distribute the rehab financing in stipends or draws. This means that LendingHome will actually fund $105,000 of the $120,000 purchase price and the full $25,000 rehab, for a total of $130,000.
What’s more, Bob knows that lender fees are taken directly out of the loan. So, at 2.5 points, the lender fees on his loan are equal to: ($130,000) x (2.5%) = $3,250.
This means that LendingHome actually covers the following portion of Bob’s initial purchase:
($105,000) – ($3,250 lender fees) = $101,750
Lenders typically send the initial loan payment directly to an escrow or settlement service company that distributes the funds to the seller and transfers title ownership. This means that in addition to the $101,750 Bob will have to spend $18,250 out of pocket to cover the full $120,000 purchase price.
Bob will then receive the remaining $25,000 for the rehab in draws as renovations are made. If Bob accepts this offer, the time to funding will typically be 10 – 15 days.
4. Home Purchase
Once the rehab loan is approved, Bob can execute his purchase agreement, buy the house, and transfer title. Remember from the step above that the lender is covering $101,750 of the $120,000 purchase price, meaning you’ll have to cover the remaining $18,250, which you can distribute to the same escrow or settlement service company.
However, the total purchase costs don’t stop with lender points and application fees. Purchasing a property also means covering the closing costs, usually between 2% – 5%. At the average of 3.5%, this means Bob will have to pay an additional $4,200 in closing costs, equal to:
($120,000 purchase price) x (3.5% closing costs) = $4,200
These initial closing costs bring Bob’s total purchase costs to:
($199 application fee) + ($3,250 lender points) + ($4,200 closing costs) = $7,649
Now Bob’s renovations can finally start!
Bob has estimated that completing renovations will take two months. Lenders such as LendingHome actually reimburse renovations after the rehab is complete. This means that Bob will need to front the $25,000 renovation budget. He can either use cash savings, float the costs on credit cards, or negotiate net-60 payment terms with his contractors or suppliers. At the end of the rehab, LendingHome refunds Bob or pays the contractors the full $25,000 amount. However, during the rehab, Bob will be required to make monthly “holding cost” payments, which are costs that add up while you rehab your property.
The first of the holding costs are the monthly, interest-only payments to the rehab lender, which in this example are equal to:
($130,000 loan amount) x (10% interest) / 12 months = $1,083 monthly interest payments
Multiply $1,083 x 2 and you get $2,166 for the two months Bob spends completing the rehab.
During the rehab Bob will also have to cover any property taxes and utilities. If property taxes are 2% and utilities are roughly $100 per month, Bob can expect additional holding costs of:
$333 property taxes + $100 utilities = $433 per month
Multiply this number by two and add it to the $2,166 in interest payments, and Bob gets $3,032 in holding costs while he rehabs the property.
At the end of the renovation, LendingHome reimburses Bob the $25,000 in rehab costs. He’ll have to show proof of rehab work – through invoices and / or receipts – in order to receive the rehab funds. At this point, Bob can replenish his savings, pay off his credit cards, or pay his contractor/suppliers.
6. Exit (Sale or Refinance)
Bob has successfully renovated his property! Not only that, but the fair market value is now $200,000. To date, Bob has paid $10,681 in costs, expenses, and fees, found as:
$7,649 total purchase cost + $3,032 two-month holding cost = $10,681
The next step for Bob is to execute his exit strategy and pay off the rehab loan.
Fix-and-flippers will want to sell the property as fast as possible to avoid incurring additional holding costs. Long-term investors looking to buy, hold, and rent will want to find a renter and refinance to a conventional mortgage equally fast. Unfortunately, exit strategies take time. It can easily take 2 months to either sell the property or find a renter and refinance to a conventional mortgage. During this time, the investor continues to incur additional holding costs. In Bob’s case, it’s another $3,032 in holding costs, bringing his total costs to:
$10,681 + $3,032 additional holding costs = $13,713
Exit 1: Fix, Flip, and Sell
If Bob is doing a fix-and-flip project, the repayment of the loan is funded by the sale of the property itself. In this scenario, Bob would sell the property for the $200,000 fair market value. If Bob’s not a licensed real estate agent, he’ll have to cover additional closing costs of 3.5% or $7,000.
This brings Bob’s total rehab costs as a fix-and-flipper to $17,281, derived as:
$7,649 total purchase costs + $6,064 total holding costs + $7,000 total selling costs = $20,713
Since he sold the property for $200,000 and then repaid LendingHome the $130,000, Bob made a total profit of $52,719, derived as:
($200,000 sale price) – ($130,000 loan repayment) – ($20,713 total costs) = $49,287 total profit
Exit 1: Buy, Hold, and Rent
If Bob is a long-term investor, the repayment of the hard money rehab loan is funded by refinancing the house with a conventional mortgage, afterwhich the home is used as a rental property. However, many banks like to see renters already occupying a rental property before refinancing, meaning Bob should expect a similar 2 month timeline from the completion of his rehab to the approval of the conventional mortgage.
In this scenario, Bob will incur total costs of $17,713, similar to a fix-and-flip project. The only difference is that Bob may have to pay a loan origination fee for the refinance of around 2% rather than the closing costs associated with selling the property:
$7,649 total purchase costs + $6,064 total holding costs + $4,000 loan origination fee = $17,713
However, since long-term investors expect to rent the property instead of selling it at the end of the rehab loan, you’ll make monthly rental income until you finally decide to sell.
In both scenarios, Bob’s total rehab timeline from pre-qualification to exit is around 4 – 5 months.
Rehab loans are great for fix and flip projects and for buying rental properties that need a little work done. Rehab loans offer investors a short term loan with interest-only payments, quick approval times, and facilitate both the purchase of a house and it’s rehab costs into a single loan.
If you’re ready to begin your next rehab project, take a few minutes and get pre-qualified at LendingHome. With funding up to 75% ARV, rates as low as 7.5%, and nationwide lending, they can be a valuable partner for short-term and long-term investors alike.