Buying and Improving a Home: Lender Requirements

There are several steps your lender may take to help you with your home improvement investment. During the contractor review, your lender may review the construction contract and help you to make sure your contractor is licensed and bonded, and meets any applicable certification standards. In addition, your lender likely will require an appraisal of the property to determine its current value and to estimate the value of the property after the renovation work is completed. This value is referred to as the post-renovation value. Most lenders will also require that you set aside 10 to 15 percent of the renovation costs as a contingency reserve fund, which can be used to cover cost overruns and unexpected project changes that may occur. Change orders are a common occurrence during renovations, sometimes necessitated by unexpected problems that are encountered as work is done on the property. These problems may lead to design or structural changes that increase the cost of the project. Your lender may want to approve any change orders before the contractor proceeds with the modification. In the event you change the original scope of work, your lender may require that you deposit additional funds to pay for the changes. At the closing, you will sign customary mortgage documents, as well as a separate renovation loan agreement, which spells out how the loan proceeds will be used and provides details about how and when the contractor will be paid. The funds you borrow to finance your home improvements, plus the contingency reserve, will be placed in an escrow account after closing. As construction progresses, payments will be made to the contractor from the escrow account in accordance with your construction contract and renovation loan agreement. While stringent lender oversight can be valuable in a renovation project, it does not replace your active involvement in the process. You typically have daily interaction with the contractor and should continually check to ensure the project is proceeding as planned. As issues arise, you may want to consult with your lender to determine how best to proceed. For information and educational purposes only.