If you’re planning on flipping houses for profit, or fixing up rental properties you can hold long term, you’ll likely have to make significant repairs and renovations to the homes you buy. You’ll probably need a rehab loan to pay for the property and its repairs.
Instead of applying for multiple loans, such as a mortgage and a separate home renovation loan, with this approach, you buy or refinance a home that needs repairs and roll the cost of the renovation into your mortgage.
There are three main rehab loan programs you should know about, as well as more creative types of financing. Here’s how they work.
What Is a Rehab Loan?
A rehab loan is also referred to as a renovation loan and allows homebuyers to finance both the purchase, or refinance, of a home or investment property.
Real estate investors and some homeowners look for distressed properties that need to be renovated. Depending on whether you plan to renovate the home and then occupy it, are looking for financing to fix and flip, or want to fix up a property and then refinance it and rent it out, there are a few loan options worth considering.
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1. FHA 203(k) Rehab Mortgage Insurance
If you’re looking for a rehab loan for a property involving residential property, the Federal Housing Administration (FHA) 203(k) Rehab Mortgage Insurance program is a popular choice.
Section 203(k) insurance allows homebuyers and homeowners to finance both the purchase (or refinancing) of a house and the cost of its rehabilitation through a single mortgage. It can also be used to finance a rehab project for their existing home.
And this program may even help finance the rehab of a residential portion of a property that also has non-residential uses; or to cover the conversion of a property of any size to a one- to four- unit structure.
A low down payment of just 3.5% is required. The cost of the rehab must be at least $5,000, but the total value of the property must still fall within the FHA mortgage limit for the area which can limit available properties.
Homebuyers or homeowners who need a smaller loan amount (up to $35,000) can consider the Limited 203(k).
Although the FHA renovation loan is fairly flexible there are some thing you cannot do with the loan:
- Any project that will take longer than six months
- Minor landscaping projects
- Adding luxury amenities like a swimming pool or tennis court
2. Fannie Mae HomeStyle Renovation Mortgage
This loan program allows borrowers to finance renovations as part of a conventional mortgage. It may be used for:
- a one- to four-unit principal residence;
- a one-unit second home;
- a one-unit investment property;
- a manufactured home; or
- a unit in an eligible PUD, condo, or co-op project.
Compared to the 203(k) loan, it may be faster and allow for a wider range of renovations. Another advantage: the rate can be lower than a home equity loan or line of credit.
The maximum allowable loan-to-value (LTV)/combined loan to value (CLTV)/and home equity combined loan to value (HCTLV) is 97% for 1-unit, principal residence, purchase and limited cash-out refinance transactions. If the LTV is greater than 95% on a purchase transaction, the borrower must be a first-time homebuyer unless combined with Fannie Mae’s HomeReady loan program.
3. Freddie Mac CHOICERenovation
This loan program can be used for financing of primary residences, second homes, one-unit investment properties and manufactured homes.
LTVs vary from 80—97% depending on the type of property and borrower qualifications. All loans with greater than 80% LTV will require mortgage insurance.
It can be used to refinance a current mortgage, in which case the maximum renovation costs allowed are up to 75% of the “as-completed” appraised value.
For purchases, renovation costs are up to 75% of either the total of the purchase price and renovation costs or the “as-completed” appraised value, whichever is less. (Manufactured home rehab costs are limited to $50,000 or 50% of the “as-completed” appraised value, whichever is less.
How Does a Rehab Loan Work?
Home improvement loans are often short-term loans with high interest rates. By contrast, rehab loans have more affordable terms, and allow financing of both the home and the renovation costs.
The process for obtaining a rehab loan is generally straightforward:
- Apply with an approved lender
- Meet the credit requirements
- Get homeowner’s insurance
- Choose a contractor
- Get written estimates for needed repairs
- Rehab plans will be reviewed
- Get approved for the loan
- Rehab costs will likely be placed in an escrow account
- Partial/full cost of materials advanced to contractor
- Complete the repairs and get inspection
- Funds released to contractor
- Pay your mortgage like a typical mortgage loan
What Can You Use a Rehab Loan For?
Depending on the type of rehab loan you get, some of the uses for a rehab loan include:
- Kitchen and bathroom remodels
- Septic system improvements
- Major appliance replacement
- Heating and air conditioning upgrades
- Improvements to make the home more energy efficient
- Replacing carpet and flooring
- Replacing the roof, new gutters and downspouts
- Structural modifications
- Improving disability access
- Converting a single-family home into multifamily property
- Larger landscaping projects
- Connecting to public water or sewer
What Does It Take To Qualify for a Rehab Loan?
To apply for a loan, you must work with a lender that offers the type of loan you hope to get. Not all lenders offer all types of loans.
For the FHA 203(K) program, for example, you’ll need to work with an FHA -approved lender. FHA 203(k) loans currently require a credit score of 500 for a 10% down payment. Borrowers with credit scores above 580 may qualify for a down payment of just 3.5%.
For Fannie Mae and Freddie Mac loans, you’ll need to work with a lender that offers these types of loans who can help you get prequalified, and then guide you through the underwriting process.
Freddie Mac CHOICERenovation loans require a minimum credit score of 660 or higher.
Fannie Mae HomeStyle Renovation Mortgages require a minimum credit score of 620 or higher. There are no income limits.
Note that mortgage lenders have traditionally used FICO scores when evaluating credit scores. but in the future VantageScore credit scores will also be used for mortgage loan decisions.
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Alternative Rehab Loans
1. Investment Property Line of Credit
Best for: Investors who own property that need continual access to credit
If you already own a property, you can tap into that house’s equity—it’s current value minus what you owe on the mortgage—to finance your renovations on your new property. Investment property lines of credit work just like home equity lines of credit. You can borrow a percentage of your property’s equity, and use it again and again as needed.
Because investment property lines of credit are secured by the property, they tend to have lower interest rates than unsecured loan options. Repayment periods may vary, but commonly these loans feature a draw period during which funds can be borrowed, followed by the repayment period during which the balance must be repaid.
To qualify for an investment property line of credit, you likely need good to excellent credit, a low debt-to-income ratio, and have equity in the property.
2. Hard Money Rehab Loan
Best for: Investors looking for a short-term financing option
If you’re having trouble finding financing, perhaps due to bad credit scores or a limited down payment, consider a hard money rehab loan.
Unlike traditional lenders, which look at your credit score and income, hard money lenders base their decision to approve you for a loan based on collateral. If you have valuable property to serve as collateral, a hard money lender is more likely to work with you, even if your credit score is less-than-stellar.
When determining your loan amount, hard money lenders will look at the property’s after repair value (ARV). Generally, lenders are willing to loan you up to 75% of the property’s ARV.
Rates will vary from lender to lender. In general, hard money rehab loans have higher interest rates and shorter repayment terms than other financing options. However, they also can be processed and disbursed much faster; you could get the money you need in just a matter of days.
3. Business Credit Cards
Best for: Investors needing relatively small amounts for fix and flip loans
Never thought of a business credit card as a type of real estate investment loan?
You may want to give it a look. Some business credit cards offer intro 0% APR financing for several months. That may give you enough time to make repairs so you can sell or refinance. Plus, business credit cards usually don’t report to personal credit unless you default. That means they won’t affect your personal credit scores unless you don’t make your payments.
Choose a rewards credit card and you can even cash in those rewards points or cash back to take yourself on vacation somewhere fun or relaxing after all that hard work.
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How to Qualify for a Rehab Loan
When you’re applying for a rehab loan, lenders will expect you to meet the following requirements:
- Credit score: You’ll need a score of at least 550, or 500 for FHA 203(k) loans; 660 for a Freddie Mac CHOICERenovation loan; or 620 for a Fannie Mae HomeStyle Renovation Mortgage. Hard money loans may not have minimum credit score requirements.
- Income: Income requirements vary significantly. For traditional loans, lenders look for stable demonstrated income. Expect to be able to document sufficient ongoing income to repay the loan. Hard money lenders may be very flexible.
- Real estate experience: For some types of loans (such as hard money loans), lenders may look for borrowers who have completed a few real estate flips before, and turned a profit.
Many companies and lenders offer rehab loans, including some big name banks and online lenders that specialize in investor loans.
Rehab Loan FAQs
What is a bridge loan?
If you need to cover the gap between when you buy a property and when you can secure long-term financing—for example, if you need to come up with a downpayment—a bridge loan can be a smart solution. With a bridge loan, you can get the money you need in the short-term, then you can look for other financing options, such as a traditional mortgage, to cover the rest of it.
Is it possible to flip houses with no money?
If you want to flip houses, you don’t necessarily need thousands of dollars to get started. There are plenty of ways to flip houses with no money, including wholesaling, working with private money lenders, and partnering with real estate investors.
Can I use a business loan to rehab houses?
Using a business loan for small business to rehab houses is technically possible. However, qualifying for a business loan for real estate investing can be more complicated. To qualify, you must treat rehabbing or flipping houses as a business, and you must be in operation for several years before you can be approved. You’ll need to prove that you have successfully completed flips in the past, and have made regular profits. Some business loans may require good business credit scores.
What is the best loan for rehabbing houses?
The best loan for rehabbing houses is the one that gets you into the property you want to buy at terms you can afford. It won’t be the same loan for everyone. An investor who is trying to flip a house has very different needs than a homeowner who just wants to fix up a home with features that let them age in place.
Just like finding the right property will take effort, finding the right loan will take some work too. Ultimately, though, it will hopefully pay off.
What credit score is needed for a hard money loan?
Hard money lenders may not even check credit scores. If they do, they could be looking for signs of financial distress (such as bankruptcy or collection accounts), rather than a specific credit score.
How do I qualify for a hard money rehab loan?
Be prepared to make a down payment. Some lenders may have lower down payment requirements, but they will scrutinize the deal very closely.
How long does it typically take to close on a hard money rehab loan?
Hard money loans can often close very quickly, in as little as several business days. Research lenders in advance, so that if you find a good deal you can make an offer and close quickly. This will give you an advantage over other potential buyers.
How quickly can I obtain a hard money rehab loan for a fix-and-flip project?
If you’ve done research, talked to lenders, and gathered the information they require, you may be able to close very quickly—in a matter of days—on a rehab loan for a fix-and-flip project.
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This article was originally written on November 7, 2019 and updated on January 9, 2024.
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