As a real estate investor, I am constantly trying to teach myself about different ways to purchase real estate properties. My strategy has typically been the buy and hold method. I prefer to purchase rental properties because I love and want the monthly cash flow and plan on reaching financial freedom with this rental income.
I learned about renovation loans years ago and always thought they were an intriguing option. If the opportunity ever arose for me to use one, I would and at last the opportunity finally came when I found a gem of a fixer upper listed on the MLS. I purchased this property which is now my primary residence using a Fannie Mae HomeStyle Renovation loan. This is my experience with a Fannie Mae HomeStyle Renovation loan.
What is a Fannie Mae HomeStyle Renovation loan?
The Fannie Mae HomeStyle® Renovation Mortgage is a conventional loan program that allows you to purchase a fixer upper property and include the repair costs in the loan. It’s basically the non FHA version of the 203k renovation loan.
From an investor perspective, it can make a lot of sense to use a loan like this because it allows you use other people’s money (OPP) to fund and fix up a house all with the intention of having built in equity once it’s completed. Sounds easy huh? Well let’s take a look below to see how it worked out for me and whether or not it ended up being a good or bad strategy to use.
Finding a House/Property:
Finding a house that you think will be a good fit for using this type of rehab loan can be a very difficult task. You see not all houses fit this model as the purchase price of the house must be low enough so that the renovation costs plus the purchase price is equal to at the most 97% of what the after appraised value is.
Once you find your property it’s a matter of running some numbers to make sure it makes sense to you. For me it was a matter of determining how much built in equity would be left for me after totaling the acquisition costs plus renovation costs and deducting the after appraised value. My justification on using this loan program was based on getting a discount on the new home in the form of having built in equity AFTER everything was completed. Essentially, free money! 🙂
The Estimated Numbers:
As an investor, you know that you have to be very accurate yet conservative when running numbers and determining if a property will be a good investment or not. Not every house will make a good investment and when purchasing a primary residence, it kind of throws those numbers out the window. I mean a primary residence after all is not going to be bringing in income. It’s not a cash flowing asset therefore the way I ran my numbers was based on how much built in equity I would have with the final product. Whatever the remaining equity would by my investment return so to speak.
These were my original estimates and how I thought the numbers/returns would pan out.
Purchase Price: $120k
Renovation Costs: $100k
Closing Costs + 5% Down Payment: $16k
Total Costs: $236,000
After Repair Value (House appraised value after the renovation): $310k
Total Cash Used: $16k
Estimated Built-In Equity: $74000
$74k in estimated equity after all is said and done is absolutely amazing!! It’s equal to getting a $74k discount on the full retail value. Or a 24% discount. Not too shabby! Keep reading and you will see eventually what the actual numbers. Let’s just say my numbers were a little off 😉
Finding a Lender:
Okay now that you understand the program and ran some initial numbers, it’s time to take action and start looking for a lender capable of doing this type of loan. For me, I really wanted to find a local lender because I thought a local lender would have a list of contractors available willing to do this kind of renovation. (more on that later).
I called over a dozen local banks here in Indianapolis looking for a specialist with actual experience closing this type of rehab loan. I was only able to find one lender/broker that said had experience with “hundreds” of these renovation loans over the years including FHA 203k loans. He seemed very knowledgeable about the whole process and had an answer to all my questions. There was a 2nd loan officer I spoke with (a much younger guy) who claimed he had closed a few of these but he didn’t seem too confident when I was asking him questions.
I highly recommend you call as many lenders as you can and interview them if you will about these types of loans. Many lenders will claim they know how to do one but have not actually ever closed on a loan of this sort. I doubt it will be easy to find a lender very familiar with these types of programs. These renovation loans are not easy to manage, take a lot longer time to close and involve more parties then a typical loan type. The more parties involved, the higher risk of failure and the potential for longer delays.
Finding a Contractor:
If you thought I spent a lot of time calling around trying to find a lender, wait until you see how difficult it was for me to find a contractor willing on taking this type of renovation and for this amount. As it turned out, the local lender I went with, did not have any contractors he was willing to recommend. For one reason or another, he did not feel the contractors he had dealt with previously on these loan programs were good enough to continue using.
With that being said I called literally over 40 different local contractors in the area looking for a licensed contractor willing to take on such a huge renovation and go through this loan program.
I could find only 4 contractors willing to give me a quote on this and claiming to have done these types of programs in the past. You see in order for a contractor to do this type of program, it will require they have their own funding to pay for the renovation up front as well as deal with a bunch of red tape and documentation from the lender and Rehab consultant needed to fulfil this loan program. I mean if I were a licensed general contractor, there is no way I would do one of these loans. Why go through so much trouble knowing there are so many other jobs out there without having to deal with all this extra red tape.
The only benefit I can find about doing one of these renovation loans as a contractor is just knowing that the funding for the renovation is already there and will be disbursed by the lender. (as long as the work gets completed of course) So there is a little less risk associated from doing a job and not getting paid for it.
Here were the 4 quotes I initially received:
Contractor 1: 111k (This contractor left out a bunch of items I had asked for, payed little attention to our initial walk through and somehow came up with this $111k bid)
Contractor 2: $110k (This contractor left out on a few stuff and seemed to give me the proper attention I was looking for)
Contractor 3: $120k (This contractor added a bunch of amenities I never asked for to come up with this price which seemed like a good deal to me initially)
Contractor 4: $0 (this contractor never sent me a quote after walking the property and saying he would.)
It came down for me between Contractor 2 and 3. After researching these contractors thoroughly on the internet, it turned out that contractor 3 has a prior felony for scamming people on construction jobs. Awesome!! Hooray for the internet, I would have never have found something like this otherwise.
So, with that being said , I went with Contractor 2. Or to for lack of better terms, I was stuck with contractor #2. After going back and forth with this contractor for about 6 weeks, we finally came to a final estimate of $120k. This would be the final estimate submitted to the lender for the closing package. Per the contractor, the total time until completion would be 6 months which also happened to be the max time allotted for this type of loan program.
Finding a Renovation Consultant:
If you are getting an FHA 203k loan, it requires you work with an FHA Renovation consultant to act as the 3rd party inspector. This inspector checks on the work done by the contractor during the multiple stages of the renovation and is in charge of authorizing/approving the cash disbursements as each milestone is completed. Well the HomeStyle loan program also requires this same inspector although it is not an FHA product.
As it turns out there were only a few active FHA renovation consultants in Indianapolis and I could only get a hold of one of them. I was forced to use this person even though I had found bad reviews online about this person about previous home inspections they had completed. I bit the bullet and just went along. I mean how bad can inspector be right on a full gut job renovation?
Total Time to Close on the Loan: (note this is before any construction/renovation has even begun)
After dealing with all the paperwork, lenders, contractors and consultant, we finally got to the point where we could close on the loan.
Total time from entering the purchase agreement on the home to the closing date: 4 months and 1 week
It literally took over 4 months just to get to the point of actually closing on this program. Most conventional loans take 30 to 40 days. Not this bad boy, prepare for a long arduous experience just trying to get to a closing date. There was a lot of stress involved getting to this point.
After Closing/Renovation Experience:
Now the fun begins and the renovation is underway. The initial estimated time of completion for this project per the contractor was to be no more than 6 months. The contractor had actually told me it would be closer to 4 months but wanted to indicate 6 to cover for your typical contractor issues and delays.
Long story short, the total time of completion from the contractor ended up taking 9.5 months. Yes folks, it literally took the contractor 9.5 months to complete this project and as you can imagine, I was not pleased.
The contractor had issues getting people on the job. Most weeks I would say there were only a few days worked and there were times where weeks would go by with literally no work being done. It was very frustrating to say the least and believe me I expressed my frustration toward the contractor. Typical contractor BS is you ask me.
The contractor also ended up extracting another $10k from me in additional costs for items that were “uncovered” during the demo and renovation. I would say that the contractor experience for this ended up being very negative and it was a dream come true when they finally completed and I was able to get them out of my life for good! Seems to be a trend here in Indianapolis with contractors as I have been discovering lately on other real estate investment projects I am doing.
The Final Actual Numbers:
The whole experience from purchase agreement to completion and money disbursement of the renovation ended up taking about 11 months. 11 whole months from beginning to end for this entire loan/renovation process. Can you imagine dealing with this for almost a whole year? It was not fun and I am very thankful that it’s over.
Here are what the actual numbers ended up being:
Purchase Price: $120k
Renovation Costs: $130k
Closing Costs + 5% Down Payment: $16k
Total Costs: $266k
After Repair Value (House appraised value after the renovation): $300k
Total Cash Used: $16k
Estimated Built-In Equity: $34k
As you can see, my original estimates were quite off. I underestimated the rehab costs and overestimated the after appraised value of the house. I also had no idea that the whole process would consume almost a year of my life. $34k in built in equity is not too bad either. I still feel I got a decent deal out of it and more importantly, the house will continue to appreciate because of the location it is at in downtown Indianapolis.
Now that I have been living in my new primary residence for 4 months, I have had time to cool off and do not feel so much anger toward the process and the experience I went through. We are really happy living in our new home in downtown Indianapolis and the final product ended up being exactly what we wanted. Granted it took forever and cost more than originally thought. We plan on living in this home for the foreseeable future. We want to raise our kids in this neighborhood.
We ended converting our old primary residence back into a rental property and you know I love me some cash flow so I was very happy to add another rental to my portfolio.
If it were not for this FannieMae HomeStyle Renovation loan, we would not be living in our dream neighborhood. Oh, did I mention that that this house just happens to me in our favorite and in my opinion, the best neighborhood to live at in all of Indianapolis?!.
I do not regret using this loan product and would use it again if it makes sense. At the time, I did not have the money to do this kind of extensive renovation on a home in this location so this loan product was exactly what I needed. The experience albeit was not very good but the product itself can be very useful.
Wow! No wonder youve gone silent for so long. A new kid and this! Good job regardless
Haha yeah mainly that and a horrible flip I’ve been doing for a year now
Will write about that as well once its completed and sold. Oh and baby #2 is coming in November.
Dude! slow down! 😉
Howdy! I have followed you for a while. I came back to the site looking for your quarterly update and stumbled on this gem. I am in a related situation though not using OPM but my own. Two questions if you have the time:
1) for your networth calculation purposes, how do you account for a house you own but is unlivable/needs rehab? My project was $111k purchase, ~$100-120k rehab, best guess post-reno value $375-425k.
2) Using #1 as a brilliant segue: your networth calculations always show fluxuation in property value, how do you estimate these values or what source do you use? I have another property which is effectively uncompable due to no similar sales anywhere nearby (for years now). It is a duplex nested amongst SFHs and condos. My other is a unique, custom log home which is also desprately difficult to comp. Question 2b) would be how you estimate/account for land value in your tracking.
Hi Jeff, Sorry for the late reply I havent been checking on the blog recently. To answer your questions:
1) This was a tough one, at first I was valueing the proprety based on how much I paid for it and the amount of money I had put into it so far, but eventually I just stopped accounting for it and decided I would just value the property AFTER it was all rehabbed and listed for sale. If i were you, I would probably do something similar.
2) I only update my properties once at most twice a year. I use redfin sold comparisons to find the value of the property and come up with my own value. I usually stick on the conservative side of valuing the property as I would rather under price it then over price it. In your situation it might be worth it to talk to an appraiser about comping those unique properties or seeing if there is something similar listed for sale so you can see what they think the property is worth if that makes sense.
I have a few comments on the information you provided about the Homestyle Loan in your article-
1- Under Fannie Mae Homestyle, the lender is not allowed to refer you to, or suggest, any contractors for your job. That is why your lender did not do so.
2- the contractor does not have to fund the entire project up front. A 50% draw of total material costs is given to the contractor at the time of closing.
3- Renovations must be completed in one year, not 6 months.
I am interested to hear details on why it took so long for you to reach an agreement and get to close!
Its been 3 years now since I got that loan and at the time, those were the conditions. Im sure the product has evolved and has different criteria by now so it’s always best to speak to your loan officer about what the current rules and regulations are regarding that loan type. The main reason why it took so long for me came down to problems with the contractor. They took forever, had bad communication and were not very responsive. Since then I have rehabbed multiple homes and can see now that most contractors are like that. It’s extremely difficult to find a good contractor and with decent prices.