Can You Afford to Buy a Fixer-Upper?

— -- intro: Many homebuyers are drawn to the lure of the fixer-upper. And with good reason, at least on paper.

But the “buy low, sell high” ethos of fixer-uppers isn’t exactly a guarantee. There are plenty of people who snagged the worst house in a great neighborhood and turned it into their dream home. You’re just as likely to find overworked and overspent homeowners ready to run from their money pits.

Committing to a fixer-upper is a big decision, one that can impact your financial picture for years to come. Before you start swinging a hammer, you’ll first need to find a way to finance your purchase.

You may need a specialized mortgage product to buy a fixer-upper. Some lenders and loan types want properties in “move-in ready” condition, which can obviously pose a problem.

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Here are a few options to consider.

quicklist:title: FHA 203ktext:

The Federal Housing Administration offers a government-backed rehab loan that allows buyers to finance renovations based on the property’s projected value. There are two distinct types of 203k loans: a streamline version and the standard.

Buyers using the streamline option can add up to $35,000 to their loan to make non-structural repairs, like new carpet, paint or even a kitchen remodel. The standard 203k loan gives borrowers more leeway in terms of how much they can borrow and how they can use the money.

Repairs must be completed within six months. Homebuyers can also finance up to six months’ worth of mortgage payments, a bonus that can help cover costs if you need to live elsewhere during the renovation.

The FHA 203k loan program can be a great fit for low- and middle-income borrowers. Credit and down payment benchmarks (3.5 percent) are lower for FHA loans. But there are also some downsides. FHA loans carry costly mortgage insurance and limit borrowers in most parts of the country to a max loan of $271,050.

quicklist:title: Fannie Mae HomeStyletext:

These rehab loans also let qualified buyers finance remodeling costs, based on the “as completed” worth of the home.

Unlike with 203k loans, borrowers can use Fannie Mae’s HomeStyle program to make “luxury” improvements like pools and landscaping. The only caveat with repairs is that they’re permanent and increase the property’s value.

Getting one of these loans can be a bit tougher. Conventional loans usually require higher credit scores and at least 5% down. But your borrowing reach can extend because these loans are linked to the conforming loan limit, which is currently $417,000 in most places.

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Buyers who plan to live in the home can do some of the renovation work themselves, as long as financing for the DIY portions doesn’t exceed 10% of the home’s projected value.

quicklist:title: Conventional Renovation Loanstext:

Some conventional lenders offer rehab loans outside of these two programs. Rules and requirements will vary. As with any type of home loan, it pays to shop around.

Some lenders won’t allow you to do any of the work yourself. Others will require you to have several months’ worth of mortgage payments in reserve.

Knowing what shape your credit is in before you begin the mortgage process can help you determine which loan option will work best for you. That means pulling your credit reports to look for errors or other issues that need to be addressed, along with your credit scores to see where you stand in general. You can get your credit reports for free once a year from each of the three major credit reporting agencies, and you can use a free service like Credit.com to see your credit scores.

quicklist:title: What You Can’t Affordtext:

Regardless of the financing path you choose, make sure you pay for a professional home inspection along with the home’s appraisal. Home inspections are important even when you’re buying a nearly new home that’s move-in ready.

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They’re critical when you’re considering a property that needs work. You can retrace the inspector’s steps later with a contractor to get a good sense of what it’ll cost to resolve any problems.