Today there are several options to purchase and fix up a home with one loan. This takes the headache out of having two loans and dealing with different rules. The two most common options available are the Fannie Mae HomeStyle loan and the FHA 203K. Both loans offer the same opportunity to fix up a home with a purchase loan, but there are some stark differences between the two programs.
How the Home Renovation Loans Work
Both the Fannie Mae HomeStyle loan and the FHA 203K work the same way. You borrow money based on the future appraised value of the property. This means after the improvements. This works much differently than a standard purchase loan. Let’s say for an FHA loan – you would be allowed to borrow up to 97.5% of the current value of the home. The remaining amount you need to provide in the form of a down payment. With either of the renovation loans, you can borrow beyond the current value of the home. The exact amount depends on the work you intend to have done on the home and the value it provides to the home.
Both loans only require you to take one loan and have one closing. The loans work in two parts, though. The first part of the loan is the purchase loan. This works similarly to a standard purchase loan. The seller receives his money at the closing and any loans the seller had on the home are paid off. You use the remaining funds for the renovations and the lender holds the funds in an escrow account until the designated disbursement date.
The Differences in Qualifying
Just like a standard conventional and FHA loan, there are differences between the two programs. The Fannie Mae program requires stricter underwriting guidelines because it is a conventional loan. The FHA 203K loan has looser underwriting guidelines, but has more property restrictions than the Fannie Mae program.
For example, the FHA program only allows renovations on primary residences. They also do not allow any type of luxurious renovations. If you have a high debt ratio or lower than average credit score, though, you will probably be able to qualify.
The Fannie Mae HomeStyle Renovation loan will not allow exceptions for lower credit scores or higher debt ratios, but it does not limit you to your primary residence. You are free to use the loan on second homes and even investment homes.
The Mortgage Insurance Difference
You will likely have to pay mortgage insurance for either the HomeStyle or the FHA 203K loan. How much you pay can greatly differ, though. The Fannie Mae program does not charge upfront mortgage insurance like the FHA program does, so there is a savings right there. In addition, the FHA 203K program requires a flat percentage every month for mortgage insurance. There is no changing how much you pay because you have good credit or a lower loan-to-value ratio. You also pay mortgage insurance for the life of the FHA loan; you cannot cancel it at any point. The Fannie Mae program provides you with more flexible mortgage insurance because they base it on your credit score and LTV. The higher your credit score and the lower your LTV is, the lower your PMI. In addition, you can cancel conventional PMI once your LTV is less than 80% of the value of the home.
The Down Payment Difference
The FHA 203K loan offers the same down payment requirements of a standard FHA loan. At just 3.5%, the down payment is easy to afford. Because this loan is for lower income families or those with lower than average credit, it offers many flexibilities that the conventional loan does not offer.
The Fannie Mae HomeStyle Loan requires a minimum down payment of 5%. This might not seem like a lot, but if you are dealing with a loan amount of around $300,000, it is a difference of $4,500 between the two down payments. This is a significant amount of money that can make a difference in your finances.
Credit Score Requirements
Sometimes you have to base the program you use on your credit score. The FHA 203K loan has lower credit score requirements, just like its counterpart, the FHA loan. The FHA allows lenders to provide this program to borrowers with a credit score as low as 580. Because it is up to lender discretion, though, not every lender will provide a loan to someone a score below 620.
The Fannie Mae HomeStyle loan requires a credit score of at least 620 and sometimes higher. This again, is up to lender discretion. Some lenders will accept a lower credit score while others prefer to minimize the risk of default by requiring higher credit scores.
In either case, any compensating factors you can provide the lender can help your case. For example, a low debt ratio or large down payment can help your case. The lender looks at these cases as less risky because they “compensate” in other areas. A borrower who has a high debt ratio, borderline credit score, and minimum down payment does not compensate for anything – he poses a serious risk for default.
Which is Better the Fannie Mae HomeStyle or FHA 203K?
The provocative question is which is better, the Fannie Mae HomeStyle or the FHA 203K? The answer depends on your situation. For example, a borrower with a 590 credit score, 3.5% to put down on the home who wishes to purchase and fix up a primary residence would benefit from the FHA 203K. On the other hand, a borrower with a 650 credit score, 10% to put down on the home and who wishes to purchase and fix up a vacation home would benefit from the Fannie Mae HomeStyle loan. You have to look at the big picture to determine which loan is right for you.
Once you decide on a loan program, make sure to shop around. Many lenders offer these programs. No two lenders will have the same underwriting requirements or fees. The more you shop around, the better deal you will find. Your hard work will pay off in the end!