Can I roll rehab cost into FHA loan?....other financing options?

Question

Hello!

I'm currently looking to put an offer in on a triplex. It has two 2 bedroom units upstairs, and then the walkout basement currently has another 2 bedroom unit it half. The other half of the basement is unfinished but can be turned into a 1 bedroom unit. There are even unfinished studs in place to turn this into a 1 bedroom unit.

This would be my first deal and I plan to house hack and live in one of the units (the other two units are rented). I would like to finish the basement and rent it to live for free versus paying rent to myself. The current plan is to do an FHA loan on the house with 3.5% down. I'm getting married in October, so I'm trying to keep as much in my bank account as I'm going into this next stage of life. Because of this, I was wondering if I can pay more for the property and have the seller essentially write me a check for the additional pay.

He's asking about 155k for the property. Can I instead make my offer for 175k and then have the seller write me a check for 20k? This would go towards my closing costs and then the rest would go towards fixing up the 4th unit to rent out. Is this legal? If I make the mortgage company aware of my plans, are there any concerns? I don't have the cash to make this refurb on my own, so looking at ways to make it happen.

On a similar note, any ideas for creatively financing the house with different means? The property is for sale by owner and recently taken off market due to many people low balling him and not seeing eye-to-eye on the price. He is an older gentleman and this sale is part of his retirement package plans. He does not own the property free and clear. The auditor website shows he purchased property for 135k in 2005. I've read a lot and listened to a lot of BP podcasts, but not sure what financing methods might work here (if any) or if FHA is the best option. Subject to financing? Perhaps something else? Maybe if I give him the downpayment directly, I could get a better deal by making payments to him each month? Not sure what could be applied well to this situation that is a win for both parties.

Thanks,

Nicholas

Michael Pearse · Answer

@Nicholas Morgan Great question, it looks like what you are looking for is a construction rehab loan. Essentially this is where a bank will provide a rehab budget added on top of the original loan. I have used this myself and would highly recommend this as you build your portfolio. See guidance below regarding a construction loan.

1. Construction loans are easier to obtain with smaller banks. Build a connection with a loan officer in your area and maintain a good connection with them. Tell them your goals for the investment property, what you expect to rent each unit for, what your next plans are after the deal (Invest in more homes, raise rents, ect). As you build up confidence in your rehab estimates and demonstrate a successful business with your portfolio, the bank will eventually give you 1. lower interest rates, 2. higher rehab budgets, and 3. more opportunity to take on additional risk as they trust your knowledge on making sound decisions.

2. Having a construction loan will increase your down payment, but this will give you greater access to additional funds that don't need to come out of pocket for the rehab. Overall this should equate to less of your money going into the deal, which allows you to leverage and have more reserves.

3. Using a construction loan will require a SOW (Scope of Work). This is where you will need to have a list of what you plan to do to improve the property, and how much it will cost you (or the contractor) to get the job done. You will need to track this closely and inform the bank if any estimates change from your original assessment. If costs increase, the bank may want you to cover this with your own cash. So have reserves ready in case this does happen. Rule of thumb, expect costs to be 20% more than what you estimate. This should ensure a good safety net and keep the project moving along in case you run into any hiccups.

4.  Once you find a bank that gives you a rehab loan, look at the down payment required. Look at what your monthly mortgage will be, and verify that once you complete the project market rents can support the loan.

Hope that helps and good luck on the investment deal!

Michael Pearse · Answer

@Nicholas Morgan A construction loan is typically paired with the home selling price. You could talk to the bank and request a construction loan with the intent of not starting any rehab until 1 to 2 months down the road. If you want to have the loans from 2 different banks, you could just get a personal loan written out and use that for rehab. Keep in mind that using 2 different banks is fine. Though I find it much more advantageous to stick with 1 good bank for a while to build a relationship with them. They are more likely to offer loans/lines of credit for what you are looking for. Such as what you have expressed.

Cheers!

Nicholas Morgan · Answer

Thanks for the info, Michael! That seems like something I could really take advantage of. Is it necessary to pair this construction loan with the main home purchase loan? For example, can I just get a normal FHA loan and then in like a month or two, can I get the construction loan? Do both loans need to be from the same institution?  I've found a lender to use for my FHA, but if he doesn't do this construction loan option, can I just do that with another lender?

Thanks!

-Nicholas