What Is Sweat Equity in Real Estate?
Sweat equity in real estate refers to the time, physical labor, and, well, sweat you put into improving your home. You can use sweat equity as a way to cover your down payment, save money and build a home you’ll love — while boosting your potential profit when it comes time to sell. Learn more about sweat equity below, including how it works, how to calculate it and the benefits and risks to consider.
How sweat equity works
Sweat equity involves making improvements and repairs to a property yourself instead of paying someone else to do it. If you’re a homebuyer, using sweat equity can help you qualify for a mortgage and reduce renovation expenses. For real estate investors, sweat equity can help you run a house-flipping business.
Let’s take a closer look at how sweat equity works for homebuyers and real estate investors.
How sweat equity works for homebuyers
Homebuyers can invest time and effort instead of cash — here are the steps you’ll need to take:
- Get preapproved. It’s best to get preapproved for a loan program that allows for sweat equity — like an FHA loan or the Freddie Mac Home Possible® loan — before house shopping. Fill out an application and let your loan officer know you plan to use sweat equity as a down payment.
- Find a home. Look for fixer-upper homes advertised “as-is.”
- Negotiate the purchase price and repairs. Count on your real estate agent for help with negotiating a home price. You’ll need to agree on what the house is worth as-is, as well as the value of the repairs. After the repairs, the house will have an “as-completed” price.
- Get an appraisal. A property appraiser will validate the price of the materials and labor that you plan to do, and confirm or adjust the as-completed value.
- Complete the work. There are no specific requirements for this process, but you must complete the work you’ve agreed to in the purchase contract. Save the receipts for any materials you buy.
- Get a confirmation. The appraiser does a final review and verifies the monetary value of the sweat equity that the lender will count as your down payment.
- Close on your mortgage and enjoy your home. Once the loan amount and your sweat equity are finalized, you’ll provide any remaining documentation necessary for the approval and close the loan.
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How sweat equity works for real estate investors
If you plan to flip houses, you may want to grab a pair of construction gloves. Whether you’re one of the buyers or just asking for a share of the proceeds as a reward for your labor, your hard work could pay off. Here are the steps:
- Be realistic about the work you can complete. This way you can help identify the best real estate purchase option. Look for properties advertised as-is. It’s important to create a sweat equity agreement — a contract that outlines the work you plan to do and what your payment will be — so there are no misunderstandings down the road.
- Purchase the property and make a plan. Treat your sweat equity like you would treat your money — where does it make sense to “spend” the most time and energy? Would redoing the kitchen bring the most value compared to the effort you spend on it? Or is improving another part of the house a better option?
- Complete the repairs. After the investment property is in your hands, it’s time to get to work. Remember to strike a balance between getting things done and pacing yourself so you don’t burn out before reaching the finish line.
- Consider getting a home appraisal. While the homebuyer will need to have a separate home appraisal, getting one yourself can solidify the home’s value, a reasonable purchase price and how much profit you could make from the sale.
- List and sell the home. Once you complete the repairs, you can put the home on the market. Review these tips for selling your home.
How to calculate sweat equity
To calculate the sweat equity in your home, you’ll generally need the following information:
→ Your home’s purchase price. To determine your sweat equity, you’ll need to know the original amount you paid for your home. You can find this information on your home closing documents or by checking property records.
→ Your home’s market value. The next thing you’ll need is your home’s current market value. You can get an estimate of your home’s value using an online real estate marketplace.
→ Cost of the materials. You’ll want to factor in the amount you spend on materials, additional labor and other expenses for completing your renovation project.
Once you have all of these details, you can calculate your sweat equity by subtracting the original purchase price from the current market value, and then deducting the costs of materials.
Benefits and risks of using sweat equity in real estate
Benefits of using sweat equity
You can save money buying a fixer-upper. Properties in need of repairs are typically less expensive than move-in-ready homes.
You can have an emotional payoff. It can be fulfilling to live in a space that you put effort into designing and changing for you and your family’s needs.
You can financially benefit. By doing the repair work yourself, you can save money on labor and increase your home’s value, leading to a higher profit when you sell.
More income from tenants or guests. If you’re renting out units in a multifamily property or hosting guests through Airbnb, you may be able to charge more once the upgrades are complete.
Risks of using sweat equity
Quality of life during construction. Living in the home while construction is ongoing may affect your family’s quality of life.
Mistakes can cost you. If you damage your home during a DIY project, your homeowners insurance may not cover the repairs, while professionals are typically licensed and insured.
Results may look unprofessional. DIY work often lacks the polish of professional craftsmanship. Subpar results could reduce your home’s value and potentially lead to costly repairs or replacements if you need to hire someone to fix your work.
Time and financial investment. Not everyone has the skills or tools to do landscaping, cabinetry, woodworking, masonry and other repair work. You may need to spend time studying and practicing. Additionally, you may need to purchase safety equipment and buy or rent tools for the job.
Programs that allow sweat equity as your down payment
Here’s an overview of three different programs that allow you to use sweat equity for your down payment.
FHA loan
The FHA 203(k) program allows you to include renovation costs in your home loan. It provides more lenient eligibility requirements, including a lower minimum credit score, when compared to conventional first-time homebuyer programs that allow for sweat equity.
Here are the details:
→ You could be approved with a credit score as low as 500 — provided you can make at least a 10% down payment.
→ You only need a 3.5% down payment if you have a 580 credit score or higher.
→ You can have a debt-to-income (DTI) ratio as high as 43%, though exceptions are possible if your DTI is higher.
Freddie Mac Home Possible® loan
The Freddie Mac Home Possible® program allows borrowers to use sweat equity to cover their down payment and closing costs. The program doesn’t limit the amount of sweat equity you can apply to your down payment and closing costs, as long as it’s recorded in the purchase contract and appraisal. You can use the Home Possible® income and property eligibility tool to find out if you qualify for a mortgage based on your income and the location of the home you’re interested in.
Habitat for Humanity
Habitat for Humanity works in communities across the U.S. and requires housing applicants to contribute sweat equity. To qualify, your household income can’t exceed 60% of your area median income, and a loan committee will evaluate your finances to ensure you can afford the monthly mortgage payment. Find out if this program is available where you live.
Frequently asked questions
Whether sweat equity is a good idea depends on your specific situation and goals. If you have the time and skills to handle renovations yourself, sweat equity can be a great way to increase your home’s value and save on labor costs. On the other hand, if you’re short on cash and time, you may want to consider other ways to fund home improvements, including a cash-out refinance.
The amount you invest in sweat equity can be added to your home’s cost basis, which may reduce your capital gains taxes when you sell the home. Capital improvements, including renovations that boost your home’s value or prolong its use, can help reduce your tax liability.
Thinking about renovating your home? Learn more about tax-deductible home improvements.
As a real estate investor, it’s important to have a written agreement that details the sweat equity you’re contributing to a deal and what you’ll get in return. One common approach is to structure the agreement so that the person providing the sweat equity receives a proportional ownership stake in the property based on its value after the renovations are completed.