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How to Use ‘Sweat Equity’ to Get a Mortgage With No Down Payment

Having solid handyman skills can save you money on regular home maintenance, and when it comes to buying a home, your construction competence could be as good as money in the bank. That’s because of something called “sweat equity,” and the concept is simple: If you have the expertise to improve the condition of a home in need of work, your “sweat” — in the form of the labor and cost of materials it takes to make those improvements — can act as a down payment toward the purchase of the property.

How sweat equity works versus a regular down payment

Normally, you must have the cash for a down payment, find someone willing to give you the money as a gift or find some sort of down payment assistance from a local government housing agency or private nonprofit.

With sweat equity, the down payment comes from the value of the labor and cost of the materials needed to make improvements to the home you’re buying, rather than from any actual asset account.

Let’s say you decide to buy a $100,000 house that needs about $3,000 worth of work done. You can get a great deal on all of the materials, and the bulk of your contribution will be the skilled labor it takes to get all of the improvements done.

If you can document that the cost of the labor for your skills plus the materials is $3,000, you can use that as your down payment to purchase the home.

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The process for a sweat equity down payment

It’s important to understand the steps you need to take if you want to use sweat equity as a down payment. You’ll need to work with a seller who agrees to include in the contract the repairs and improvements you will be doing.

  • Step 1: Get preapproved for a sweat equity-friendly loan program: Fill out a loan application and let your loan officer know you plan to use sweat equity as a down payment. Your credit report will be checked, and based on your income and debt, you’ll have an idea of how much you qualify for.
  • Step 2: Find a house listed with an “as-is” value: The term ‘as-is’ usually indicates that the seller knows the property is being priced based on needed repairs or deferred maintenance. The seller either doesn’t want to make the improvements, or doesn’t have the funds to fix up the property, and prices the home accordingly.
  • Step 3: Let the seller know you are interested in buying the property: It’s best to make sure you qualify for a loan program that allows for sweat equity, such as an FHA loan or the Freddie Home Possible® loan before you make an offer.
  • Step 4: Negotiate the price before and after the repairs: Once you agree on an as-is price with the seller, you finalize the repairs and improvements that you want to make using your sweat equity. After you’ve agreed on the cost and type of repairs to be done, you’ll add the costs to the price to calculate an “as-completed” price with the work you are going to complete.
  • Step 5: An appraisal is ordered: You’ll provide a contract referencing all of the agreed items in Step 3 to an appraiser. The appraiser will validate the price of each item that is going to be done, and confirm what the as-completed value will be.
  • Step 6: You put your sweat equity into the repairs and get them done: Now that you have the value confirmed, you need to do the work agreed to on the contract. There are no specific requirements for you to do the work — the appraiser just has to be able to confirm the work was done in a workman-like manner.
  • Step 7: The appraiser does a final inspection and verifies the monetary value of the sweat equity: The actual dollar value of the sweat equity will be determined by the appraiser, a cost estimating service or with receipts for the purchase of the materials.
  • Step 8: The final loan amount is determined: Once the value of the improvements has been determined, the appraiser will complete the as-completed value and finish the appraisal. The lender will use the lesser of the as-completed value or the as-is price plus the cost of improvements to determine how much sweat equity is credited toward your down payment.
  • Step 9: The loan approval is completed and you close: Once the loan amount has been finalized, you’ll provide any remaining documentation needed for the approval and close the loan.

Programs that allow sweat equity as the whole down payment

There are a number of programs that allow you to use sweat equity for a down payment. Each has different flexibilities and restrictions as far as income, credit and the type of property you are buying.

Here is a brief overview of the three programs that allow sweat equity to account for all of your down payment from sweat equity.

FHA mortgage

This program is most frequently chosen by first-time homebuyers. It provides more flexibility for credit and income histories when compared with conventional first-time homebuyer programs.

The minimum down payment requirement of 3.5% can be made with properly documented sweat equity. This is a good program if you have poor credit since it allows for scores as low as 580.

It permits more debt compared to your income than the conventional loan programs that allow for sweat equity. The mortgage insurance is the same regardless of your credit score; if you have a low credit score, your monthly payment will be lower than on a comparable conventional loan. There is no maximum income requirement, but FHA maximum loan amounts will vary based on where you live.

Freddie Mac Home Possible®

At the end of 2018, the guidelines on this conventional loan program were changed to allow for sweat equity for the entire down payment. A Home Possible® mortgage requires as little as a 3% down payment. Borrowers with good credit could qualify for a lower monthly payment with Home Possible® than they would with an FHA loan, because with conventional loans, the mortgage insurance premium is based on your credit score. Borrowers without credit scores may be eligible to borrow using an alternative credit history.  Since mortgage insurance companies will not insure a conventional loan below a 620 score, most lenders are using 620 as their minimum credit score.

While the minimum 3% down payment gives Home Possible® an edge over the FHA program, it’s not available to all. If you buy a manufactured home, you’ll need 5% sweat equity for the down payment.

There is no maximum loan limit, but there may be income maximums based on the median incomes where you are buying. You can use the Home Possible® income and property eligibility tool to find out the income limits for a specific property you’re interested in.

Habitat for Humanity

A global nonprofit housing organization, Habitat for Humanity works in communities across all 50 states in the U.S. to promote affordable housing. You are not only encouraged to contribute sweat equity but also required to participate in the building process.  Each state has its own process for receiving applications and uses a committee approval process to select Habitat homeowners.

It doesn’t matter if you have construction or handyman experience. Most of the construction labor is donated, and Habitat gets materials with no mark up, making them very affordable for the families selected.

There are no set income, debt or credit requirements, although a loan committee will review your income and debt to make sure you can afford the payment. The interest charges are very low, so the monthly payments are much lower than the FHA or Freddie Home Possible® mortgage programs. To find out if this program is available where you live, click here.

Here is a side-by-side comparison of the FHA, Home Possible® and Habitat for Humanity down payment requirements, income limits, debt-to-income ratios and allowable property types.

FHA vs Home Possible® vs Habitat for Humanity
Program Minimum down payment Income limit Loan amount limit DTI maximum Property types
FHA 3.5% No income limit FHA loan limits apply 43%, with exceptions possible over 50% Single-family residence, condo, manufactured home, multi-unit
Freddie Mac Home Possible® 3% (5% if buying manufactured home) None in low income census tract; otherwise area median income. Varies 45—50% max SFR, condo, manufactured, multiunit
Habitat for Humanity Depends on program in area where you live. Based on financial need determined by selection committee Based on financial need determined by selection committee Loan selection committee determines Usually single-family homes

Other programs that offer a sweat equity option

Fannie Mae’s HomeReady® program allows for sweat equity, but the down payment requirement is 5%, and only 2% of that can be from sweat equity. You’ll have to come up with the other 3% from your own funds.

The USDA also offers grants to nonprofits to help them build houses for families in areas across the country. Mutual self-help housing tech assistance grants provide funding to government nonprofits, federally recognized tribes and private nonprofit organizations to help low-income families construct their own homes in rural areas.

Risks to going the sweat equity route

The appraisal carries the most weight when it comes to determining the market value of your labor. There are two calculations the lender will be looking at that to determine how much sweat equity is counted toward your down payment: the price of the house plus the estimated repairs, and the after-improved value.

The price plus repair costs you provided represent the minimum as-is value. The as-completed value estimates the value of the house with the improvements done. If for some reason the as-completed value is lower than your estimated repair costs plus the sales price, you may end up having to come up with the difference in cash.

Make sweat equity work for you

You need to do your homework on what is reasonable and customary in your area for the repairs you’ll be doing; lenders that offer sweat equity as a down payment option don’t provide guidance about the types of repairs that are acceptable. Getting bids from local home improvement companies to see what they would charge might help at give an idea of whether your estimate is in the ballpark.

 

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