Conventional vs. Rehab vs. Land & Construction

Magnifying glass in front of a home help by someoneWhen you begin your housing search many people and resources ask you the question of which mortgage can you qualify for. However, did you know that there are restrictions that can be applied to the house you are looking at as well? It is unlikely that you will find a house that does not fit within the mortgage program you applied for, but each program does have its own restrictions. It is important to know what red flags you need to watch out for, before you go looking at homes.

So, what are the main differences between the three mortgage types of conventional, rehab, and construction. A conventional loan is the most standard loan and will typically require the house to have an occupancy permit for the mortgage to close. A rehab loan allows you to look at houses that might need improvements such as cosmetic work, structure work, utility work, etc. However, the work that needs to be done on the house has to be started 30 days from closing and end within a 6-month period. A construction loan allows you to buy a piece of land and build a house on that land, this type of mortgage requires a higher down payment and typically construction must be done within 1 year.

Now that you have a brief overview, let us dive a bit deeper into what each mortgage type requires the house to have starting with the conventional loan. The benefits of picking a conventional mortgage loan are that the interest rates tend to be lower, and they have better terms. These types of loans can be used on a mortgage for your primary residence, a vacation home, or an investment property. However, these homes need to be either a single-family home or a multi-family with no more than 4 units in size and located within the United States or a United States Territory. So, unfortunately you would not be able to use this loan type to buy your dream European vacation home. Other standards the home must meet include, but are not limited to:

  • Residentially zoned
  • Have a good title
  • Be insurable for flood and home risk
  • Easily accessible by roads (that meet local standards)
  • Connected to utilities (that meet local standards)
  • Classified for Year-Round Use
  • Appraised Value equal to or above Offered value
  • Free of Pest infestations (especially termites)
  • No Asbestos, lead paint, moisture intrusion, or radon gas

The house must meet all these requirements at the time of the closing for the lender to approve the mortgage. With a conventional mortgage loan, if you decided to purchase a home that needed some work, you would need to make sure it meets those requirements, and you must either pay out of pocket or get another loan to pay for the repairs. If you do get a house that needs some work, you do have the benefit of taking a longer time to do the updates and doing some of the work yourself**.

A rehab mortgage loan is a bit different from the conventional mortgage loan. With a rehab loan you will have a higher interest rate, but you are able to use a portion of the loan on the home purchase and the other portion on repairs. When you apply for a renovation loan, what you borrow must cover both the home purchase and the repairs, meaning what you can offer on the home is less than what your mortgage total will be. The cost of repairs is not in addition to the cost of the home, so make sure to keep that in mind if you are using one of these loans for a home purchase. These mortgages have fewer requirements for the home and include but are not limited to:

  • Can only be used for a primary residence (single or multi-family only)
  • Renovations and repairs must be done by a licensed general contractor
  • Work must begin with 30 days of closing
  • Work must be completed within 6 months of the start date
  • Must meet all conventional loan requirements after the 6 months of repairs is complete
  • The amount needed for the renovation is placed in an interest-bearing escrow account and paid out in phases as the work progresses. Prior to each disbursement, an inspector must verify the work has been completed.
  • Final inspections are required for the final disbursement

This loan is great for those who might not be able to afford an updated home in the area that they want to live in. It allows them to buy an outdated home that needs some work and helps them afford the work that needs to be done.

The final mortgage type is a land and construction loan. This mortgage type allows you to purchase a piece of land and build your home on it. Depending on the lender you might also be able to use this loan to build on land you already own or for renovating an existing structure. These loans are much different from a conventional or rehab loan, typically you will pay only interest payments for the first 12 months before you begin to pay down the principle. The total amount of the loan is also not given out as one lump sum, it is instead given out as withdrawals at specific check points signed off by an inspector that the previous work has been completed.

For this type of mortgage, the land must be buildable and meet zoning requirements and the construction must be performed by a licensed general contractor. Plans and specs, a building permit, and Builder’s Risk and Liability insurance are also required prior to closing. The completed home will have to pass for an occupancy permit and with all contracted work completed as per the builders contact and plans and specs.

Land for sale falls into one of three categories:

  1. Raw land
    1. This typically has no utility hook ups in place and may not even be accessible by road yet. This makes it harder to qualify for the loan with this land because it is at high risk that it may not be suitable to build a home.
  2. Unimproved land
    1. This is very similar to raw land, but it typically has a few utilities already in place but not all. This makes this land easier to qualify for a loan than raw land but not necessarily the lowest risk option.
  3. Improved land
    1. This has the most improvements and is the lest risky of land purchases. This land typically has access to roadways and has electricity and water hookups. It may also have more improvements such as engineering plans and possibly even certain systems completely installed. However, because of the low risk they are typically more expensive.

Due to the higher risk nature of a land construction loan, it typically has higher interest rates and higher down deposit percentages as well. This option even though it can be a more difficult loan to ascertain, can give you the ability to build the exact home you want.

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**Doing work yourself without proper knowledge is not recommended. Please make sure you know what you are doing before you begin work on your house and get the proper inspections and permits.