What is sweat equity?
Home improvement projects are a great way to touch up your property’s imperfections and turn a fixer-upper into your bona fide dream home. That’s important to keep in mind if you’re trying to buy a house in a competitive real estate market.
You could even say that home renovations are a win-win for homeowners because they also increase the market value of your property. And in some cases, you might even be able to use your “sweat equity” in place of a down payment. Embrace the DIY spirit and start making your home your own through sweat equity.
What is sweat equity and how does it work?
If you’ve spent any time in the world of startup companies, you may have heard the term “sweat equity” used to describe uncompensated work that employees put into the organization. But when it comes to real estate, sweat equity has a very distinct purpose.
What is sweat equity?
Sweat equity refers to home renovations and repairs that you make as the borrower, which can then be used as an acceptable source of down payment in certain, limited circumstances.
In essence, when you use a sweat equity mortgage, the lender agrees to accept the investment you’ve put into renovating the home — materials, labor, etc. — as a form of down payment. As such, it can be a great way for homebuyers on a budget to purchase a fixer-upper and turn it into a dream home. First-time homebuyers — especially anyone with capable handyman skills — may find sweat equity mortgages particularly appealing.
Who qualifies for sweat equity mortgages?
A crucial aspect of sweat equity — no matter what context you’re using — is that it involves unpaid labor. And in this case, that means you. That’s right, you do the work yourself, not a contractor or some other professional laborer.
That doesn’t mean you can cut corners or do half-hearted work, though. In fact, lenders that offer a sweat equity mortgage will typically require you to have some discernible construction skills before agreeing to this kind of arrangement.
In many cases, sweat equity programs will also insist that any home improvement projects must be completed before your closing date to be eligible as an acceptable source of down payment. Whether you have 30 days or 60 days to close, that’s a pretty tight window to fit renovations into, especially for a one-man construction team.
Lenders also need to have the quality and value of your work validated by a knowledgeable third party. In this case, that means an appraiser. Freddie Mac’s Home Possible® program, for instance, requires all sweat equity-eligible renovations to be certified by an independent appraiser.
What are the benefits of sweat equity?
If sweat equity sounds like a lot of work to take on, then you’re absolutely right. That’s why it’s called “sweat” equity. You need to pay for the cost of materials and handle all of the renovations yourself. But, if you have the handyman skills and inclination to take on such home improvement projects, you may find plenty to like with sweat equity:
- Cover your down payment
- Increase your home equity
- Renovate on a budget
- Expand your house-hunting options
Cover your down payment
If your lender agrees to accept sweat equity in lieu of a cash down payment, then you’ll have a lot more financial flexibility when you close on a house. You could put that money toward additional renovations to your home, apply it to your monthly mortgage payments or simply save it for a rainy day.
Increase your home equity
As we’ve discussed elsewhere, every mortgage payment you make boosts your stake of equity in your home. The potential equity you can gain is capped by the market value of the property, which means that as your home’s appraised value goes up, you can tap into more equity.
Home equity loans and home equity lines of credit (HELOC) are some of the most useful financial tools at your disposal as a homeowner. You can trade off of the equity you’ve put into your house to pay for just about anything.
Sending your kids to college? A HELOC mortgage could cover tuition. Thinking about finally tying the knot? Home equity loans can help with wedding expenses. With that in mind, maximizing your equity is a shrewd financial move for any homeowner. The improvements you make to your home through sweat equity could increase its market value, which may mean more equity possibilities for you to consider.
Renovate on a budget
Home renovations can get pretty pricey, but if you have the tools, skills and drive, you may be able to take on those projects yourself without paying for a professional contractor or handyman. That’s great news for crash-strapped homeowners who want to refresh the old homestead.
The scale of these home improvement jobs will largely depend on your knowhow and comfort level. Smaller projects like painting rooms, staining decks or even replacing doors are all perfectly viable for dedicated DIY-ers. More complex issues like roofing and electrical work, on the other hand, should be left to the professionals. Just keep in mind that the more renovation work you put in, the less you’ll need to pony up for your down payment.
If you don’t have the funds on hand to take on these projects, you may want to consider a home improvement loan. There are plenty of options to choose from to help you get renovations underway.
Expand your house-hunting options
Trying to buy a house in a red-hot real estate market can feel pretty discouraging at times, especially if you’ve hit your budget’s limit and still can’t find anything. Move-in ready homes may not be totally practical in those situations. While you could look at other areas where the competition is a little less fierce, you have another option: consider a fixer-upper.
Houses that need a little TLC, but are still perfectly habitable, are far more affordable than anything you’ll find that has updated kitchens, open concept designs, spa-quality bathtubs and any other in-demand amenities. Now, some home improvement projects will require a full team of workers, but you’d be surprised what you can get done yourself with a little knowhow and elbow grease.
How much is sweat equity worth?
The value of sweat equity really depends on the scale of your home improvement project — and by extension, the amount of time and money you put into it. A fully renovated kitchen, for instance, will cost you a lot more in materials and labor than a new faucet.
Even so, every little bit helps. Patching damaged drywall, staining your deck and replacing finicky doorknobs all add value to your home. The best part? Since you’re doing all the work yourself, you don’t have to pay the cost of labor. It’s the other way around, in fact. You can factor your time and labor into your sweat equity, lowering your down payment or possibly even replacing it entirely. And that will really help you boost the return on these investments.
First and foremost, though, home renovations should focus on maximizing your home’s potential and making it a space you can call your own. You can’t put a price on that. Unless you’re planning to sell your house someday soon, the cash value of home improvement projects should be a secondary concern at the end of the day.
How to apply for a sweat equity mortgage
Your first order of business should be to find a lender that offers sweat equity loans. Most mortgage lenders will not accept sweat equity for traditional home loans. Others may permit sweat equity when used with very specific loan types — FHA loans, for example.
In many cases, you’ll need to go through a dedicated program, like Freddie Mac’s Home Possible®. That means you’ll need to work with an FHLMC-approved lender to take advantage of that particular program. Bottom line: Don’t be surprised if you find that your sweat equity options are pretty limited.
When it comes time to apply for your mortgage, be sure to let your lender know that you want to use sweat equity in place of some or all of the down payment. Your loan officer will help coordinate an appraisal to review the current condition and market value of the home, as well as the estimated cost and return on your planned repairs.
Build sweat equity with these home renovations
Home improvement projects can be pretty daunting at times, no matter what kind of DIY experience you have. Even figuring out where to begin can be tough. Here’s a little food for thought to help get you started:
- Upgrade your sinks: Heavy-duty renovations like installing a steam shower or kitchen island may be out of the question for some folks, but upgrading your sinks may not be as difficult as you might think. Replacing old fixtures with the latest styles can make your home seem new again.
- Replace old carpet: Nothing lasts forever, and that goes double for carpeting. Even the nicest carpet will wear down over time — and that’s before you consider any stains or odors it may have absorbed through the years. Tearing out and putting down new carpet is a perfectly reasonable DIY project, although it can be time-consuming.
- Add new flooring: If replacing carpet sounds like a lot to handle, then putting in wood or laminate flooring may seem downright insurmountable. But, with the right guidance and preparation, this could be a home renovation you’re able to tackle yourself.
- Update landscaping: Real estate agents know the value of curb appeal, and a big part of that is good landscaping. Planting flowers, bushes, trees and other plants make your home more appealing, so extend your green thumb and start gardening!
In the mortgage lending world, sweat equity refers to home renovations and repairs you complete in place of a cash down payment. Your own effort and toil is key here; if you’re paying someone else to do the work, then it’s not sweat equity.
Embracing sweat equity can help you turn a flawed house into your dream home without breaking the bank. On top of that, you can also increase your property’s potential home equity, which can then be used for other large expenses. It’s an appealing loan option for anyone who has the construction skills to take on home improvement projects.
Whether you’re buying a house on a budget or simply want to brighten up your home, sweat equity may be the way to go. So, roll up those sleeves, flex those muscles and put your equity to work.
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