Obtaining funds for your home remodel does not have to be difficult with some basic construction financing knowledge. There are many options for to finance your remodel. Construction loans, including a Home Equity Line of Credit (HELOC), a cash-out refinance, a Federal Housing Administration (FHA) 203k, or a more conventional renovation loan.
To better inform our clients about these options, we engaged Faramarz Moeen-Ziai from Cross Country Mortgage to present information regarding construction financing. Faramarz has been in the loan industry since 2003, and, together with his team, has funded over 3,000 loans. He specializes in Purchase and Refinance, and Refinance loans. We’re thankful for his time as he shares his expertise with our team, and our clients.
Below is a transcript of the information he shared during this presentation:
Hi there. My name is Faramarz. I work at Cross Country Mortgage. I’m the branch manager of the Berkeley office here on College Avenue. We’re going to talk today about some renovation loan products, and see if you have any questions. You can always email me. My contact information is right behind me here at FMZ@myccmortgage.com. Feel free to reach out with any questions you have on any of these things that we go over today.
I’m going to share my screen with you and walk you through the renovation loans and the renovation loan process. Generally, we’re going to do an overview. We’re going to talk about some limitations, and we’re going to talk about the documentation requirements. Then, I’ve also got an example of how the finances on these loans work.
Construction Finance Okay for Remodels
The renovation loans can be used for any type of renovation. It’s not just things that have to be done to a property. You can do landscaping. You can do an extra bedroom, an extra bathroom, put on a second floor. There’s really no limitation to what you can do. Renovation loans take about 60 days to close. They take a little bit longer because the documentation requirement is a little bit more extensive. It’s a little bit of a slower process than the normal loans that we do in 20 to 30 days.
They can be either conventional or FHA 203K. There are two types of loans, and we’re going to get into some of the details. The value of the home is based on the post-construction value, so we can loan up to 95% of whatever that value is after all the work has already been completed. After the loan closes, the money for the renovation is held by the lender and doled out to the contractor at certain milestones, because the last thing you want to do is start a project, be halfway done, and run out of money, so there are milestones and checks in place to make sure that doesn’t happen.
Construction Financing Limits
Here are some of the limitations on renovation loans. The maximum loan amount here in the Bay Area is $970,800. That means that if you have a million-dollar loan, this product’s really not for you. If you’ve got a 600, 500, $400,000 loan, then there’s some room there to do some significant improvements to your property.
The work must be performed by a licensed contractor. If you are a licensed contractor, it’s possible that we can get an exception to have you do the work yourself, but generally speaking, they want someone else, a third-party licensed contractor to do the work. We have to have a really thorough bid with the application. You can’t just have an estimate that says it’s going to be about $300,000 for this project. We really need a detailed cost bid. The reason for that is we have to give that to the appraiser who then values the home based on all of the work to be done, so we really need a good idea of what’s going to happen.
Types of Construction Financing
As far as the documentation, you have two buckets. You have your traditional loan, which is the loan application, the income, the assets, and the credit that goes with that. In addition to that, we need the detailed bid by the contractor and other documentation from the contractor. The contractor is underwritten by an expert from the construction field on the lending side. They’re also looking over the bid to make sure it is reasonable? Was anything missed? Is the amount being requested really going to cover the scope of the project, or not?
Once that’s all in, we’ll give that detailed bid to an appraiser who’s specially certified to do renovation loans, and they’ll appraise the property as if all of that work has already been done. If your house is worth $800,000 today, and you owe $600,000, but you want to do a $300,000 project, not a problem. If your house is going to be worth $1.1 or $1.2 million after the work is done, then you can go to that $970,000 limit and get the funds necessary to do that. We’re not concerned too much about what the value is now, but what it’s worth afterward.
Let me give you a quick example of what the numbers look like on the renovation loan. We have an example where your current loan amount on the property is $500,000. You want to do a $250,000 renovation, so the total package cost is $775,000. Now, why does that not make sense? $250,000 plus $500,000 is $750,000. But, there’s also a 10% buffer built into that renovation loan based on the cost of the project, just in case there’s some cost overrun; they always have a little bit extra. On a $250,000 project, you’re going to have about a $25,000 buffer built in.
These are the two options here. On the left side, we have a conventional loan. On the right side, we have FHA 203K. The FHA, it’s an okay loan, but the conventional is a much cheaper way to go because of the rates on these. You’ll notice in the interest rate box that the rates on these loans are much higher than the market, usually about 1% higher than what your market rate rates would be.
Exiting Construction Financing
Generally speaking, after completing the renovation, most people refinance out of these loans into a more traditional conventional loan with a lower interest rate. During the renovation period, you do carry that higher interest rate. You can see that the monthly payment is calculated on the full $775,000 that’s being borrowed. The closing costs are estimated down below. The costs and everything for these are the same, except the FHA 203K, because it’s an FHA loan. UFMIP stands for Upfront Mortgage Insurance Premium. They charge 1.75% of the loan amount. In addition to that, you have to carry mortgage insurance, whereas you don’t necessarily have to with the conventional loan. Again, we try to see if most people can fit in that conventional bucket because it is a much cheaper loan. You’ll see down here that points are being charged right now. That’s because rates have gone up, and I’m recording this right now in the first half of 2022, rates have gone up significantly.
Those points weren’t always there during COVID, when rates were really low, but right now, it costs one or two points. One point equals 1% of your loan amount. It could be as cheap as one point, maybe as much as two, so this gives you that worst-case example. With a total construction cost of $775,000, we’ve got all of our closing costs factored in, so we are doing a new $795,000 loan, which leaves that $270,000 there for the renovation project. That’s basically how this structure would work. If you have any questions on this, I’d be happy to answer them, but otherwise, feel free to contact me anytime. Thanks.