Residential Magazine

Good As New

Renovation loans can play a key role in solving the nation’s housing shortage

By Jim Bopp

Today’s headlines warn that the inventory of homes for sale will continue to be low for months if not years. Mortgage lenders and originators may wonder where their purchase loan volume is coming from for the remainder of this year and beyond. Delving beyond the headlines, however, reveals an opportunity to expand purchase volume, move prequalified clients into homes and benefit local communities by offering renovation-based purchase and refinance loans.

A look at historic data from the federal government shows that the 4.4-month supply of U.S. homes for sale in April 2021 was about even with supply levels seen during 2013 and 2015. This recent mark, however, is well below the 5.8-month supply in April 2019.

What’s even scarcer than single-family listings in today’s market? Available homes that are considered move-in ready. The proportion of U.S. housing stock that is old (and getting older) continues to grow.

Two factors influence the age of homes. The first is obvious: how long ago a home was built. The median age of a U.S. home in 2019 was 39 years, with the youngest median ages in the Sun Belt states and the oldest in the Northeast, according to a report from the National Association of Home Builders (NAHB).

The second factor is less obvious: how much new housing stock is added to the overall housing supply. NAHB reported that delays in material deliveries and rising construction costs drove single-family home starts down by 13.4% month over month this past April. This number rose by only 4.2% in May. Meanwhile, increases in new-home prices or interest rates could make it even more challenging for homebuyers to afford turnkey properties.

Different viewpoint

Lenders would do well to look at the available housing stock from a different viewpoint. Renovation home loans support buyers and homeowners whose improvements modernize housing inventory. With inflationary pressures likely to lead to a rise in interest rates, renovation lending offers another avenue for lenders and originators seeking to grow their purchase and refinance market shares in the short term and beyond.

What strategies can lenders use to increase renovation lending? Mortgage originators can seek out current homes in the multiple listing service (MLS) that would benefit from renovation by searching for renovation-related words in property descriptions. 

A focus on key phrases in property listings may lead to homes that could be marketed and sold using a renovation loan plan. Some of these keywords are obvious, including “as-is,” “charmer,” “handyman special,” “needs some TLC,” “just reduced,” “has potential” and “location, location, location.” Other phrases include “room for expansion,” “convert back to” or “unfinished.” Bank-owned or foreclosure listings also may benefit from renovations. And MLS research may uncover real estate agents whose specialty is to market and sell these fixer-uppers. 

A renovation lender can help a buyer acquire a property with renovation potential that is priced below the client’s maximum qualifying ratio. The right renovation loan builds the money to fix up the home into a single affordable purchase loan. This strategy also will appeal to pre-approved clients fighting against multiple offers, cash offers, or offers with no or minimal contingencies.

The bottom line is that the mortgage industry can increase the supply of turnkey housing and improve existing housing inventory by embracing homes in need of renovation.

Addressing supply

There are two questions to ask these types of prospective buyers. One is whether they’ve recently seen listings that are in the ideal location but may need repair. If so, ask if these properties are priced below their maximum qualifying mortgage amount.

If the answer to both questions is “yes,” then the next question would be whether they’d consider submitting an offer on a home that could be purchased with a renovation loan, allowing them to make repairs and improvements before they move in. This could be what moves the client from a prequalified borrower into a homeowner who closed a loan with your company.

Renovation loans also can help homeowners who would like to sell their home but are unable to find a new home. The concept is to educate them on the benefits of a renovation loan — in essence, “fix up if you can’t move up” — in situations where only a few things about their current home are causing them to want to move. With interest rates remaining low, this option may be much more attractive than incurring the costs of selling a home, acquiring another one and moving.

Also, originators can apply this strategy to borrowers who have limited equity in their home based on its “as is” value, or those who lack enough equity to open a line of credit line large enough to complete the projects they envision. Borrowing based on the “as-completed” value can leverage potential post-renovation equity. 

In some cases, it may be possible to roll closing costs into the renovation loan and even avoid paying mortgage insurance. Other potential benefits include extending the term to lower payments, as well as having a single loan payment versus the dual payments of a traditional mortgage and an equity line.

The bottom line is that the mortgage industry can increase the supply of turnkey housing and improve existing housing inventory by embracing homes in need of renovation. At the same time, lenders and originators can grow their volume by moving home shoppers from the prequalification pipeline into the funding pipeline.

Game-changing loans

Mortgage originators who currently offer renovation loans are reaping the benefits of these creative and game-changing programs. Those who are not may benefit from getting in the game. 

Effectively selling renovation loans takes time and effort since these products contain more moving parts than a vanilla purchase or refinance. A quick overview will show the important differences.

The lack of turnkey listings not only affects homebuyers; it affects real estate agents as well. When Realtors become familiar with the concepts of renovation loans, they in turn become more aggressive in accepting listings that otherwise might be difficult to sell. 

Real estate agents also can help to spread the word to buyers about renovation loan programs, thereby increasing their own sales. To get Realtors in the game, correspondent lenders can offer seminars on renovation-based purchase loans or set up displays at fixer-upper open houses that show bids and building materials from contractors who are ready to remodel.

How it works

A renovation loan is based on the after-repair value of the property, even though the improvements will be made after closing. The appraiser values the home based on plans and specifications for all repairs, improvements and additions to the property.

At closing, the lender places the funds for the planned improvements in an escrow account. Funds get disbursed in periodic draws as an inspector confirms that the contractor has completed each phase of the project. In many cases, borrowers will have six months to complete their project, with the possibility of longer periods for bigger projects on conventional loan options.

The most widely used programs are the Federal Housing Administration (FHA) standard or limited 203(k) rehabilitation mortgage, Fannie Mae’s HomeStyle Renovation Loan or Freddie Mac’s CHOICERenovation option. These products offer fixed-rate financing with terms up to 30 years and high-balance options. Each of them requires mortgage insurance based on the loan-to-value (LTV) ratio.

Depending on the loan program and investor offerings, eligible properties include one- to four-unit single-family homes, manufactured homes titled as real property and mixed-use properties. Fannie Mae and Freddie Mac also offer mortgages for single-family investors and second homes. 

Renovation loans allow first-time homebuyers to purchase and create the home of their dreams for the same price as a move-in ready home.

Solutions to fit

To determine which renovation program best suits a borrower, originators should consider the borrower’s financial profile and the dollar value of the renovations. FHA allows for lower credit scores and higher debt-to-income (DTI) ratios than conventional loan options, and these mortgages can carry LTVs as high as 110% of the as-improved value. 

HomeStyle and CHOICERenovation typically require higher credit scores and lower DTIs. As with the agency’s non-renovation loans, FHA requires a 3.5% downpayment, while conventional options require a 5% downpayment unless the borrower is a first-time homebuyer and/or has completed an approved homebuyer education program. A 3% downpayment option could be used in these cases, making renovation financing a viable option for the first-time homebuyer with less cash on hand. 

Renovating a home can be a messy business for homeowners who want to do major remodeling, especially if their project includes kitchens or bathrooms. FHA and conventional programs allow the borrower to finance up to six months of housing payments so they can live off-site and not have to make two separate housing payments. This is an excellent feature for first-time and move-up homebuyers with major renovation projects.

What could be

Renovation loans require more time and documentation than traditional mortgage programs. Some lenders have a dedicated staff to originate, process and underwrite their renovation loans while walking borrowers through the entire process.

Renovation loans allow first-time homebuyers to purchase and create the home of their dreams for the same price as a move-in ready home. For millennials and members of Generation Z who are still living at home or renting, the ability to finance up to six months of initial housing payments allows them the time to renovate and purchase furnishings. Realtors gain immediate, saleable inventory, lenders gain volume and communities benefit from property value improvements that boost the tax base.

Last year, Americans spent more than $420 billion on home improvements, and some of this spending created much-needed housing inventory. With renovation loans, consumers can look deeper and envision what a home could be. Originators and real estate agents benefit by turning these prospective homebuyers into homeowners. ●


  • Jim Bopp

    Jim Bopp is vice president of national renovation lending at Planet Home Lending LLC, where he manages retail and correspondent renovation loan programs, including FHA 203(k), VA alteration and conventional loan offerings. Bopp has more than 25 years in the financial industry. He is an active Mortgage Bankers Association (MBA) member, helped to start the New York MBA, sits on the national trade association’s FHA committee and leads its FHA 203(k) working group.

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