When You Can Finance Home Improvements with Your Mortgage
Fannie Mae allows you to roll improvement costs into your mortgage in two specific situations. You can finance improvements that will happen after you close on the loan, or you can pay off existing debt from improvements you already completed before applying for the mortgage.
The 15% limit applies to both scenarios. If your home appraises for $400,000 after improvements, you can finance up to $60,000 in improvement costs through your mortgage.
Say you're buying a house for $350,000 that needs a new kitchen and bathroom. You plan to spend $50,000 on these improvements after closing. Your lender will order an appraisal that assumes the work is completed. If that "as completed" appraisal comes in at $420,000, you can finance the full $50,000 since it's under the 15% limit of $63,000.
How the Escrow Process Works for Future Improvements
When you finance improvements that will happen after closing, your lender sets up a completion escrow account. All the improvement money goes into this account on closing day. You can't just get a check for the full amount.
The escrow process protects both you and the lender. You get reimbursed as you complete work and submit receipts. The lender knows the money is actually going toward the improvements that justified the higher loan amount.
You can get reimbursed for materials you purchase, but not for your own labor. If you install the kitchen cabinets yourself, you can get reimbursed for the cost of the cabinets but not for your time installing them.
Required Documentation for Improvement Financing
Your lender needs specific paperwork to approve and track improvement financing. For improvements happening after closing, you'll need detailed contractor estimates and a written scope of work before you close.
After you complete work, you must provide invoices and receipts for everything. Your lender keeps copies of all these documents in your loan file. The appraiser will also inspect the completed work and provide a completion report with photographs.
For improvements you already completed before applying, you need invoices and receipts showing what you spent and when. The appraiser will verify the work was actually done and factor it into the home's current value.
The 180-Day Completion Deadline
You have exactly 180 days from your closing date to finish all improvements. This deadline is firm. If you don't complete the work on time, your lender must report the issue to Fannie Mae's quality control department.
Plan your timeline carefully. Factor in permit approvals, contractor availability, and potential delays. If you're doing major work like a kitchen renovation, 180 days can go by quickly, especially if you run into unexpected issues like electrical or plumbing problems.
Weather can also affect your timeline. If you're planning exterior work and close in November, winter weather might prevent completion within 180 days.
Using Mortgage Proceeds to Pay Off Existing Improvement Debt
The second scenario involves paying off debt from improvements you already completed. Maybe you used a personal loan or credit cards to renovate your kitchen last year. Now you want to refinance and pay off that debt with your new mortgage.
The same 15% limit applies. You can pay off up to 15% of your home's current appraised value in existing improvement debt. Any remaining balance on that debt stays your responsibility and counts toward your debt-to-income ratio.
Your closing statement must show the mortgage proceeds going directly to pay off the existing debt. You can't receive cash that you then use to pay off the debt yourself.
Appraisal Requirements and Challenges
Both scenarios require interior and exterior appraisals. For future improvements, the appraiser must provide an "as completed" value assuming all work is finished. This requires detailed plans and specifications so the appraiser knows exactly what to value.
Getting an accurate "as completed" appraisal can be tricky. The appraiser needs enough detail to estimate the finished value without seeing the actual completed work. Vague contractor estimates won't work. You need specific materials, fixtures, and finishes spelled out.
For existing improvements, the appraiser must verify the work was actually completed and factor it into the current value. This is usually more straightforward since they can see the finished product.
What Counts as Eligible Improvements
Not every home improvement qualifies for this financing. The improvements must add value to the property and be permanently attached. Kitchen and bathroom renovations typically qualify. So do HVAC systems, roofing, flooring, and structural improvements.
Cosmetic improvements like paint and landscaping usually don't qualify. Neither do luxury items like pools or hot tubs in most cases. Your lender will review your improvement plans to determine eligibility before approving the financing.
Common Problems and Gotchas
The biggest risk is not completing work within 180 days. Once you miss that deadline, you're in violation of your loan terms. Plan conservatively and have backup contractors identified.
Cost overruns create another problem. If your $40,000 kitchen renovation ends up costing $55,000, you'll need to cover the extra $15,000 out of pocket. The escrow account only contains the original budgeted amount.
Contractor problems can derail the entire process. If your contractor disappears or does poor work, you still have the 180-day deadline. Always verify contractor licenses, insurance, and references before starting work.
Any leftover money in the escrow account gets applied to your loan balance if you're current on payments. If you're behind on payments, it goes toward bringing your loan current first.
References
For the official guidelines, see 4606.3: Mortgage requirements in the Fannie Mae Selling Guide.
Mortgage guidelines change. Stay current.
Fannie Mae and Freddie Mac update their rules several times a year. Get notified when changes affect your mortgage eligibility, required documents, or loan terms.
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Original Freddie Mac Guideline Text
This section contains requirements related to:
Mortgages used to finance eligible improvements
(a)
Mortgages used to finance eligible improvements
When the Mortgage proceeds are used to finance eligible improvements completed after the Note Date:
Use of proceeds:
The maximum amount of the proceeds that may be used for the purchase, installation, repair or upgrade of eligible improvements is limited to 15% of the “as completed” appraised value of the Mortgaged Premises
Mortgage file documentation:
The Seller/Servicer must obtain and retain in the Mortgage file copies of all invoices and/or receipts, as applicable, related to the cost of the eligible improvements
Completion escrow account:
On the Note Date, funds sufficient to cover the cost of the eligible improvements must be deposited into a completion escrow account. The Seller and the Borrower must execute a written escrow agreement detailing how the funds will be managed and disbursed. A copy of the escrow agreement must be retained in the Mortgage file. A contingency reserve is not required.
Completion escrow account disbursements:
Funds in the completion escrow account may be used to reimburse the Borrower for the cost of materials purchased to complete the eligible improvements. The Seller/Servicer may not reimburse the Borrower for any self-performed labor. After all eligible disbursements have been made, any remaining funds must be applied:
If the Mortgage is delinquent, in accordance with the application of payment requirements in the Note and Security Instrument
If the Mortgage is not delinquent, to reduce the UPB
Appraisal:
The Seller/Servicer must obtain an interior and exterior inspection appraisal with an “as completed” appraised value of the Mortgaged Premises, subject to all eligible improvements being completed. See
Section 5601.4
for additional appraisal requirements.
Completion report:
After completion of all eligible improvements, the Seller/Servicer must have the appraiser:
Inspect the Mortgaged Premises to verify the eligible improvements have been completed, and
Provide the Seller/Servicer with a completion report that includes photographs of the completed improvements. The Seller/Servicer must retain the completion report in the Mortgage file.
Completion deadline:
All eligible improvements must be completed no more than 180 days after the Note Date. If the eligible improvements are not completed by the required completion date, the Seller/Servicer must notify Freddie Mac quality control pursuant to the reporting requirements in
Section 3402.10
.
Energy report:
An energy report meeting the energy report requirements in
Section 4606.4
may be required
(b)
Mortgages used to pay an Existing Debt
When the Mortgage proceeds are used to pay an Existing Debt:
Use of proceeds:
The maximum payment towards an Existing Debt is limited to 15% of the appraised value of the Mortgaged Premises
Remaining Existing Debt:
Any remaining balance of the Existing Debt must be included in the calculation of the monthly debt payment-to-income ratio. If the remaining balance is reamortized, the Seller/Servicer must obtain and retain in the Mortgage file sufficient documentation evidencing the new payment, including a copy of the new promissory note, if applicable.
Settlement/Closing Disclosure Statement requirements:
The Settlement/Closing Disclosure Statement must reflect that the proceeds were paid directly to the holder of the Existing Debt. The total amount of proceeds disbursed to the Borrower at closing must not exceed the maximum amount allowed pursuant to the “no cash-out” refinance Mortgage requirements in
Section 4301.4
.
Mortgage file documentation:
The Mortgage file must include documentation (e.g., invoices, receipts) of the eligible improvements completed before the Note Date and their costs
Appraisal:
An interior and exterior inspection appraisal is required. The appraisal must reflect all eligible improvements that were made. See
Section 5601.4
for additional appraisal requirements.
Sections 4301.4
and
4301.8
for payoff of PACE obligation requirements.
