How to evaluate rehab loans: a practical, step-by-step guide

Rehab loans let investors buy and renovate properties without paying all cash. But the wrong loan can erase expected profits through high fees, long timelines, or restrictive rules. This guide shows how to compare rehabs loans, run the numbers correctly, and pick financing that supports a profitable flip.

Common rehab loan types (and when each fits)

  • FHA 203(k): Government-backed for owner-occupants who need to finance repairs and purchase together. Useful for owner-occupant investors and some partner strategies; strict contractor and scope rules apply (HUD 203(k) program details: https://www.hud.gov/program_offices/housing/sfh/203k).

  • Fannie Mae HomeStyle Renovation: A traditional mortgage that adds renovation funds, often with broader eligible repairs than 203(k). It can be used for some investment scenarios but has stricter credit and documentation requirements (see Fannie Mae/HomeStyle guidance at FHFA and Fannie Mae resources).

  • Conventional loans with renovation add-ons: Offered by some banks and credit unions for borrowers with strong credit. They can be lower-cost than specialized products but require qualified appraisals and underwriting.

  • Hard money loans: Short-term, asset-based loans focused on the property’s after-repair value (ARV). They’re fast and flexible but carry higher rates and fees—good when speed matters. See our primer on hard money loans and use cases for more on when to pick short-term private lending: “Hard Money Loan” and “Hard Money Short-Term Loans: Use Cases for Real Estate Investors.” (internal links below)

  • Portfolio or private lender rehab loans: Local banks or private lenders that keep loans on their balance sheet. Terms vary; some offer interest-only draws tied to completed work inspections.

Key metrics to compare (definitions and why they matter)

  • ARV (After-Repair Value): Your best estimate of the property’s resale price after renovations. ARV drives many lender limits and is central to profit calculations.

  • Loan-to-Value (LTV) and Loan-to-Cost (LTC): LTV compares the loan amount to ARV or current value; LTC compares the loan to acquisition + renovation costs. Hard-money lenders often use LT C, while traditional lenders use LTV.

  • Maximum Advance on Renovation Draws: Some lenders release renovation funds in phases after inspections. Confirm whether the lender pays contractors directly or disburses funds to you.

  • Interest Rate, Points, and Fees: Compare all financing costs: interest, origination points, underwriting fees, and draw inspection fees. These can add up to 2–5% (or more) of project costs for specialty lending.

  • Term and Prepayment Terms: Flips are short-term; prepayment penalties or long loan terms can pinch returns. Look at payoff fees and balloon payments. (See our guide on interpreting prepayment clauses.)

  • Closing/Holding Costs: Include closing costs, property taxes, insurance, utilities, and carrying costs during renovation.

  • Time-to-Close and Draw Schedule: Faster closing and frequent draw inspections reduce holding time and interest accrual.

Quick evaluation checklist (apply to each loan option)

  1. Does the lender finance to your ARV or to purchase plus rehab costs (LTC)?
  2. What is the maximum advance on rehab draws and when are inspections required?
  3. Total all-in cost: interest for expected hold time + fees + points + inspection charges.
  4. Does the loan require owner-occupancy or limit investor flips?
  5. Are there hard budget caps or mandatory contractor lists?
  6. What are prepayment terms or exit loan requirements?
  7. How long is the approval and disbursement timeline?

Calculating profitability: simple formula and example

Core flip profit starts with:

Profit = ARV – (Purchase Price + Renovation Costs + Financing Costs + Closing Costs + Selling Costs + Contingency)

Financing costs example (simplified):

  • Purchase price: $150,000
  • Renovation budget: $50,000
  • ARV: $300,000
  • Holding time: 6 months
  • Hard money loan: 10% annual interest, 2 points origination (2% of loan), and 1% inspection/fees

Loan amount (example hard-money LTC): lender funds 70% of purchase + rehab = 0.7*(150k+50k)= $140,000

Interest for 6 months = 10% * 140,000 * 0.5 = $7,000

Points = 2% * 140,000 = $2,800

Inspection/fees (1%) = $1,400

Total financing costs ≈ $11,200

Now include selling costs (6% agent fees typical), title/closing costs (~2%), property taxes/insurance/holding ~ $3,000, and 10% contingency on repairs ($5,000).

Profit = 300,000 – (150,000 + 50,000 + 11,200 + 4,800 + 3,000 + 5,000)
Profit = 300,000 – 224,000 = $76,000

This simplified model shows how financing costs materially affect profit. Replace line items with your local numbers and always stress-test the timeline and ARV.

Loan-specific considerations

Due diligence and lender selection tips

  • Ask for sample loan packages and a clear draw schedule.
  • Verify the lender’s experience with flips and request past client examples or references.
  • Confirm whether the lender requires licensed contractors, permits, or specific inspection companies.
  • Compare the effective annual cost of each loan (not just the headline rate): include points, fees, and inspection expenses.
  • When speed is required, hard money or local portfolio lenders can close faster than government-backed loans.

Risk controls and exit strategies

  • Build a minimum 5–10% contingency into renovation budgets; many pros use 10–15% for older homes.
  • Have a backup exit: refinance to a longer-term mortgage (hold-to-rent) or extend the rehab timeline if the market softens.
  • Track schedule weekly and tie draws to completed, inspected milestones to avoid downstream delays.

Common mistakes to avoid

  • Using ARV that’s too optimistic — get two independent comps.
  • Ignoring holding costs — long renovations eat profit through interest and taxes.
  • Over-improving for the neighborhood — not every upgrade yields ROI.
  • Choosing the cheapest lender by rate alone without checking timelines or draw procedures.

Professional takeaways

In my experience working with investors, the best-financed flips start with conservative ARV assumptions, tight renovation scopes, and a lender whose timelines match the project pace. Hard money is invaluable for speed and flexibility, but without tight cost controls it can turn a profitable flip into a marginal deal. For projects where owner-occupancy is possible and interest rates matter, FHA 203(k) or a HomeStyle approach may make sense—but expect slower underwriting and more documentation (HUD; Fannie Mae guidance).

Resources and authoritative references

Professional disclaimer

This article is educational and not individualized financial advice. Loan products and underwriting rules change frequently; consult a licensed mortgage professional and a real estate attorney to confirm program eligibility, costs, and legal terms for your specific project.

For calculators and downloadable checklists that walk you step-by-step through ARV, LTC, and profit math, see the related guides on FinHelp’s resources section.