michele

HOUSE Magazine , January/February 2005
By Michele Francis
Homeowners with plans to add onto their house or to undertake major renovations have typically turned to home equity loans or home equity lines of credit (HELOCS) to finance their projects. These loan products are extremely useful and can be quite versatile as well. Simply put, homeowners are allowed to borrow a percentage (usually 90% - sometimes 95%) of the equity they have accrued in their home. As their name suggests, these loans are driven by current equity and so are heavily reliant upon the appraised value. Thus, if the appraised value comes in below expectations or if the owner recently purchased the house and so has not built very much equity, these loan products are of little use. Faced with little equity in the house, homeowners should not be deterred. Financing for a renovation or addition can be obtained through a construction to permanent rehabilitation loan.

A rehab loan is similarly dependent upon an appraisal. When ordering the appraisal for such a loan, I simply request the appraiser to calculate the completed value of the home based on the plans and specs to be provided by the builder or contractor. The owner can borrow up to 90% of the completed value. Unlike a straight purchase transaction, this type of loan closes early in the process, before the construction work begins. The lender will insist upon occupying first lien position, so the existing mortgage would be paid off at closing. Money is disbursed in a series of draws for work completed in the construction period, during which the owner can pay interest only. Once the construction is completed, the borrower has the same “end” loan options available for a standard purchase or refinance: 15 or 30 year fixed rate, adjustable rate, hybrid ARM, and so on.

To see the benefit of such a loan, consider the following example. A past client called me last spring to explore his options for financing a family room he wanted to add to his house. Because he put down 10% when he purchased the house 2 years ago, he had not yet accumulated the equity required to use a HELOC loan. The balance on his mortgage was $524,000, the house was worth approximately $655,000 and the anticipated project costs were $215,000.

I provided the plans, cost of materials, and cost of construction documents to the appraiser who calculated a completed value of $890,000. The borrower was then able to borrow up to $801,000 (90% of the completed value), more than enough to cover the payoff of their existing mortgage, the construction costs, and the closing costs, a total of $779,000.

Despite the fact that construction was expected to last only six months, I informed my client that he could lock in for a full 12 months at the same rate available for a six month lock. By doing so, he had the option of paying interest only for the first six months after the work was completed. At the end of the 12 month lock, my client began making regular principle and interest payments on the 15 year, fixed “end” loan that he opted for.


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