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New problem when getting a loan to remodel a home

Some homeowners are running into a big problem when the take out a mortgage (or refinance a mortgage) to pay for a remodeling project. The problem occurs if the remodeling is so extensive that the owners temporarily move out while the work is being done.

Generally, lenders give better terms and rates to homebuyers who plan to stay in a home as their primary residence, as opposed to investors who plan to quickly remodel a home and “flip” it to a new owner. Investor loans are riskier, so lenders typically require a larger down payment and a higher interest rate. To qualify for better terms, buyers who plan to stay put often have to prove that they’re actually living in the home – which they can’t do if they’ve moved out during remodeling.

In addition, even some banks that don’t have their own residency requirements are interpreting a new federal law – passed after the recent real estate crash – as requiring proof of residency in certain cases. Since the Consumer Financial Protection Bureau hasn’t yet officially ruled on the issue, some banks feel they have to interpret the law very conservatively in order to avoid getting into trouble during an audit down the road.

If this is a potential problem, here are a few options to consider:

Shop around. A lender might be more flexible if it plans to keep the loan on its own books, instead of reselling it to a government-related entity such as Fannie Mae.

Refinance later. If you’re stuck with an “investor” loan, you can always plan to refinance it once the work is done and you can move back into the property.

Consider other options. The residency rules generally apply only to traditional mortgages, and not to equity lines of credit, bridge loans or reverse mortgages.

Cut a deal. Some lenders will let you temporarily move out as long as you sign an “occupancy affidavit” saying you’ll move back as soon as the work is completed, and you provide proof of residency once you do. This is especially true if you have a health-related reason for moving out, such as exposure to lead paint or asbestos.

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