I have been asked what types of construction financing might be possible to buy and rehab a 2 unit or duplex type property, or as they are known in Chicago, a “2 flat”. As a Loan Officer who has worked for years with various types of renovation loans I wanted to present loan options for this type of renovation or conversion that may not be as common as other renovation projects.
In many cities and close in suburbs around the country there are older properties that were built for two families. Usually a first floor and then a second floor apartment or built side by side with a common wall. Each part might be a 2 or 3 bedroom dwelling with one bathroom. Many of them were solidly built out of brick & mortar with unfinished basements and held up well over the years. As time has passed and neighborhoods have evolved there is new interest in these structures because they can provide a solid platform to use as a single family home. Another positive aspect of them is it may be cheaper to convert one than to build new in some areas. Today’s construction techniques might not result in as solid and long-lasting a structure given the potential financial constraints of building a new structure in some areas. Or the neighborhoods might be near cultural institutions, highly rated schools, sports venues, public transportation and all that living in an urban area offers. It then makes perfect sense that converting an old, but structurally sound 2 unit building into a modern single family home becomes appealing and perhaps economical. Many times there may be an estate sale of a 2 unit where a family lived and never did much to update it so it can be purchased at a price point conducive to renovation. Or perhaps there is a foreclosed property available to convert. Or maybe the 2 unit property is the worst house on the block but in a great neighborhood where single family homes sell at a premium.
In this Blog I want to offer education on how to secure financing for a 2 unit conversion into a single family. There are renovation loans that will work well and do not require previous experience at renovation or managing a construction project. The differences between them involve the size of the mortgage needed primarily and particulars of how each works. Two of the examples below are about financing both the purchase of the property and adding funds to convert to a single family. But these loans will also work in a situation where the property is owned already, and a family wishes to convert from 2 units into a single family home. I have included one example of that situation.
Purchase and convert a 2 unit into a single family with HomeStyle by Fannie Mae
- HomeStyle is a conventional loan that allows for funds to purchase and re-construct a 2 unit property to a single family in the same 30 year term loan, at the same interest rate, for all the money. The maximum loan amounts vary somewhat from county to county across the country but generally allow a maximum loan size presently in 2018 of $453,100 for a single family home. It is what the property will become rather than what it is today that sets the loan maximum.
- If purchase price is $250,000 for a 100 year old 2 unit that perhaps has never been updated, or even a foreclosure or estate sale, that allows a budget of over $200,000 for the renovation to fit within the maximum loan size of $453,100. Down payment can be as little as 5% in this example.
- With HomeStyle a borrower can also borrow up to 6 months of house payment funds in the loan. That would be principal & interest, escrows for property taxes & insurance plus any required mortgage insurance. A nice option for those that already have a housing expense and now would have two house payments to make even though the property cannot be occupied for up to 6 months perhaps.
- The key to making all this work is defining the future, “As Completed” value the property will attain when construction is done. This occurs by having an Appraiser review a General Contractors detailed description of rehab work details with all related costs. In that way the future single family home’s value can be projected off paper so the loan can be approved with both homeowner and lender knowing the finished value of the home up front, prior to loan approval and closing of the sale. The rehab fund portion of the mortgage is capped at 75% of final, “As Completed” value of the home to be sure the home is not over improved for the area.
- There is also an automatic 10% to 20% emergency reserve or Contingency fund included off the base rehab budget to be used during the rehab process for any unforeseen or surprise expenses found once walls or floors are demolished, etc. This protects the home Buyer, who may have used all their liquid funds on the down payment and closing costs, from paying for extra costs that could jeopardize the rehab project if funds are not in place in advance.
- In the above example if purchase price were $250,000 and conversion rehab base budget is $200,000 then there would be at least a 10% reserve off that or $20,000 more. The total transaction is $470,000. The down payment is calculated off this total of both purchase price and construction sum. At 5% down that would be 5% of $470,000 or $23,500 down payment. The loan size would be $446,500 which is within the HomeStyle 2018 single family limit of $453,100 in most counties. (There are a number of high cost counties around the country where the limits are higher. These limits are reviewed annually and adjusted if need be across the country so may well be higher in 2019 and years beyond).
- What is most important for both Buyer and lender is the final, “As Completed” value. In this example with a total transaction cost of $470,000 the end value should be at least $470,000 with a 95% mortgage of $446,500.
- One regulation of HomeStyle is the rehab portion of the mortgage cannot itself be greater than 75% of “As Completed” value or in this case, 75% of $470,000 which is $352,500. Since the example rehab budget is less at $220,000 its fine.
- It may be, depending on the area, that a property is worth significantly more reconfigured as a single family home than as a 2 unit. If that occurs, the extra value is new equity created due to the renovation the home owner will have.
- I have seen the 2 unit conversion to single family renovation consist of adding more bedrooms and baths; opening up the floor plan for an open concept arrangement and adding a family room, bedroom and full bath in the basement. Basically gutting out the old separate apartments to end with a 4 or 5 bedroom home with 2, 3, or more baths plus a garage outside. In this way value may be added to the property in most markets.
Refinance and convert a 2 unit into a single family with HomeStyle by Fannie Mae
- HomeStyle can be used for a current Owner of a 2 unit property to secure funds to build it out into a single family home. The main difference here is any current mortgage(s) must be paid off using part of the HomeStyle mortgage and remaining funds are for the construction.
- For example, a home Owner who owes $200,000 on their current mortgage can secure a loan based on the future, “As Completed” value as in above Purchase example. Since HomeStyle is a first lien product, the current lien or mortgage, must be paid off and remaining loan funds used for the rehab project.
- In this example if the rehab cost were to be $225,000 plus a 10% Contingency reserve of $22,500 (as described in the above Purchase example) the total new loan is for $447,500 ($200,000 to pay off current mortgage + $225,000 base rehab budget + $22,500 reserve off that). Note that if there was a second mortgage lien it must also be paid off with HomeStyle.
- What is key is the final, “As Completed” value as in the above Purchase example. In this refinance example the “As Completed” value would be expected to be at least $471,053. The new loan can be equal to 95% of the total which is the $447,500.
- All the same HomeStyle regulations apply on a refinance such as the rehab portion of the mortgage not greater than 75% of “As Completed” value.
Purchase and Convert a 2 unit into a single family with a Jumbo loan
- There can be situations where the loan size must be greater than what HomeStyle may allow in a given county. For this situation there is a Jumbo renovation loan available up to $1,500,000 with a 20% down payment or up to $2,000,000 with a 25% down payment. This includes purchase funds and renovation funds.
- On Jumbo renovation the maximum cost of renovation can be up to $250,000 or 30% of the “As Completed” value, whichever is less.
- There is a 10% to 20% Contingency reserve required to allow for any unforeseen costs that arise during the renovation.
- If a purchase price for a 2 unit is $600,000 and the single family rehab budget is $250,000 (including a 10% reserve) then transaction total is $850,000. Down payment is minimum 20% of that $850,000 total or $170,000. The mortgage size is $680,000 ($850,000 – $170,000 down payment).
- As with HomeStyle above, “As Completed” value is important. In this example of an $850,000 transaction let’s assume the former 2 unit is now worth $1,000,000 as a single family home. That means max renovation amount cannot be greater than lessor of 30% of the value, which is $300,000 or a flat $250,000 as it is in this example.
- For those who own the property currently a Jumbo refinance transaction is also possible to pay off the current mortgage(s) and finance the renovation in one Jumbo loan.
- A Jumbo refinance example might be an Owner who has a current mortgage of $500,000 and needs $200,000 for renovation plus a 20% reserve of $40,000. The total to pay off the current mortgage and secure the rehab funds is the sum of these or $740,000 for the new Jumbo mortgage.
- Assuming the future “As Completed” value as a single family is now at least $925,000 then the loan at $740,000 is not more than 80% of that value. It falls within the guidelines of the Jumbo renovation loan.
In cases where a Jumbo renovation budget must be in excess of $250,000 please contact me about an alternative that may be possible in some circumstances.
In this Blog I wanted to present a specific case of how to finance the renovation of a 2 unit or duplex into a single family home. In some markets this can be a wise, less costly alternative to buying a brand new home that may well be more costly given all the work is completed and the Builder may want to make a profit. With most any renovation loan a Buyer or Owner will have the tools to go forward to renovate a property into exactly the home they can envision.
I hope this post has been helpful and encouraging to those that may have thought a Renovation project was too complex or beyond their ability to manage. My intent is always to inform, educate, and generate discussion. Please call me or email me directly or visit my website for more information on renovation loans. I welcome your comments and questions!