The US housing stock is aging rapidly, suggesting more homes will need major renovations in the years ahead. But for homeowners, accessing the financing they need to renovate is difficult and expensive. And renovation loans have high denial rates.
The Neighborhood Homes Investment Act, reintroduced in the House of Representatives in April, could help provide rehabilitation financing for underresourced areas. But this would not solve the whole problem. Policymakers must also improve the federally backed financing options the Federal Housing Administration (FHA), Fannie Mae, and Freddie Mac offer.
These programs have misaligned incentives. Borrowers are required to source their own construction contractors, even though they lack expertise in what renovations are cost-effective. These financing programs are also cumbersome for lenders. For Fannie Mae and Freddie Mac programs, lenders are on the hook if construction is done poorly or is not completed. As a result, many lenders do not want to make these loans, and households cannot access the capital they need for renovations.
A fundamental redesign of existing programs, such as shifting some of the risk of renovation loans to the contractor, could increase access to renovation financing amid a national housing shortage.
A lack of financing options for renovations can hurt both first-time homebuyers and those looking to selling their home
Limited access to home renovation financing has several adverse consequences for individuals and the housing market overall.
First-time homebuyers can’t buy homes that need repairs if it’s too difficult to finance those repairs. Without that financing, individuals often can't compete with investors to buy fixer-uppers because investors can pay in cash and are sure to close.
In addition to hurting the finances of first-time homebuyers, the lack of financing options also affects existing homeowners in aging properties who are looking to move. They might end up selling their home below market value, depending on the strength of the investor bid. Second, the lack of financing options means less affluent homeowners are less able to do renovations, even though the homes they buy are more likely to require them.
If more renovation financing were available, the total housing stock would likely be refreshed more frequently, allowing communities to better maintain their existing housing stock. This is especially crucial, given the nation’s acute housing shortage.
Though the US housing stock is aging, the volume of renovation loans is falling
In 2023, the median single-family home was built in 1980 and was 43 years old. By comparison, in 2005, the median home was built in 1972 and was 33 years old.
As the housing stock has aged, one would assume renovation loans would become a bigger share of all home loans. In reality, the volume of renovation loans has fallen, likely because of how expensive, cumbersome, and risky it is for lenders to make these loans.
The FHA’s renovation loan share has fallen recently, but it’s always been low, hovering between 0.5 and 3.1 percent of total purchase and renovation loans.
By comparison, Fannie Mae and Freddie Mac renovation loans have fallen significantly after hovering between 4 and 10 percent from 2005 to 2017.
In 2023, fewer than 1 percent of Fannie Mae first-lien originations were renovation loans. In 2016, 6.4 percent were attributed to renovations. We see a similar trend with Freddie Mac renovation loans. In 2023, just 0.8 percent of its first-lien originations were renovation loans. In 2016, nearly 7 percent of originations were renovation loans.
Not only is the volume of renovation loans low, but the denial rate is very high. Renovations loans have a 43 percent denial rate, versus 10.6 percent on purchase loans.
Current renovation loan options are difficult to access and often don’t cover the full cost of repairs
If a homeowner has substantial equity in their home and wants to do a renovation, they can finance it through a second lien, a home equity line of credit, or a cash-out refinance. These options generally require a loan-to-value ratio of 80 percent or less, based on the home’s value before renovations.
But if a homeowner wants renovation financing based on the home’s market value after it has been repaired, financing is more difficult to secure.
One financing option is the FHA’s 203(k) renovation program, which offers two types of financing:
- a limited option, which does not permit structural repairs, is subject to a low maximum repair cost, and does not require a US Department of Housing and Urban Development (HUD) consultant
- a standard option, which permits structural repairs and requires a HUD consultant
Recent changes to the 203(k) program that went into effect in November 2024 could help more homebuyers access renovation financing, but it’s too soon to tell. In particular, the FHA increased the loan amount for the limited program from $35,000 to $75,000 and indexed it to inflation. For the standard program, the FHA increased the compensation for consultants and increased both the time limits for completing the work and how long the borrower could be out of their home.
Other financing options include Fannie Mae’s HomeStyle Renovation and Freddie Mac’s CHOICERenovation. Though these programs do not require a consultant, they do require the originator to bear the risk until the renovation is completed.
Freddie Mac’s CHOICEReno eXPress program does not have recourse to the lenders, but the renovation amount is limited to 10 percent of the property’s value (or 15 percent in high-need areas). This amount is likely insufficient for most renovations, as illustrated by the fact that Freddie Mac’s renovation share is very similar to Fannie Mae’s.
The easiest fix for the government-sponsored enterprise (GSE) programs would be to raise the limit on Freddie Mac’s CHOICEReno eXPress and have Fannie Mae adopt a similar program. Though this would marginally raise the risk to the enterprises, Fannie Mae and Freddie Mac can develop renovation financing expertise more easily than their lenders can.
Realigning incentives and streamlining the financing process could make renovation loans easier to access
But fundamental issues would remain in renovation financing, which require shifting some risk to construction contractors. Currently, borrowers must design their project and find a contractor, though they often have no idea which projects are cost-effective. Lenders are also not construction experts but, in the GSE lending programs, take on the risk of poor construction under the current financing structure. Correcting this misalignment could increase the availability of renovation loans.
In the case of the FHA’s 203(k) program, administering the loan is cumbersome for the lender. Before submitting the loan application, the lender must find a HUD-approved consultant to check the feasibility and cost estimates the contractor provided, have a project plan and disbursement schedule, and schedule an appraisal based on the property’s market value after repair. After the loan is made, the lender must also ensure the HUD consultant does inspections before each disbursement.
For GSE renovation loans, the borrower must find the contractor to make the repair, while the lender is responsible for ensuring the project is delivered on time and to specification, and any deviations must be explained. During the construction phase, the GSEs have recourse to the lender, meaning the lender assumes the risk if the work is done poorly or is not completed.
To shift more of the risk to the construction professionals, the GSEs and the FHA could contract with a short list of preferred vendors. These vendors could scope out the work and give borrowers a fixed price. The borrower could then go to the lender with the preferred vendor’s estimates to get financing. In this system, the vendor would ensure the work is done to specification.
Though this would be a major change, the GSEs are in a better position to make it than the FHA. They already have a list of preferred vendors for their real-estate-owned properties, who would gain business by participating.
Given the aging US housing stock, it is critical that the GSEs and the FHA improve renovation financing. Amid a housing shortage, we are losing an opportunity to preserve and enhance the existing housing stock. Failure to improve renovation financing programs could lead more homes to become unlivable, further reducing the already limited housing supply.
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