Chapter 6

Surveying Special Situation Loans

IN THIS CHAPTER

check Tapping home equity

check Getting too much of a good thing: 100 percent loans

check Financing cooperative apartments

check Considering balloon loans

This book would’ve been much shorter a couple of generations ago. Many of the loans we so diligently describe in Mortgage Management For Dummies hadn’t been invented when Richard Nixon was president.

That’s no typo. Invented is precisely what we meant to say. Loans are indeed invented by lenders. Adjustable-rate mortgages, which occupy a significant chunk of Chapter 5 , and reverse mortgages, the sole topic of Chapter 13 , are two types of mortgages that didn’t exist in the early 1970s.

We devote this chapter to a marvelous medley of mortgages designed to satisfy special financial requirements. If you don’t see the mortgage product you desire, tell your friendly financier. That’s how new loans are invented!

By the way, we use mucho loan lingo in this chapter. If you haven’t read Chapter 4 yet, now’s an ideal time to peruse it. Nudge. Nudge. We have many charms. Subtlety isn’t one of them.

Understanding Home Equity Loans

Equity is the difference between what your house is worth in today’s real estate market and how much you currently owe on it. For example, if your home’s present appraised value is $225,000 and your outstanding mortgage balance is $75,000, you have $150,000 of home equity. Lucky you.

There’s only one tiny problem with all that equity in your home — its utter lack of liquidity. Having equity in your house isn’t like having money in your checking account or a mutual fund you can sell any day the financial markets are open. To get your hands on your home’s equity, you must figure out a way to extract it from the property.

For instance, suppose you seek copious quantities of cash. If that’s your dilemma, we have two suggestions. You can free up all your equity by selling your house or tap some or most of it by refinancing your mortgage.

If selling is your pleasure, rush to the nearest quality bookstore for your very own copy of the latest edition of Eric and Ray Brown’s book House Selling For Dummies (Wiley). On the other hand, if you’d rather pull big bucks out of your home without selling it, you have the right book but the wrong chapter. We thoughtfully devote Chapter 11 to the arcane art of refinancing. This section tells you how to nibble into your equity by turning your home into an ATM.

Using home equity loans

Home equity loans may be excellent financial tools for homeowners who want to use a relatively small amount of their equity or who don’t need all their money at once. For example, you may need $20,000 of that $150,000 equity to remodel your kitchen. Or perhaps your twins are heading to college next fall, and you’ve generously decided to pay their tuition. Folks often tap their home’s equity to buy a new car or pay off unexpected medical bills.

These loans are frequently called home equity lines of credit or, given the mortgage industry’s love of acronyms, HELOCs. Home equity line of credit is an appropriate term, because this type of loan is essentially a line of credit secured by a second mortgage on a property.

As long as you don’t exceed the maximum loan amount previously agreed to by you and the lender, you can borrow precisely as much money as you need exactly when you need it. Take all the cash in one fell swoop or dole it out as you desire. You pay interest only on the outstanding loan balance, not your total line of credit.

warning Watch out! Many home equity loans contain clauses giving lenders the unilateral right to cancel or suspend a line of credit. Suppose, for example, your lender thinks your home has declined in value due to a soft local real estate market. The lender can yank your line of credit. Woe be it to you if you just started to remodel your kitchen or were counting on using the equity to pay the twins’ college tuition for next fall.

tip The best defense is a good offense. Instead of living in fear that your lender is going to pull the HELOC partway through your project, a prudent person like you can get the money out while the getting is good. Withdraw all funds you estimate needing before starting your project or before the tuition is due. Put the money into a fully liquid interest-bearing account (such as a money market mutual fund) to partially offset your interest charges. (The gap between the interest you pay for the HELOC and interest you earn on the funds is called the opportunity cost of money.)

Equity loans are also aptly referred to as debt consolidation loans. If you’re burdened by consumer debt from unpaid credit card balances, installment loans, and personal loans — and you’re a homeowner with sufficient equity in your property — you can use a HELOC to consolidate all your high interest rate loans into one relatively lower interest and lower monthly payment loan.

Operating instructions

There isn’t a standard, one-size-fits-all format for HELOCs. On the contrary, they can be extremely flexible financial instruments.

Depending on which lender you select, you may be able to customize your personal HELOC. For instance, you could get a fixed-rate loan unless, of course, you’d rather have an adjustable-rate mortgage. Other possible options are to take your money in one lump sum, use an ATM card to make withdrawals whenever you need cash, or write checks on your credit line — it’s up to you. You can opt to repay the funds you borrow in a fully amortized loan program or make interest-only payments until your loan is due. What’s your pleasure?

remember However, one common thread does run through these infinitely variable HELOCs: Every one of them is firmly secured by a lien on your home.

Because home equity loans are second mortgages, they have higher interest rates than first mortgages. That extra charge is justified because, from a lender’s perspective, second mortgages are inherently riskier than firsts. Even so, interest rates on HELOCs are generally significantly lower than interest rates charged on credit cards. A home equity loan at 6 percent interest, for example, sure beats paying 18 percent interest — or more — on credit card debt.

As a rule, you’ll get the lowest interest rate if the total amount of your first mortgage plus the HELOC doesn’t exceed 75 percent of your home’s fair market value (FMV). For example, suppose that your home is worth $200,000 and you have an existing first mortgage of $130,000 on it. To obtain the most favorable financial terms in this case, you’d limit the HELOC to $20,000 (images less your $130,000 first mortgage).

tip The higher your credit score, the more you may be able to borrow. Some lenders will allow you to tap up to 90 percent of your home’s FMV for the first mortgage plus HELOC. We cover how to improve your credit score in Chapter 3 .

warning You can lose your home if you don’t repay a HELOC. Unlike department store charge accounts, credit card debt, student loans, and other unsecured liabilities, home equity loans permit lenders to foreclose on property when borrowers default. And if the total of your first mortgage plus the equity loan exceeds 80 percent of your home’s FMV, you’ll pay higher loan origination fees and a higher mortgage interest rate on your HELOC. Be sure to review Chapter 1 so you understand how much mortgage debt you can truly afford given your overall financial situation and goals.

Considering tax consequences

All people are created equal. All debt isn’t. For example, the interest charged for student loans, credit card debt, and car loans is classified as consumer interest. This distinction is noteworthy because consumer interest isn’t tax deductible.

Mortgage interest, on the other hand, generally is tax deductible. One of a home equity loan’s most appealing features is that the interest you pay on a HELOC may be deductible for both federal and state income tax purposes. Whether the interest actually is deductible depends on three IRS tests:

The amount of debt taken out on the home when it was acquired and the dreaded alternative minimum tax (AMT) may also limit the amount of home equity interest you can deduct. Chapter 9 covers the complexities of mortgage interest deductibility in awesome detail. However, these details have a way of changing. Because Congress takes devilish delight in continually revising U.S. income tax rules and regulations, it may be prudent to review the nuances of your specific situation with a tax advisor before you sign the dotted line for that HELOC.

Eyeing 100 Percent Home Equity Loans

As we note in Chapter 2 , lenders have a disarmingly simple technique to estimate the probable risk of a mortgage. They divide the loan amount by a property’s appraised value to get a loan-to-value (LTV) ratio. Referring back to our previous example, your home’s LTV ratio is 60 percent if the appraised value is $150,000 and you have an existing $90,000 mortgage on it ($90,000 divided by $150,000).

The lower the LTV ratio, the lower a lender’s risk of being unable to collect enough money from a foreclosure sale to repay the loan if a borrower defaults — and vice versa. Lenders compensate for riskier loans by increasing interest rates and loan fees when a conventional mortgage’s LTV ratio exceeds 80 percent. High-risk borrowers must also pay for private mortgage insurance to protect lenders from losses. High LTV ratio loans aren’t cheap.

Back when 30-year fixed rate loans were the only option in the mid-1970s, 95 percent loan-to-value financing was the steel-reinforced concrete ceiling for conventional mortgages. During the crazy lending days in the 1990s and early 2000s, some loans were being done up to 125 percent or more of the home’s value based on the now proven false theory that home values only go up. Now, even after the very difficult lessons learned in the late 2000s, some financial institutions will lend creditworthy borrowers up to 100 percent of their home’s value.

warning Consider the toxic consequences of 100 percent HELOCs:

tip You can probably get a better deal on some lower interest rate credit cards than on a 100 percent loan — and without placing your home at risk of foreclosure. Because credit card rates vary from bank to bank, do some comparison shopping. There are several online sites (like Bankrate.com, CreditCards.com, ConsumerReports.org, and Kiplinger.com) that routinely provide comparison shopping information on the current lowest credit card rates.

Getting a 100 percent loan may be prudent if you use the proceeds to pay off other debt with an even more outrageous interest rate, such as an unsecured loan to pay for a medical emergency. On the other hand, if you need a 100 percent loan to pay for a dream vacation in Hawaii or buy a spiffy new car (when you have a perfectly good one sitting in your garage), you’re exhibiting ominous signs of a severe credit management predicament. Be sure to read the sidebar “Pay attention: Warning signs of credit trouble .”

Taking a Closer Look at Co-Op Loans

Cooperative apartments, usually called co-ops, can be difficult to finance. Wait. Why sugarcoat the situation? On our patented mortgage-origination-degree-of-difficulty scale, where 1 equals a slam dunk and 10 will never happen in your lifetime no matter how much you beguile, beg, and beseech lenders, getting a co-op loan is 9.8 nearly anywhere in the United States.

That fact no doubt seems odd when you consider that condominium financing is generally affordable and plentiful. Condos and co-ops are, after all, the two most common types of attached residential dwelling units. You can’t tell which is which simply by looking at a building’s exterior. Why, then, is financing co-ops so tough when getting condominium loans is relatively easy?

We thought you’d never ask.

Identifying the legal structure of co-op loans

The first reason obtaining co-op financing is more difficult than financing a condo is that even though a condominium development and a cooperative apartment building may look identical physically, they have different legal structures:

technicalstuff About now you’re probably wondering whether cooperative apartments are some kind of ultraexpensive shell game. If you don’t own the real property, who does? The cooperative corporation owns the building in which your cooperative unit is located; it holds the property’s deed in its name. But because you own shares in the cooperative corporation that owns the building, that makes you a co-owner of the building as well as a tenant in the building you partly own. Does the word discombobulated describe how you feel about now?

Dealing with deal-killing directors

The internal management structure is another reason that buying and selling co-ops is more difficult than buying and selling a condo. Stock cooperatives are corporations governed by a board of directors elected by individual housing unit owners. Like the homeowners association in a common interest development, a co-op’s board of directors is responsible for overseeing day-to-day operations, including the setting of the fees and assessments and reserves, which are critical to prudent financial planning. Some co-ops are well run, but often the assessments and reserves are kept artificially low and inadequate funds exist for expensive repairs or replacements of major building systems, such as roofing, elevators, or plumbing.

The co-op’s board of directors can have a say in your desire to sell your housing unit, whereas a condo’s homeowners association has essentially none as long as all the assessments are paid to date. Many cooperatives won’t let individual owners sell or otherwise transfer their stock or proprietary leases without written consent from the board of directors or from a majority of other owners. That arrangement may be fine with you as a co-op owner, but it makes most lenders intensely uneasy. In their opinion, giving up your right to sell your housing unit to a creditworthy buyer is far too high a price to pay for the right to select your future neighbors.

Buying a cooperative unit isn’t any easier than selling one. Would-be buyers almost always have to provide several character references plus a detailed financial statement and then submit to an intrusive interrogation by the directors. Many people find the Byzantine approval process so meddlesome that they won’t consider buying a co-op. This reluctance further reduces the number of prospective purchasers for your unit.

Offers you receive from prospective purchasers must be conditioned upon subsequent approval by the board of directors. When you finally find the perfect buyers, brace yourself. These paragons may be rejected. The directors, in their infinite wisdom, may believe that your buyers have a propensity to entertain too frequently. Or perhaps they’re of the opinion that your buyers can’t afford to shoulder their share of the co-op’s operating expenses. Whatever their rationale, valid or capricious, directors can nix your deal.

warning If you haven’t purchased a cooperative housing unit yet, think twice before doing so. Don’t buy someone else’s problem. If it’s difficult to find financing when you want to buy a co-op, and equally troublesome to find prospective purchasers when you want to sell it, the real estate market is trying to tell you something. The best time to think about selling a co-op is before you buy it.

Tracking down a loan

If you’re still reading, we obviously haven’t dissuaded you. Trust us when we say that getting a co-op mortgage will be tough. Here’s what you’re up against:

Real estate agents and cooperative building owners are excellent financial ferrets. They generally know which lenders in your area are currently making co-op loans. You may also be able to obtain financing if your employer puts in a good word for you with the lender who handles the corporate accounts. Some commercial banks offer co-op loans as an accommodation to an important business relationship.

warning We strongly advise pouring cold water on your burning desire to own a cooperative unit if you discover that few lenders in your area offer co-op financing. Limited competition usually results in higher loan origination fees and interest rates. Things may get even worse. Suppose that no lenders are making co-op loans when you decide to sell. You’ll either have to delay your sale until you can find an all-cash buyer or carry the loan for your buyer. Owner-carry financing, as we point out in Chapter 7 , can be risky business.

Grasping Balloon Loans

Loan amortization refers to the process of repaying a debt by making periodic installment payments until the loan term is completed or you sell or refinance, whichever comes first. Speaking of firsts, be advised that first mortgages are almost always fully amortized. That’s lender jargon to describe a loan that will be completely repaid after you make the final, regularly scheduled, monthly mortgage payment. (See Chapter 4 if you want more details on loan amortization.)

Some second mortgages are also fully amortized. However, some second mortgages come due long before they’re anywhere near to being fully repaid. Any mortgage that comes due with an unpaid balance is known as a balloon loan. Others may be home equity interest-only loans for, say, 10 years and then fully amortize over the remaining 20 years. Thus, they will have a big jump in payment after ten years.

The final monthly installment that pays off a loan’s entire remaining principal balance due is called a balloon payment. As you’ll discover after scanning the next section, balloon payments generally resemble blimps.

Because balloons bring to mind images of birthday parties and light-hearted frivolity, it seems somewhat misleading to name these mortgages after something so benign. They’re more aptly referred to as bullet loans by lenders who’ve seen balloon loans mutate into financial bullets blasting hapless borrowers who can’t repay or refinance their mortgages when they come due.

We don’t want to scare you away from balloon loans. They can be used to augment your cash for a down payment, reduce your interest charges, or pull equity out of your present house to buy your next home. They’re useful financial resources when used properly. Without further ado, the following sections offer a bunch of bright balloons that you can safely consider for your edification and judicious fiscal enjoyment.

80-10-10 financing

Surprising as it may seem, some folks with hefty incomes find that it’s mighty tough for them to save enough money to make a 20 percent cash down payment on their dream homes. Buyers using conventional financing who can’t afford to put 20 percent cash down must purchase private mortgage insurance (PMI). As we note in Chapter 4 , buying PMI increases the cost of home ownership and, ironically, makes it even more difficult to qualify for a mortgage.

Good news: You’re about to discover how you may be able to circumvent those nasty PMI costs with 80-10-10 financing.

Even if you put 20 percent down, you could still end up paying a higher interest rate on your home loan if you get a jumbo first mortgage. Per our succinct section in Chapter 4 , these mortgages exceed the Fannie Mae and Freddie Mac conforming loan limits. In the upcoming section, “Shrinking jumbo can slash your interest rate ,” we show you how to shave up to ½ percent off your first mortgage’s interest rate by using 80-10-10 financing.

Using 80-10-10 financing to avoid private mortgage insurance

If you’re a dues-paying member of the cash-challenged class, don’t despair. Given that your income is sufficiently high, it’s eminently possible to avoid getting stuck with PMI. That’s why 80-10-10 financing was invented. It’s called 80-10-10 because a savings and loan association, bank, credit union, or other institutional lender provides a traditional 80 percent first mortgage, you get a 10 percent second mortgage, and make a cash down payment equal to 10 percent of the home’s purchase price.

Where do you obtain the 10 percent second mortgage? The most common sources are

  • House sellers: We provide a detailed dissertation about seller financing in Chapter 7 . At this point, we’ll just say that some sellers offer qualified buyers attractive secondary financing either as a sales inducement or because they want to generate income from the loan. Owner-carry second mortgages are generally less expensive than seconds made by institutional lenders such as banks and credit unions because most sellers don’t charge loan origination fees — and sellers usually offer lower mortgage interest rates to boot. Seller seconds are nearly always short-term balloon loans due and payable three to five years after origination.

    tip The institutional lender that holds the first mortgage will most likely insist upon reviewing the terms and conditions of the owner-carry second mortgage. For one thing, the lender needs to be sure you can afford to make monthly loan payments on the first mortgage plus the second without overextending yourself. The lender will also probably insist upon at least a five-year term for the second mortgage, so you’ll have plenty of time to save up for the balloon payment when the second comes due. Five years will also usually allow for home appreciation to create homeowner equity that can be tapped through a HELOC loan to repay the second mortgage, or you can refinance all your debt into a single new loan. (That way, if you use your current lender, they get to charge you more points and fees!)

  • Institutional lenders: Yes, the same friendly folks who originate your 80 percent first mortgage may also provide secondary financing. This type of loan program varies from lender to lender. Some lenders structure the second as a home equity loan; others offer a conventional second mortgage. The secondary financing may or may not be in the form of a balloon loan. If the second is fully amortized, it’s usually structured as a 15-year mortgage.

tip Don’t get hung up on terminology. Just because this type of financing is referred to as 80-10-10 doesn’t mean you absolutely, categorically must put down 10 percent cash. The same principle applies if you can afford to make only a 5 percent down payment — 80-15-5 financing may be available. Because a smaller cash down payment increases the lender’s risk of default, however, don’t be surprised when you’re asked to pay higher loan fees and a higher mortgage interest rate for 80-15-5 financing and 80-10-10 financing versus traditional financing where you make a 20 percent down payment.

Playing with the numbers

Now we’re going to crunch some numbers so you can see with your own eyes 80-10-10 financing. Each of the following examples assumes the same three conditions — that the home you’re buying costs $200,000, that you’re making a 10 percent ($20,000) cash down payment, and that you’re a creditworthy buyer:

  • PMI: In this scenario, you didn’t read this fine book and hence don’t know about 80-10-10 financing. You foolishly get a $180,000 (90 percent of purchase price), 30-year fixed-rate first mortgage with an 8 percent interest rate. Your monthly loan payment is $1,322. PMI costs an additional non-tax-deductible $78 per month (it’s possible that tax law changes enacted after this book was published may make PMI costs tax deductible, so check the current rules). You pay $1,400 per month in total loan charges.

  • Owner-carry second mortgage: After reading this book, you diligently search until you discover a seller who’ll carry a $20,000 fixed-rate second mortgage amortized on a 30-year basis. The loan, however, is due in five years. You negotiate a 7.5 percent interest rate; your payment is $140 per month. With 10 percent down and a 10 percent second, you need only a $160,000 (80 percent) 30-year fixed-rate first mortgage at 8 percent interest costing $1,175 per month. Total loan charges are $1,315 a month, $85 less per month than the PMI example — and all the interest you pay on both mortgages is tax deductible. The final advantage is that you can pay off the owner-carry second mortgage any time you want. PMI, conversely, is harder to get rid of than head lice. You’re so smart.

    warning Not so fast, smarty. Don’t forget that the second mortgage is a balloon loan. It’s due and payable in five short years. You’ll be dismayed to discover that 94.6 percent of your original $20,000 loan remains to be paid five years after the loan is originated. In other words, your loan balance is $18,920 images even after paying the seller $8,400 (60 monthly payments of $140) over five years. What if you can’t refinance the second mortgage when it’s due because you lose your job? Or what if property values drop and the appraisal comes in too low to pay off the second? Or what if interest rates skyrocket and you can’t qualify for a new loan at the high mortgage rates? Now maybe you understand why they’re called bullet loans.

  • Institutional lender second mortgage: In this example, the seller of your dream home won’t carry a second. Having scrutinized this book, you wisely opt for 80-10-10 financing from a bank. You get a $160,000 (80 percent) 30-year fixed-rate first mortgage at 8 percent interest costing $1,175 per month. The bank offers you a choice for your $20,000 second — either a fixed-rate mortgage (FRM) amortized over 30 years but due in 15 or a fully amortized, fixed-rate, 15-year loan. You’d pay $191 per month for the 30-year, FRM balloon loan with an 11 percent interest rate versus $225 a month for the 15-year FRM at 10.75 percent interest. What to do? What to do?

    What an interesting (sorry — we couldn’t resist) choice. You’d pay $1,366 per month images for an 80-10-10 that has a $16,760 balloon payment due in 15 years. Taking the fully amortized second mortgage increases your monthly payment $34 to a nice round $1,400 images . On the plus side, you’d build up equity faster with that second mortgage, and there’s no balloon payment to fret about. (If that kind of fiscal pressure debilitates you, either of the bank’s second mortgages are preferable to the owner-carry second with its five-year due date.)

    tip Truth be known, it’s highly unlikely you’d keep either of the second mortgages for 15 years. Given their high interest rate, you’d wisely refinance the one you select as soon as possible (see Chapter 11 ) or pay it off when you sell your house and move into a magnificent mansion.

    Given those assumptions, we’d advise taking the balloon second mortgage and investing the $34 a month you save in a good mutual fund. If the thought of balloon payments causes you to lose shuteye, however, you have our permission to take the fully amortized second. The choice is yours.

Shrinking jumbo can slash your interest rate

Congress sets upper limits on mortgages Fannie Mae and Freddie Mac purchase from institutional lenders for resale to private investors. These loan limits are adjusted annually to ensure that they accurately reflect changes in the U.S. national average home price. For example, the maximum single-family dwelling loan Fannie Mae and Freddie Mac could buy when this book was printed was $636,150. That amount may have changed by now, so be sure to check with your lender to determine the present loan limit for the type of property you intend to purchase.

As we note in Chapter 4 , mortgages that neatly fall within the current Fannie Mae and Freddie Mac loan limits are called conforming loans. Conventional mortgages over the maximum permissible loan amounts are referred to as jumbo conforming or true jumbo loans. This is a critically important financial distinction if your mortgage happens to exceed the conforming loan limit. Interest rates on jumbo conforming or true jumbo fixed-rate mortgages are normally ½ to 1½ percent higher than their conforming fixed-rate brethren.

tip Why pay one red cent more than you have to for your home loan? If the amount of money you need to borrow is slightly over the Fannie Mae and Freddie Mac current conforming loan limit, use the 80-10-10 financing technique to cut that costly jumbo loan down to size.

Bridge loans

It’s highly unlikely that you’ll remain in your first home forever. Sooner or later birth, death, marriage, divorce, job transfers, retirement, or another monumental life change will probably force you to confront the eternal seller’s quandary — should you sell your present house before buying a new one or buy first and then sell?

There are, of course, risks associated with either course of action. However, we firmly believe that it’s ultimately far less perilous to either sell your current house before buying a new one or to sell your house concurrently with the purchase of your next dream home. You’ll also sleep a whole lot better.

Why? Because, if you’re like most people, you can’t afford the luxury of owning two homes simultaneously. You have to use the proceeds from the sale of your present house to acquire your next home. That’s how things work in the real estate food chain.

Unfortunately, some folks create serious problems for themselves by purchasing a new home before their old one has sold — which brings us to bridge loans, an uncommon type of balloon loan that enables qualified borrowers to pull a portion of the equity out of their house before it sells. This financial bridge provides enough cash to complete the purchase. We’re not fans of bridge loans. If you’re not careful, they can be the fiscal equivalent of a dose of arsenic. Here’s why:

Bridge loans are fine if you’re wealthy enough to afford owning two houses for an extended period of time. We grudgingly authorize the use of a bridge loan in one other situation — if the house you’re selling has a ratified offer on it, if your transaction is currently in escrow, if all the conditions of your sale have been removed, and if the sale will be completed in four weeks or less. Even under these stringent conditions, a bridge loan is risky because your deal could fall through.

warning Like rattlesnakes, bridge loans should be approached with extreme caution. Consider them a last resort. Stifle the unseemly urge to obtain bridge financing so you can buy your dream home before selling your present house. A bridge loan could turn that dream into a nightmare.

Construction loans

Watch your step, please. Be careful. We’re about to enter a hardhat zone. This last balloon loan is covered with a fine coat of dust — construction dust.

Like the other loans we cover in this chapter, construction financing is extremely diverse. No one standard loan instrument exists that all lenders use to finance construction projects. On the contrary, the terms and conditions of construction financing vary widely from lender to lender and project to project.

That variability isn’t at all surprising when you consider the full spectrum of project types and sites. Do you need a small loan to do a little cosmetic painting and landscaping around your house; or are you about to embark upon a major rehab of an inner-city, multifamily dwelling; or do you plan to construct a country retreat from the ground up? Will your project be completed in two months or two years? Are you doing the work yourself, or will you use an architect and licensed contractors?

Financing for small, do-it-yourself type projects is usually handled with home equity loans. Funding of larger projects, on the other hand, is generally paid out in installments as each previously agreed-upon stage of construction is satisfactorily completed. You pay interest on construction funds only as they’re disbursed. After your project is completed, the construction financing is customarily converted into a permanent, long-term mortgage.

tip Construction financing is specialized. Many lenders aren’t interested in financing rehabs of major fixer-uppers or making new construction loans. Real estate agents who handle this kind of property generally know which local financial institutions offer construction loans for your specific type of project. Architects and contractors are also good bird dogs for local banks or other lenders who provide construction loans.

Renovation/remodel loans

Fannie Mae and the FHA have specialized loans that will fund both the purchase of a home and the renovation and repair costs. Fannie Mae calls its loan the HomeStyles Renovation Loan, and the FHA calls its program the 203(k) Home Improvement Loan. If a home is too beat up to qualify for traditional financing and you can’t afford to pay cash for the home, then these loans may be for you.

Be aware, however, that these loans are a lot of work and are slow to close. Consequently, some listing agents aren’t fond of accepting offers with renovation financing. But if there isn’t a cash buyer on the horizon, the listing agent will work with you and your renovation loan. Additionally, renovation loans include a lot of nuances (for example, you’re not allowed to personally perform the work; you have to use a licensed contractor), so you need to find a loan officer who is highly proficient with renovation loans. Saying all of that, these can be awesome loans — but you may not feel that way until after you’re finished with the renovation!