Should you invest in a fixer-upper?

Key takeaways

• A fixer-upper can be a practical path to homeownership on a tight budget, but only with a realistic plan.
• Most lenders will not finance a fixer-upper with a standard mortgage, but several loan programs let you roll the purchase price and renovation costs into a single loan.
• Look at comparable home sales in the area to estimate what the home would be worth after renovations, then add up the purchase price and projected repair costs. If the total exceeds what similar homes are selling for, the deal may not be worth the risk. 

Buying a home on a tight budget often means considering a fixer-upper. These homes are priced below market because they need significant work, and for the right buyer, they can be a practical path to homeownership. But a fixer-upper is not a bargain if you go in unprepared. Understanding the costs, the financing options and the risks before you make an offer is what separates a smart investment from a money pit.

A fixer-upper is a home priced below comparable properties because it needs substantial repairs or renovations. Some fixer-uppers are livable during the renovation process. Others are not, depending on the scope of work. Before committing, you need a clear picture of your budget, your tolerance for disruption and the gap between what the home is now and what it would cost to make it what you want.

Be realistic. A fixer-upper will require more time, money and patience than a move-in-ready home. You may discover problems after closing that were not visible during the initial walkthrough. Your daily life will be disrupted, whether you live in the home during renovations or manage the project from elsewhere.

If you plan to live in the home while work is underway, consider whether you can function without a fully operational kitchen or bathroom. If that is not realistic for your household, you can phase the renovations over time to reduce the disruption.

Get a home inspection. A professional inspection is not optional. It tells you what repairs the home needs and gives you a rough sense of what they will cost. Ideally, get the inspection done before you close so you can make an informed decision about whether the home is worth the investment or whether the renovation costs would exceed what you can afford.

Create a budget. Once you have the inspection results, build a detailed renovation budget. Know what you have to spend and build in a cushion for unexpected costs. Something will come up during the renovation that you did not plan for. That is not a possibility. It is a near certainty.

Most lenders will not finance a fixer-upper with a standard mortgage. Several loan programs, however, allow you to roll the purchase price and renovation costs into a single mortgage. Here are the most common options:

• FHA 203(k). Backed by the Federal Housing Administration, this loan lets buyers purchase a home and finance renovations with one mortgage. It is also available to existing homeowners who want to refinance and add renovation costs to the new loan.
• Fannie Mae HomeStyle. A conventional mortgage that covers the purchase and renovation of a home or allows existing homeowners to refinance and fund improvements. A certified contractor must submit a cost estimate with a detailed scope of work, and renovation funds are held in a separate escrow account to pay contractors directly.
• Freddie Mac CHOICERenovation. Another conventional mortgage option that rolls renovation costs into a single loan. It can also be used to repair a home damaged by a natural disaster.
• VA renovation loan. Available to eligible military borrowers and their spouses, this loan is guaranteed by the U.S. Department of Veterans Affairs. It combines the purchase price and repair costs into one loan. Borrowers must use a VA-approved contractor.

Not all renovations carry the same weight. Focus your budget on the work that affects safety and livability first:

• Plumbing repairs or replacement
• Electrical work
• Roof, gutters and downspouts

These are the systems that keep a home safe and functional. If any of them are failing, they should be addressed before anything else.

• Paint
• Countertops
• Other cosmetic updates

If everything is structurally sound and the home's major systems are working, cosmetic improvements can be spread out over time.

A fixer-upper becomes a bad deal when the cost of repairs outweighs the savings on the purchase price. After your inspection, think carefully before buying a home with any of the following:

• Structural damage
• Foundation problems
• Old or deteriorating plumbing
• Outdated electrical systems

Repairing these issues can be extremely expensive and may affect your family's safety in the home.

Many renovations require permits, and the requirements vary by location. Common projects that typically require a permit include:

• Structural work
• Room additions
• Fences
• Plumbing and electrical work
• Window installations

Check with your local building department before starting work. Skipping permits can result in fines, and unpermitted work can create problems when you eventually sell the home.

Before you buy, do the math. Look at comparable home sales in the area to understand what the home would be worth after renovations. Then add up the estimated cost of all the work it needs. If the purchase price plus renovation costs is significantly less than the home's projected after-renovation value, it is likely a sound investment. If the numbers are close, or if the renovation costs push the total above what comparable homes are selling for, it may not be worth the risk.

More on this topic:

• Top home improvements that add value
• Homeowners should remodel this, replace that for the best return on investment, study says
• Simple steps that will increase the value of your home