First Time Fixer - Rewards, Risks, and Financing A Fixer

Are you a first time buyer thinking of purchasing a fixer? Maybe you’re not a first time buyer, but considering a fixer as a second home, for investment purposes, to flip or to turn into a rental. A fixer can be a great way for some buyers to enter the market. First time buyers with good risk tolerance, time, construction skills, licensed contractors, investors or developers can benefit from shopping the fixer market. From my perspective as a Realtor, here are some things buyers ought to consider when shopping for a fixer. 

“This will be easy, and cheap right?” Slow Down, Turbo

There are advantages to buying a fixer. After all, fixers are priced lower, and maybe the buyer could live with certain issues while less demanding repairs could be deferred over time on their budget. Plus they can add customized updates rather than pay for someone else's taste in updates…or, “surely I could flip this house and make a nice net…” However, like anything else worth doing, there are challenges that arise along the way. 

Many buyers have the idea that purchasing a house that needs work might be a way to get into the market with less resistance, but this is not necessarily true. 

One thing even experienced buyers forget about during the shopping process is RISK TOLERANCE. On top of having a reserve budget to repair the house post purchase, the buyer should have adequate funds to perform their due diligence (inspections), and be prepared to afford necessary repairs or appraisal gap coverage to complete the purchase should this become an issue with a lender's appraisal process. 

When touring a home, there are the problems buyers can readily see - a bad roof, water damage, cracked concrete, worn out flooring or paint… But, there are plenty of issues that can't be seen at a typical showing - i.e outdated electrical systems, plumbing problems, environmental problems such as underground storage tanks, radon, asbestos, lead paint, etc... Most of the issues will turn up in the due diligence process with a licensed general home inspector and adjacent systems inspectors.. Remember, the cost to inspect a home could range anywhere from a few hundred to thousands of dollars depending on the location, size of the home and the scope of inspections. Adopt a mind set of being prepared for the unexpected. For more information about home inspections see this link to my blog about home inspections and inspection contingencies

https://samdensmorerealestate.com/blog/Home-Inspections-and-Residential-Sale-Agreement-Negotiations---What-to-expect-during-the-Inspection-Contingency-Period

Funding a Fixer

Having a lender who understands and explains  the nuances of lending on a fixer will put you ahead in the game. If you’re new to the home market, notice the financing terms when shopping for fixers - i.e. Cash Only, Rehab, As-Is Sale, Seller-Carry, FHA, Hard Money, etc. I’ll break down these financing terms below. 

As-Is - The seller does not want to be involved in negotiating or facilitating repairs before closing. If a seller puts “As-Is” in a listing, the buyer should adjust their expectations accordingly. Some say, “As is, until it isn’t - everything in real estate is negotiable”. Optimism is great, but could cost the buyer inspection fees if the deal has to be terminated due to unacceptable conditions that turn up during due diligence. 

Cash-Only - A Cash only sale is exactly what it sounds like. The seller will only accept cash. Usually, this is because the property is in a condition that leads the seller to anticipate that most mortgage lenders are unlikely to approve a mortgage on it. The buyer could theoretically take out a Hard Money Loan, Personal Loan, or HELOC which would allow them to spend the cash money however they like. Rates will usually be higher on these loans than normal mortgage loans. Cash only sales can work for buyers with deep pockets, or investors who get properties for low prices and then have a budget to remodel or rebuild on the site. However, this may not be great for a buyer on a tight budget hoping to do repairs while they live there.

Seller/Owner-Carry - Seller Carried financing can work when the seller and buyer are both in the position to take advantage of it. There are multiple ways to structure a seller financed transaction. This arrangement allows for a bypass of the lender’s appraisal contingency, allowing for unique homes or otherwise unfinanceable homes to become financeable. The parties to the transaction have the paperwork drawn up by their attorneys, and come to a suitable agreement regarding the financing. Read more about seller financing at my blog link https://samdensmorerealestate.com/blog/Seller-Financing-in-Real-Estate

Rehab Loans - “A Rehab loan sounds great! The lender will loan us money to take care of the repairs! We’ll have uncle Joe’s contracting company do the work. They’ll give us a good deal..”There are a few problems here. Buyers should know that the lender’s terms will have a part in determining who does the work and what repairs are to be prioritized with the rehab loan funds. Oftentimes, the lender’s vision doesn’t align with the buyer’s vision. First, DIY repairs aren’t usually allowed. There are limitations as far as the scope of the work required -  tear-downs and reconstruction, improvements that aren’t attached to the primary residence, or for business purposes might not be allowed. Some programs cap the percentage of the renovation costs relative to the property value.

Conventional Loans - Buyers will encounter less resistance when purchasing a light fixer with a conventional loan - provided that they intend to live there as a primary residence, and that the purchase price does not exceed the lender’s appraised value when the home is purchased. If a buyer can provide a substantial enough down payment to make up for an appraisal gap should the situation arise, this huddle can be overcome. Link to my blog about Appraisal Gap and Loan to Value Ratios https://samdensmorerealestate.com/blog/LTV-Appraisal

FHA Loans - For many first time buyers, an FHA loan might be a way to save a substantial amount of money and decrease the cost outlay when making a downpayment. FHA loans require low down payments as low as 3.5%, flexible credit requirements, and borrowers are sometimes eligible for assistance programs that increase their buying power. 

What FHA requires for lending on a fixer may not be what the buyer is interested in. Repairs might be required before the transaction closes. A situation like that might add issues to be negotiated between the parties to the transaction - the final sales price may be adjusted upwards if the seller can’t afford the cost of repairs, the closing date might need to be moved out in order to accommodate the necessary repairs, etc. 

FHA 203(K) Rehab Loans - 

With patience from both the buyer and seller, and a team with experience in FHA 203(K) transactions, success can be had purchasing a fixer on a budget. FHA offers rehab loans tied to standard FHA rates and terms, with up to 110% of the property after repair value. The borrower is required to assume the home as their primary residence and is responsible for paying for the repairs. However, sometimes, a seller will contribute to repairs before closing. The repairs must be deemed essential by the FHA appraiser. Only qualified contractors are allowed to complete the FHA required repairs. Every phase of work is required to be documented and a HUD approved consultant must oversee the project. The added bureaucracy can complicate the transaction and add to the timeline to complete the transaction. Finding contractors and lenders experienced with the specific FHA 203(k) process and payment structure (funds are held in escrow and released as work is completed via draws) can be difficult. 

In Conclusion

In conclusion, if you’re considering purchasing a fixer, know that there are manyapproaches to take, and it can be done affordably! Having a handle on what kind of financing will work for you, the costs and risks associated with repairs, and timeline considerations should help you prepare for success and avoid common pitfalls.

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