There are lots of ways to finance the purchase and rehab of a fixer upper. I want to very briefly outline a financing method that is extremely effective in our current market.

It’s a two step loan process that has become very popular with clients of The Minnesota Real Estate Team. This purchase program gives today’s buyers an opportunity to buy houses without having to invest a lot of cash. In some cases the cash savings are quite remarkable.

We’re not talking about some new or exotic approach to financing. This is a method that has been used in new construction for as long as I can remember. Believe me, that’s a long time. What’s different about our program is the streamlined processes developed by of our preferred partners at Cornerstone Mortgage. There are now two step rehab programs for both homeowners and investors.

As I said it’s a two step loan process. More accurately it’s two loans and several steps. Loan 1 is a construction loan used to purchase and finance the rehab of a fixer upper. With loan 1 one you get the money you need for both the purchase and the fix up costs. All the money for the purchase comes up front at closing, but the money for the rehab is doled out as the work is completed. This loan requires more time and work from the lender so the terms and interest rates are higher than a normal fixed rate mortgage. For investors buying property these are short term interest only loans from local banks. If you looking to buy a fixer upper to live in there is now a special program called Home ownership Opportunity Program or HOP. HOP is a great program for first time home buyers.

Loan 2 is fixed rate long term mortgage that replaces the short term higher interest construction loan. Usually these are conventional loans, but HOP program allows home owners to use FHA loans for the second loan.

The Concept of Future Value or ARV

So why go though all the hassle of two loans and two closing? The key benefit comes because the lenders of construction and rehab loans are smart enough to realize that your rehab will add considerable value to the property. Before they lend money for a rehab the borrower must pay for a professional appraisal that calculates a ‘future value’ of the property after the rehab is complete.  The value the appraiser comes up wit is called After Repaired Value or ARV.  Basically you get an appraisal with a Future Value rather than current value. This future value is extremely important because loan to value is a key component in mortgage underwriting.

After a buyer completes the rehab the future value or ARV  from that first appraisal is now real equity  built into the property. The underwriters for loan number 2 will now recognized this equity when they calculate their loan to value ratios. The net result is buyers are able to use this new equity towards the loan to value ratio of loan 2 and conserve their cash.

If you are interested in investment property check out Rob Bonahoom’s description of his investor rehab program on his blog Investment Mortgage Guy.

If you are interested in buying a fixer upper home to live in Alec Grebis explains the HOP loan program on his blog The Mortgage Scoop.

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