Financing a Home that Needs Work

With the continued scarcity of homes listed for sale, what’s often not pounced upon immediately are properties that aren’t in excellent condition. A growing segment of the calls I receive are from people wanting to buy a home with “issues” and want to know if financing will be a problem.

The first step is to categorize the subject property into one of 3 categories.

1) The Teardown.
There’s no problem in financing these properties. Since no value will be given to the structure, a vacant land loan is used. Consideration must go into the cost of demolition. A vacant land loan has interest-only payments until you are ready to build. The maximum term is 3 years. That’s sufficient time for anyone to get their plans, permit, and contractor in place.

2) Renovation/Improvements Required.
There are 2 types of renovation/purchase financing loans. The first is for light repairs such as a new roof, exterior painting, and/or appliances. There’s a cap of $35,000 for these renovation “light” loans. The second type is for renovations or improvements that are structural in nature. Maybe the home is okay, but doesn’t have sufficient bedrooms or bathrooms. Or in a lot of situations, our voracious termites and pounding trade winds require that extensive repairs be made in order to make the home livable again. These renovation loans are excellent because they allow for as little as 5% down on the purchase.

3) Do nothing and pray for a blind appraiser.
This is the most frequent scenario I am faced with. I am constantly asked “will the appraiser (lender) will have issues with the following problems…?” Here’s some absolute issues that will stop your transaction dead in its tracks. Obvious termite damage. Obvious roof leaks. Broken windows. No flooring. Missing built-in appliances. Missing bathroom fixtures. Exposed exterior (no paint).

If the property you are considering doesn’t have any of the above, the next consideration in the condition classification the appraiser will give to the overall condition of the home. Appraisers use a condition scale of C1 to C6, with 1 being new or recently new construction. A C6 is a total dump. Lenders will lender on C1 to C4. C5 and C6 need a renovation loan in order to be financed.

Here are the actual appraiser condition ratings and definitions for each category:

C1 The improvements have been very recently constructed and have not previously been occupied. The entire structure and all components are new and the dwelling features no physical depreciation.*
*Note: Newly constructed improvements that feature recycled materials and/or components can be considered new dwellings provided that the dwelling is placed on a 100% new foundation and the recycled materials and the recycled components have been rehabilitated/re-manufactured into like-new condition. Recently constructed improvements that have not been previously occupied are not considered “new” if they have any significant physical depreciation (i.e., newly constructed dwellings that have been vacant for an extended period of time without adequate maintenance or upkeep).

C2 The improvements feature no deferred maintenance, little or no physical depreciation, and require no repairs. Virtually all building components are new or have been recently repaired, refinished, or rehabilitated. All outdated components and finishes have been updated and/or replaced with components that meet current standards. Dwellings in this category either are almost new or have been recently completely renovated and are similar in condition to new construction.
*Note: The improvements represent a relatively new property that is well maintained with no deferred maintenance and little or no physical depreciation, or an older property that has been recently completely renovated.

C3 The improvements are well maintained and feature limited physical depreciation due to normal wear and tear. Some components, but not every major building component, may be updated or recently rehabilitated. The structure has been well maintained.
*Note: The improvement is in its first-cycle of replacing short-lived building components (appliances, floor coverings, HVAC, etc.) and is being well maintained. Its estimated effective age is less than its actual age. It also may reflect a property in which the majority of short-lived building components have been replaced but not to the level of a complete renovation.

C4 The improvements feature some minor deferred maintenance and physical deterioration due to normal wear and tear. The dwelling has been adequately maintained and requires only minimal repairs to building components/mechanical systems and cosmetic repairs. All major building components have been adequately maintained and are functionally adequate.
*Note: The estimated effective age may be close to or equal to its actual age. It reflects a property in which some of the short-lived building components have been replaced, and some short-lived building components are at or near the end of their physical life expectancy; however, they still function adequately. Most minor repairs have been addressed on an ongoing basis resulting in an adequately maintained property.

C5 The improvements feature obvious deferred maintenance and are in need of some significant repairs. Some building components need repairs, rehabilitation, or updating. The functional utility and overall livability is somewhat diminished due to condition, but the dwelling remains useable and functional as a residence.
*Note: Some significant repairs are needed to the improvements due to the lack of adequate maintenance. It reflects a property in which many of its short-lived building components are at the end of or have exceeded their physical life expectancy but remain functional.

C6 The improvements have substantial damage or deferred maintenance with deficiencies or defects that are severe enough to affect the safety, soundness, or structural integrity of the improvements. The improvements are in need of substantial repairs and rehabilitation, including many or most major components.
*Note: Substantial repairs are needed to the improvements due to the lack of adequate maintenance or property damage. It reflects a property with conditions severe enough to affect the safety, soundness, or structural integrity of the improvements.

When looking at a property, be honest and frank on the condition. The last thing you want to do is throw money away on an appraisal, plus have your earnest money deposit tied up in a transaction that will crash and burn. If the home is a C5, see what can be done to move it to a C4 before the appraisal inspection. If the seller is unwilling to cooperate, and you want the property, then a renovation loan may be your only solution.

The good news is that renovation financing is better than it ever has been. There are more options available than any other time in modern mortgage lending. If you are looking for that perfect place to call home, maybe it’s listed for sale – it just needs some renovation to make it perfect for you!

Lastly, renovation financing is specialty lending product. If you want direct, honest, and most important, correct answers to what can be done, start your conversation with the prospective lender as to how many of these loans they have actually done. Unless they know what they are doing, it will only add more frustration to the situation.