5 Dangers of Rehab Loans

Rehab loans can get you into trouble. It is important to understand the dangers of these loans so that you can avoid the damage that they can cause to your credit and personal finances. Consider these five dangers of rehab loans before you decide to borrow.

Reason #1: Higher Interest Rates

Financial institutions consider rehabilitation loans a higher risk than conventional mortgages. This is due to the fact that rehab loans are based on the projected value of the property after the renovations are complete. It is for this reason that rehabilitation loans have higher interest rates than conventional loans.

Reason #2: Payment Due Upon Sale of Property

If you are flipping a property (buying and fixing up a place for resale), or you plan to sell your home after the upgrades and repairs are made, you may be required to pay the loan in full upon selling the property. If the house sits on the market for a long time, you may be stuck with carrying costs which will reduce your profit on the sale. If you sell the property and it does not cover the projected value, you will have to pay the balance of the rehab loan out of your own pocket.

Reason #3: Unexpected Fees at Closing

It is the borrower's responsibility to cover many of the related costs at closing, including inspections, permits, and appraisals. These fees can sometimes be factored into the total loan amount, but you are still responsible for paying them, either upfront or under repayment terms.

Reason #4: Your Project Could Go Over Budget

While a rehabilitation loan will normally cover costs of repairs and renovations, there may be unexpected expenses that arise during the course of the project. Pest control, electrical problems, plumbing, or rotten flooring are among some of the costly problems that can surface during a renovation. If the loan amount does not cover these unforeseen issues, you will have to pay out of pocket to complete the work. If you have to borrow more money, you are only perpetuating a debt cycle that could be harmful.

Reason #5: The Housing Market Could Drop by the Time Upgrades are Complete

Again, your loan amount will be based on a projected value that is not necessarily guaranteed. Should depreciation occur in the general neighborhood of your project, you may not be able to sell the property for the amount of your loan. You could lose money rather than gain money, as you will still be responsible for settling the full amount of your rehab loan.

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