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What is a Rehab Loan?

What is a Rehab Loan?

renovationsA rehab loan is also referred to as a renovation loan and it will allow property buyers to finance both the purchase / refinance and rehab of a property through one mortgage.

If you are planning on flipping houses for profit, you will likely have to make significant repairs and renovations to the house. In order to do this, you’ll probably need a rehab loan to pay for the property and its repairs so you can sell it at it’s new value. 

There are three main types of rehab loans for investors you should know about:

1. A FHA 203(k) permanent rehab loan
Best for: Buyers who want to renovate a home for their own use

If you’re looking to renovate a home for your own use, or if you’re planning on renovating the property and hanging onto it for a while, one financing option is a Federal Housing Administration (FHA) 203(k) loan. 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.

How does a rehab loan work? 

Home improvement loans tend to have high interest rates and short repayment terms. By contrast, 203(k) loans are insured by the FHA, and will usually offer lower rates and longer repayment terms. 

The cost of the home’s rehabilitation must be at least $5,000, but the total value of the property must fall within the FHA mortgage limit for your location. 

What does it take to qualify for a rehab loan?

To apply for a loan, you must work with an FHA-approved lender. There is no income requirement to qualify, but you must have a credit score of at least 500 to be eligible for a 203(k) loan. 

Only owner-occupants (not investors) may use the program. 

2. 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 (its 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 other financing options. And, you can have up to 30 years to repay it. 

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. 

3. Hard money rehab loan
Best for: Investors looking for a short-term financing option

If you’re having trouble finding financing help, consider a hard money rehab loan. Unlike traditional lenders, which look at your income and personal financial history, hard money lenders base their decision to approve you for a loan based on the appraised future property value, the liquidity to close, and the ability to rehab the property. If you have additional collateral or offer a pledge of equity, a hard money lender is more likely to work with you, even if your credit score is low or you have minimal experience investing in real estate.

When determining your loan, 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; this way you can get the money you need in just a matter of days. 

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, for the best rates a score of 750+.
  • Income: Lenders will look for stable income. Income is not a concern for hard money lenders. Just need to show enough money in the bank to pay down payment, closing costs, and have some reserves.
  • Real estate experience: For the best rates, lenders look for borrowers who have completed a few real estate flips before, and turned a profit. Some lenders welcome first time investors at a higher rate.

Rehab Loan FAQs:

1. 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, 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, for the long term. 

2. 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 ways to flip houses with no money, including wholesaling, working with private money lenders, and partnering with real estate investors. Typically, lenders will look for the borrower / guarantor to have some “skin in the game” of their own money before offering a loan.

3. Can I use a business loan to rehab houses? 

Using a business loan for small businesses to rehab houses is technically possible. However, qualifying for a loan or a business credit card can be 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.

Whatever your purpose is for securing a business loan, keeping tabs on your personal and business credit scores will be key. 

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