The Easiest Way to Afford the Home of Your Dreams

Buying a house that needs a little TLC saves money and lets you put your stamp on a home.

Around September 2020 -- six months into social distancing, quarantining, and intense isolation -- I decided to sell our home and move across the state to be near family. At first, the idea was thrilling, and I studied online real estate listings like an archaeologist poring over ancient manuscripts. I was obsessed with learning everything there is to know about housing in that region.

For a while, I forgot to be rational. As much as homes in our area have appreciated, homes on the other side of the state have appreciated more. To buy a house with features similar to ours, we can expect to spend an extra $100,000-$150,000. And so began the search for ways to buy a home we like as much as our current house without spending an arm and a leg.

Traditional purchase

The prices of homes in the area we're most interested in are outrageous. Even after making a large down payment and snagging a super-low interest rate, I would always suspect we paid too much for the house, primarily because I spent months "stalking" the neighborhood and watching average prices escalate. I didn't want that to be us, so I took a deeper dive into alternatives, like buying a fixer-upper at an affordable price and doing the kinds of upgrades that make it feel like home. Here are some of the options I came across for financing a fixer-upper in our price range.

Fannie Mae HomeStyle® renovation loan

Fannie Mae is a type of conventional loan backed by the U.S. government. Their HomeStyle® renovation loan lets a buyer purchase a fixer-upper with as little as 3% down. Any upgrades or renovations that are permanently attached to the property are allowable. Buyers must work with a licensed contractor and have a credit score of 620 or higher. While it's possible to use a Fannie Mae HomeStyle® renovation loan to make upgrades to a rental property, it's not as easy as it once was, and Fannie Mae carefully controls the number of investors it approves.

FHA 203(k) loan

FHA loans are available through mortgage lenders across the country but are insured by the U.S. Department of Housing and Urban Development. Its 203(k) loans come in two flavors: limited and standard. If you're making repairs and improvements under $35,000, the limited loan (sometimes referred to as "streamlined") is your best bet. If renovations are expected to cost $35,000 or more, you'll need a standard 203(k). You must work with an FHA-approved contractor and meet the following minimum qualifications:

• Credit score of 500 (with a 10% down payment)
• Credit score of 580 (with less than a 10% down payment)
• Minimum down payment of 3.5%

VA renovation loan

My husband and I are not eligible for a VA loan, but if you are, take a closer look at the VA renovation loan. Like the Fannie Mae loan and FHA 203(k), a VA renovation loan lets you buy a less-than-perfect property and make it your own. You'll generally need a minimum credit score of 620, but it depends on the lender. The amount financed depends on how much the property is expected to be worth after all repairs and upgrades are completed. A VA-approved contractor will walk you through estimates and quotes, and a VA appraiser will predict the final value. The only fly in the ointment is that you may have to shop VA lenders to find one that offers the renovation loan.

Home equity loan

Due to the extra work involved, the interest rate on a renovation loan is typically 0.5% to 1% higher than a traditional loan. For example, if a traditional 30-year mortgage rate is 3%, you can expect to pay 3.5% to 4% for a renovation loan.

You have a couple of options to manage that extra expense. You can use a renovation loan to renovate your house, then pay the fees required to refinance the mortgage at a lower interest rate. Or, if you put enough down on the house to have equity, you can borrow against that equity to renovate.

Here's an example of how a traditional loan might work:

• Home price: $300,000
• Down payment: 20% ($60,000)
• Traditional mortgage: $240,000
• Interest: 3%
• Repayment term: 30 years
• Equity: $60,000
• Total interest paid: $124,266

Now let's say you’re ready to get a home equity loan. With excellent credit, a lender will loan you up to 85% of that equity. Here’s what that might look like:

• Home equity loan: $51,000 ($60,000 x 0.85 = $51,000)
• Interest: 4.5%
• Repayment term: 10 years
• Total interest paid: $12,427 in interest

That traditional mortgage plus the home equity loan will bring you to $136,693 in interest payments. But let's say you took out a renovation loan instead. Here's how that might break down:

• Home price: $300,000
• Down payment: 20% ($60,000)
• Renovation mortgage: $240,000
• Interest: 4%
• Repayment term: 30 years
• Total interest paid: $172,487

By taking out a traditional mortgage at a lower interest rate and paying the home equity loan off in 10 years, you'd save $35,794 in interest payments (compared to the renovation loan). That's money you can save or invest with a stock broker.

As for my family, we've taken a step back from selling our home. The market is too hot right now. To avoid bidding wars, we've decided to sit it out and let the current rush of home buyers push prices as high as the market will bear. When things cool down (and they will), we'll have several home-buying options in our back pocket, ready to create the new perfect space.