One homebuyer niche I know extremely well is 10% down payment jumbo mortgage financing. We have a good number of prospective homeowners in California, especially here in the San Francisco Bay Area, who earn strong income, who have an excellent credit profile but who just do not yet have the full 20% down payment saved for home prices that are, compared to the rest of the country, very high. These buyers have certainly not failed and they are not out of luck either. Once they understand just how competitive an 80/10/10 or other 10% down solution can be, they are often back out on the market in no time, and with renewed optimism.
It is here that they will sometimes find their next challenge, though it is not one that is limited to just a 10% down payment structure. Several of these buyers will come across a property that will need immediate renovation, remodeling or repair — assuming they are able to have their offer accepted. Their next question to me will be “Can you add the cost of remodeling or renovation into the mortgage?” The answer involves several concepts so let’s address them one by one.
Lenders use the lesser of the appraised value or the purchase price to determine loan-to-value (LTV).
If we take our “cosmetic fixer” and have an appraiser give it the ol’ once over, will the appraised value match or exceed the price the buyer is paying for the home? If the answer is “yes,” we don’t have any issue, but if the answer is “no,” we, as the lender, are going to use the smaller number to determine the loan-to-value (LTV). Let’s say the buyer is in contract to buy the home for $1MM. The buyer is financing 90% of that price, or $900,000. Now let’s say the property appraises for $950K. Again, we can finance 90% of the lesser amount so in this case that’s $855,000. Remember that if the buyer was planning to “put down” $100K in the original example, and if the contract price does not change, the buyer can ONLY finance $855K but is still buying at $1MM. This now implies a down payment of $145K. More on this next…
You cannot finance more than your loan program’s LTV threshold.
In our example just above, we are forced to increase the down payment because we would otherwise have an LTV (or “combined loan-to-value”) of more than 90% and our program guidelines may not allow for that. I’m not saying that no loan program can exceed that threshold, just that our buyers were presuming their financing would meet a 90% limit. When the appraised value comes in lower than the purchase price AND an LTV threshold is crossed, like at 20% down or 10% down, the buyer’s financing will need to be adjusted. Sellers often recognize this and may be concerned about accepting an offer if they feel a low appraisal would tank the buyer’s loan approval. This is the logic behind a 30% down payment appearing more attractive than a 20% down payment, for example. If a buyer puts down 30% and the appraisal comes in low, chances are that buyer can still keep the existing terms of his/her loan (maybe the LTV goes to 72% or 73% — but that doesn’t blow anything up). On the other hand, if a buyer is getting a loan with 20% down and the property doesn’t appraise, now that buyer either needs to bridge the difference in cash, get a small second mortgage (if permissible by the first mortgage guidelines) or take PMI (if available). You can see why this might tip the seller’s scales in favor of larger down payment offers.
The property must appraise “as is.”
Both of our examples above assume that the property is in sufficient condition to appraise “as is” and not subject to repairs and completion. The status of the report is indicated via checkbox. If the property’s condition requires extensive rehabilitation or has obvious health and safety deficiencies, a conventional loan may not be an option at this time. That brings us to our next point…
There are programs that may specifically address remodel and/or construction.
This is the province of the construction loan, the rehab loan, the FHA 203K, etc. We’re not going to cover those here but know that when you’re dealing with a construction loan, the approach to financing is fundamentally different. Whereas an “end loan” or a “conventional” loan will work off of the appraised value, a construction-type loan will look to completed, repaired or rebuilt value to set LTV. But here, understand that you’re not just getting a larger loan and a “get out of jail” card. The lender needs to know the plans, the scope of work, the schedule of completion, etc. In other words, you’ve got not only a loan on your hands, but a project too. For the average buyer just looking to purchase a home, a construction loan comes with an additional, and serious, set of considerations.
So getting back to our original question, “Can you finance the cost of renovation or remodeling into your purchase money mortgage?”, the short answer is “No.” The better answer is that “it depends,” but we must recognize that what we’re really doing in most cases is preserving the buyer’s cash. Where a construction loan program is not being used, this is often the best outcome to which we can aspire. But remember, for any home loan program you select, you cannot finance more than your maximum loan-to-value or combined loan-to-value (LTV or CLTV) and your loan officer can guide you on these.
This is a simple concept that is often confusing and difficult to grasp in the real world, so don’t be embarrassed to ask questions and drill down (no pun intended) on the math. Just because you may not be able to finance future improvements now does not mean that the home is not a great fit for your family, your future needs and your budget. And like always, a sound understanding of concepts will go a long way towards helping you make the best decision.
Sleeves rolled up,
Robert J. Spinosa
SVP of Mortgage Lending
Marin Office: 324 Sir Francis Drake Blvd., San Anselmo, CA 94960
Berkeley Office: 1400 Shattuck Ave., Suite 1, Berkeley, CA 94709
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