Rehab loans help real estate investors fund the purchase and renovation of residential properties. Short-term investors use them to fix-and-flip properties as well as long-term investors who need renovation financing for rental properties. A rehab loan combines property purchase and rehab costs into a single short-term loan with quick funding and interest-only payments.
3 Types of Rehab Loans
Investors seeking short-term financing use hard money rehab loans to purchase a property quickly, renovate, and sell it. Buy-and-hold investors may also use these loans to rehab and season properties before refinancing. Permanent rehab mortgages are used solely by investors who plan to keep the property as a rental. An investor line of credit can be used many times over to purchase and renovate property.
Common Types of Rehab Loans
| Type of Rehab Loan | Best For |
|---|---|
| Permanent Rehab Mortgage | Renovating a property and holding it as a rental |
Investor Line of Credit (LOC) | Revolving line of credit for purchase and rehab |
Hard Money Rehab Loan | Fix-and-flipping a property quickly without traditional qualifications |
Last updated on 05/07/20 | |
Permanent Rehab FHA 203(k) Loans
The Federal Housing Administration (FHA) offers loans that are intended to finance both the acquisition and rehab of owner-occupied properties. These FHA 203(k) loans are available for properties that require at least $5,000 in repairs and allow purchasers to use part of their loan funds at closing and part to pay rehab expenses.
A HomeStyle Renovation (HSR) loan can be used by owner-occupants to finance properties up to four units. HSR loans also allow investors to finance a one-unit investment property that is separate from their primary residence.
Permanent Rehab 203(k) Loan Rates, Terms, & Qualifications
Interest rates, terms, and fees for Permanent Rehab 203(k) loans typically align with those of conventional mortgages. They also require a smaller down payment from the borrower of a minimum of 3.5%. However, borrowers with less than a 20% down payment will have to pay private mortgage insurance (PMI) until the property’s equity reaches 20%. When it does, the borrower will need to ask for the PMI to be canceled.
Interest Rates | 4.5% to 7.5% |
Lender Fees | 1.5% supplemental origination fee 2.25% upfront mortgage insurance premium (MIP) 2.5%-5% closing costs |
Loan Term | 15 to 30 years |
Maximum Loan Amount | 80% to 96.5% of purchase price plus renovation costs and loan fees |
Permanent Rehab 203(k) Loan Qualifications
The biggest drawbacks to a 203(k) loan on an investment property are the borrower has to agree to live in the property for at least 12 months, and the property can have no more than four units. Another disadvantage is the approval process can be tedious and take a lot longer to close than other financing options. However, these are offset by lower credit score criteria and smaller down payment requirements.
Minimum Credit Score | 640 |
Remaining Equity After LOC | 3.5% to 20% of loan amount |
Investor Experience | None; can only be used on an owner-occupied property |
Where to Find Permanent Rehab 203(k) Loans
Permanent 203(k) rehab loans are only issued through FHA approved lenders. The United States Department of Housing and Urban Development (HUD) provides a location-driven FHA-approved 203(k) lender search tool where you can get a list of lenders who have issued a 203(k) loan in your search area within the past year. The list includes both local and national 203(k) lenders.
Investment Property LOC
Investors who already own properties outside their primary residence may be able to borrow against existing properties to finance additional purchases or renovations. These investors can often use investment property LOCs to tap the equity that they already have in investment properties. By establishing a line of credit, investors can create a revolving credit line that they can draw against as necessary and pay down when they can.
Investment Property LOC Rates, Terms, & Qualifications
To qualify for an LOC, borrowers must meet minimum equity and credit score requirements. The lender also will evaluate the borrower’s debt-to-income ratio (DTI). Debts, including the new LOC, cannot exceed 45% of the borrower’s gross income.
Interest Rates | 4.75% to 8% |
Lender Fees | Up to 5% of loan amount |
Loan Term | 18 months to 30 years |
Maximum Loan Amount | 75% loan-to-value (LTV) |
Investment Property Line of Credit Qualifications
Investment property LOC qualifications include a high FICO score but are based more on the investor’s overall financial picture, including his assets, salary, and investments. The property also needs to have at least 10% to 20% remaining equity in the property after the LOC.
Minimum Credit Score | 660 |
Remaining Equity After LOC | 10% to 20% |
Investor Experience | Strong financials and completion of two or three past projects for portfolio LOCs |
Where to Find Investment Property LOCs
Only certain lenders offer investment property LOCs. They aren’t always available at local banks and credit unions. You can check with commercial lending departments at local banks to see if an investment property LOC exists. CoreVest offers lines of credit on real estate portfolios starting at $1 million, with interest rates starting at 7%.
Hard Money Rehab Loans
Hard money loans are typically the fastest route to financing rehabs because they can often close within 15 days. Hard money loans are usually approved based on the property’s value as an investment and less heavily on the buyer’s personal qualifications. However, hard money is often more expensive than traditional financing with higher rates and fees.
Hard Money Rehab Rates, Terms & Qualifications
Interest rates on hard money rehab loans generally run between 7% and 12%. While these rates are higher than conventional mortgages, they reflect the additional risk inherent in rehab projects and the short expected loan duration. In almost all cases, investors make interest-only payments and repay the full principal at the end of the loan.
Interest Rates | 7% to 12% |
Lender Fees | 1% to 10% of loan amount |
Loan Term | 12 to 36 months |
Maximum Loan Amount | 75% after repair value (ARV) |
ARV
Rehab loans for investors combine funds for purchasing and renovating a property into a single loan. Hard money lenders typically set a maximum loan amount using a property’s ARV ratio. The ARV ratio represents a percentage of a property’s expected fair market value (FMV) after renovations are completed.
Experienced investors can sometimes achieve higher ARVs. However, they can expect to cover at least 25% of a property’s ARV with their own cash. Some rehab financing providers also require investors to pay for renovations upfront and submit invoices to the lender to get reimbursed for the rehab costs.
Hard Money Rehab Loan Qualifications
Rehab loan qualifications vary, but most lenders require some real estate experience, at least a 25% down payment, and bank statements to verify assets and income. Properties being purchased or renovated with rehab loans also typically need to be in locations acceptable to lenders.
Minimum Credit Score | 550 |
Remaining Equity After LOC | 25% of ARV |
Investor Experience | One to two completed projects, construction background, or work with licensed contractor |
Where to Find Rehab Loans
Hard money rehab loans have a bad reputation. Many reputable companies offer them, and many successful real estate investors use them. Rehab loans can be found at small local lenders as well as national online lenders. They’re beneficial for both long-term investors and short-term investors. Be sure to include the rates, terms, costs, and fees in your cash flow projections when doing your real estate due diligence.
If you’re looking for a rehab loan for investors, be sure to check out Kiavi. It’s a nationwide lender that offers rehab loans to fix-and-flip investors. It offers competitive rates as low as 6.5% to prime borrowers and can get you prequalified online in a few minutes.
Renovating a Property Using a Rehab Loan Steps
Investors who want to use rehab financing to renovate a property must follow certain steps. The application process for a rehab loan varies among lenders, but investors must follow the process to qualify for a loan and use it to renovate a property. Failing to follow these steps can keep an investor from qualifying for a rehab loan or closing on a property.
1. Get Prequalified for a Rehab Loan
Whether you’re applying for a 203(k) permanent rehab loan, investment property LOC, or hard money loan, lenders usually have a prequalification process that helps investors determine an expected ARV, LTV, or loan-to-cost (LTC) ratios, costs, fees, and other terms. The prequalification process takes a few minutes, is nonbinding, and allows real estate investors to move forward with confidence that financing for their project is available.
2. Receive Approval for a Rehab Loan
After you’re prequalified for a rehab loan, you have to work on getting final approval. Unless you’re getting an investment property line of credit, you’ll need to narrow your property search to a specific property and prepare additional documents, including your purchase contract and a list of past projects. You should already know your maximum loan amount when you start working on formal approval, so this will narrow your property search.
Purchase Contract
After you’ve made an offer on the property, send the purchase contract to your lender. You may also be asked to submit proof of prior rehab experience and a renovation budget for the property you’re trying to finance. Contracts should include the agreed-upon sale price and the terms of the purchase. In most cases, both the buyer and seller will sign the agreement and may stipulate that the purchase is contingent on final loan approval. The purchase contract is for buying a new property and not for obtaining a line of credit.
Property Appraisals
With all three types of rehab loans for investors, the lender will require an appraisal. For purchases, the lender will order two appraisals as part of its 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 renovations have been made. Appraisals are typically paid for upfront by the borrower.
List of Past Projects
If you expect to complete your renovations yourself, lenders will want to see that you have completed at least two projects previously. 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 place of experience. In this case, hard money lenders will want additional information on the contractor, including the company name, license number, scope of rehab work, overall bid, and timeline for completion.
Scope of Rehab Work
Lenders will typically require a contractor to perform the work if it’s a complex rehab project, but let you do your own renovations for simple projects. If you’re using a contractor, the scope of rehab work is typically included in their bid. If you’re doing the rehab yourself, you can prove the scope of work with estimated material costs as well as a time for completion.
3. Get Financing
Once a lender approves you for rehab financing, it will provide a breakdown of fees, interest rate, and estimated closing date. If you accept the rehab loan terms, the loan will be funded in 10 to 15 days. Lenders typically send initial loan payments to an escrow or settlement company that distributes the funds to the seller and transfers title ownership.
When it’s time to pay for renovations, your lender will distribute funds in the form of draws. The lender pays for the acquisition cost of the property at the closing, but the renovation costs will be paid to you separately as the work is completed.
4. Purchase the Home
Once the rehab loan is in underwriting, the title company runs a title search and orders title insurance, which is required by the lender. You will receive a commitment letter from your lender, letting you know when they can close the loan, and the title company will schedule the date, time, and location of closing. At the end of the closing, you’ll own the property and can begin renovations.
5. Complete Rehab Renovations
The renovations should be done right but also quickly because the longer you hold onto the property, the higher your carrying costs and the lower your profit. You should have a renovation timeline. The lender lets you know upfront how they will fund your renovations. You’ll need to inform contractors upfront how and when they will be paid, and this is dependent on how the lender distributes the funds.
6. Exit the Property by Selling or Refinancing Your Rehab Loan
Now that you have renovated your property successfully, you need to proceed with your exit strategy. This is typically done by refinancing into a permanent loan for a long-term investor or selling the property for a profit for a short-term investor.
Having a renter in the property for six months or more is referred to as seasoning, and some lenders require it before they will make a loan on an investment property. Unfortunately, exit strategies can take time. It may take two 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.
Rehab Loan Alternatives
Some investors won’t qualify for a rehab loan due to a lack of experience or lack of equity. With that in mind, there are several alternatives to rehab loans if you are willing to get creative and be patient. Alternatives like credit cards may charge higher interest rates than hard money loans but include fewer fees.
Alternative Financing | Advantages | Disadvantages |
|---|---|---|
Home Equity Line of Credit (HELOC) | Revolving line of credit; draw as needed | Risk of losing your home |
Home Equity Loan | Use equity in personal residence to fund a rehab | Need a high loan-to-value ratio |
Cash-out Refinance | Low interest rates | Increased loan term, paying higher interest |
Credit Cards | Fast funding; easy access to credit line | High interest rates; potential risk to credit score |
Personal Loans | Lender only looks at your personal financial history, not the property | Lender may not allow; higher interest rates than mortgages |
Save Cash | No finance charges, no lender qualifications | Might take long to save; you take all the risk; ties up cash |
Rehab Loans Frequently Asked Questions (FAQs)
This article covers some of the best ways to get rehab loans. Below are a few of our most frequently asked questions regarding rehab loans.
1. Can you get a business loan to flip houses?
Business loans are typically long-term loans and require business income history to qualify. That said, if your business is rehabbing, and you can document consistent income from that business, you may qualify for a business line of credit. However, with no collateral, the line may not be large enough to fund entire projects.
2. What is title seasoning for rehab properties?
Title seasoning may be required on refinances with conventional lenders. Typically, lenders require a minimum of six months of title seasoning, meaning the title must stay the same for at least six months before it will be eligible for a refinance. Many hard money lenders offer three-month seasoning requirements for their long-term financing.
3. Can you use a line of credit for a down payment on a house?
You can use a line of credit, credit card cash advance, or a personal loan for a down payment on most purchases. However, the new loan payment will count toward your DTI ratio. Also, keep in mind, some of the lines of credit will carry higher interest rates than your long-term mortgage.
Bottom Line
Rehab loans are great for fix-and-flip businesses and 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 the renovation financing in a single loan.
