A homeowner can finance their renovation project based on the home’s appraised value, after the renovation is complete. In some cases, personal funds may not be needed for the construction costs. This unique feature of a “one-time-close” Construction to Permanent mortgage leverages the home’s future equity created by a major renovation or gut rehab construction project.
Here’s how it works. Let’s say the current appraised home value is $300,000 with a $200,000 mortgage balance. The homeowner plans a major home renovation with a $200,000 budget. A home equity loan would generally only provide $70,000 which is 90 per cent of the $300,000 appraised value minus the $200,000 mortgage. If the appraised home value, after the renovation, is $500,000, they may be able to qualify for a $400,000 Construction to Permanent mortgage which is 80 per cent of the home’s future appraised value. At the loan closing the first draw pays off the $200,000 mortgage balance and $200,000 is available for the construction. When the work is complete the $400,000 loan converts to a permanent fixed rate mortgage at a rate that was set months earlier at the time of application.
There’s a caveat. The future appraised home value must cover construction costs plus any existing mortgages. This doesn’t always happen. The renovated home value may not appraise for the $500,000 needed to cover the new mortgage so the homeowner would need to use some of their personal funds. Even when the entire construction budget can be financed based on the future appraised value, personal funds are still needed to cover closing costs and typically, five per cent of the construction budget must be set aside as reserves to cover cost overruns. The lender will provide a Good Faith Estimate of closing costs and calculate reserve requirements so the borrower is prepared upfront for how much of their personal funds will be needed.
Each Construction to Permanent mortgage is structured to meet the needs of the homeowner’s specific renovation project. The lender will review the borrower’s income and overall financial condition to determine a qualifying loan amount. Generally a credit score of 680 or better is required. For larger loan amounts a higher credit score may be needed.
The homeowner should talk to a construction lender early on to understand the process from application to funding and what documents are needed for an expedient loan approval.
They should also have some idea of what their home will be worth after the renovation. A good starting point for checking home values is a Zillow home price estimate, or Zestimate. Currently, the national accuracy of a Zestimate is about 8 percent of the final sales price of a home. Homeowners can also talk to real estate professionals, either agents or appraisers, who know the market in more details and can advise on how major home improvements will affect value. An independent real estate appraiser hired by the lender will review the construction plans to determine the home value after the renovation is complete.
A major home renovation project can be a complex process. A one-time close Construction to Permanent mortgage can help make the financing simple and more affordable. The homeowner can focus on their home renovation with the peace of mind knowing both the construction financing and the permanent mortgage are approved, the rate is set and the details of financing each stage from start to finish has been worked ahead of time.
ABOUT: Arthur Aranda has over 25 years of mortgage banking experience and works extensively with home builders and homeowners on financing home construction and renovation projects. Aranda is also a Certified Financial Education Instructor and provides First Time Homebuyer Seminars. For more information on construction loans or to schedule a FTHB seminar please call Arthur Aranda at 201-741-1537.