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Background: We are considering buying home listed for USD$199,000. It is rather outdated and the systems are - we think - original to the home, built in 1976. (I'm trying to get more disclosure from the owner but they're the original owner and the systems look pretty old.) Because of this, we are considering remodeling the home, possibly even before we move in. What we are envisioning includes knocking out an interior wall, redoing the bathrooms, and replacing two heat pumps, a furnace, and a sump pump. I did a little research and found the average cost for just replacing those systems would be about $18k. We are currently planning to pay for the remodel by withholding some of our $30k down payment but, in a search for alternatives, I came across the HomeStyle mortgage from Fannie Mae.

QUESTION: What is the HomeStyle mortgage from Fannie Mae, how does it work, and what are the advantages / disadvantages?

My Own Research: From what I've read through on Forbes.com, Interest.com, and Fannie Mae's own website (1, 2, 3), it seems like they're only good for people who want to buy a house but don't have the cash to cover both a down payment and the remodeling costs. Is that right? Given the numbers I gave, we probably couldn't replace the systems, do the structural remodels, and have a decent down payment. We can wait on the structural part if that's the a problem. What's the best long-term option?

  • Not an answer, but are you sure you really need those renovations? If the existing heat pumps are working, replacing them will take basically forever to pay for itself, even if the new ones are more efficient. And if I had both a furnace and a heat pump I'd just tear our the furnace and use the heat pump exclusively. – R.. Jun 10 '16 at 17:58
  • @R.. No, I don't know they're necessary. We haven't had any professionals in there yet. We were trying to start with the worst-case scenario based on our layman evaluations. Any part of the plan that doesn't need doing yet is, therefore, an improvement on our initial idea. – Engineer Toast Jun 10 '16 at 18:33
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HomeStyle loans are a variation on the FHA's 203k loan. Both exist for the purpose stated - to allow a homeowner to buy a house that needs substantial work and borrow funds against that work.

Both require fairly small down payments (though you would end up with PMI, I suspect), 5% for Fannie Mae and even lower 3.5% for FHA. That is the percentage of the total value of the house after renovation [or, the sale price + the cost of renovation, rather], not the sale price. In both cases, you'll need to use a contractor (not do the work yourself, generally), and the lender will overseen some aspects of the renovation (including needing to approve the contractor and the work). They likely involve higher fees than a regular mortgage, and a slightly higher interest rate.

You can read this comparison of renovation loans to see the differences between the two types of loans.

A third option, which is what we ended up doing, is that you can take a regular mortgage, do the renovations yourself more slowly, and then refinance the house in a few years at its new higher value. This requires having the ability to do those renovations up front - either borrowing money from family or 0% interest credit cards or similar - but gives you some flexibility (in particular, lets you do some of the work yourself, and at a slower pace).

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Yes, your summary seems correct.

The main advantage is the cash up-front is much lower. Of course, over the long term the cash required to repay the loan is much larger.

The main disadvantages I have seen:

  • lengthy lending process. Lots of paperwork up front to estimate the cost and value of the renovations. This can be a pain when negotiating the purchase of a home

  • Harder to get renovations done. The lender must oversee and approve the work and the contractors doing the work. Contractors must be bank-approved to do the work. The lender often pays the contractors directly. This can slooooow down the renovation process and make it hard to correct mistakes or change plans (which is not uncommon on a rehab).

For example: A coworker and friend of mine had a rehab loan that drug out his move-in date by 6mo simply because one of his contractors decided to quit. The process to switch contractors and not pay the old one took forever due to red tape. He couldn't just hire someone else or do the work himself.

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