Love the neighborhood, hate the house. That is a common enough complaint from both current homeowners and prospective homeowners.
Lenders have an increasingly attractive alternative for people in this situation: renovation loans. With these, a borrower who wants to move into an existing home need not compromise on quality, and the homeowner who has outgrown the house but does not want (or cannot afford) to move can upgrade more economically.
“We’re seeing a huge increase in demand for these, and we’re foreseeing another record year in 2007,” said John Sway, a vice president of Wells Fargo Home Mortgage.
Sway said that because house values are growing more slowly, or slumping, in many markets, homeowners cannot simply wait a year and use the increased equity to upgrade their houses. “They need to rely on the future value of the home to make improvements,” he said.
Renovation loans cover the costs of the upgrades, but the total loan amounts are based on the predicted value of the house after the work has been completed.
For example, a family with a three-bedroom house worth $400,000 and a mortgage of $300,000 may want to spend $65,000 to renovate and pay for the new loan’s closing costs.
For renovation loans, lenders require borrowers to submit architectural drawings of the proposed renovations, and these are used to estimate the home’s future value.
If the lender appraises the future value of the house at $500,000, the new loan will be for $400,000 (since the owners already had $100,000 in equity in the home). Assuming they had a 30-year fixed mortgage at 6 percent, monthly payments before the renovation loan were $1,798.
Interest rates on renovation loans run slightly higher than those on 30-year fixed mortgages, to reflect the slightly higher risk that banks take when lending money on what amounts to a partly completed house. Assuming, then, a 6.75 percent interest rate on 30-year fixed renovation loan of $400,000, the owners would pay $2,594 for the new loan (and for the “new” house). The borrowers should also expect an eventual property tax increase.
Sway says renovation loans have been popular in the New York area, particularly among buyers who do not want to move into outdated homes.
Wells Fargo, for one, offers three types of renovation loans. The most popular is for an amount of $417,000 or less on single-family properties, for which the typical down payment is 5 percent.
Bruce Hirschfeld, the president of Montvale Mortgage, a mortgage brokerage in Montvale, N.J., said the local market for renovation refinance loans had also been steady. “Although prices aren’t rising the way they were, we’re still not to the point where someone can go from a three-bedroom house to a five-bedroom house as easily as they could by just doing the work themselves,” he said.
Lenders, Hirschfeld said, usually break up payments into six stages during construction and require borrowers to demonstrate completion of the previous stage before they issue a check for the next.
One attractive element of such loans, Hirschfeld said, is that lenders fold the first six months of interest into the overall loan amount, freeing borrowers from payments during the construction period.
The lack of a mortgage payment helps. “Then, you just have to deal with the construction,” Hirschfeld said, “and figuring out whether or not you can live in hell for six months.”