When looking at online mortgage companies, you may have noticed that many mortgage products are offered as "rehab" or "renovation" loans. These loans are designed for a very specific purpose: to rehabilitate a damaged or distressed property. If you're interested in improving a home or renovating it to suit your needs, a renovation loan may be the best choice. Here's what you need to know:

How a Rehab Loan Works

A rehab loan sets aside a certain amount of money in escrow for modifications to the property. If you purchase a $30,000 property with the intent of increasing its value to $100,000, the $70,000 will be rolled into the mortgage and set aside for those improvements. Of course, an appraiser will need to be consulted to ensure that the property value will reach that amount, and contractors will be consulted to bid on the cost of the improvements. 

The Advantages of a Rehab Loan

A rehab loan makes it easier to purchase a property and customize it for your own needs. Many of these properties are distressed and cannot be sold otherwise, so it's possible to get a home at below-market rates.

Other than a rehab loan, the only other way to purchase a home that needs renovations is to purchase the home and then apply for an additional loan. Not only is this harder to do financially, but many mortgage companies won't approve lending for a home that can't currently be lived in. Thus, some homes can only be purchased with the use of a rehab loan. 

Restrictions on a Rehab Loan

When using a rehab loan, borrowers usually have to rely upon licensed, professional contractors to complete the work that has to be done. That means that borrowers can't expect to do the majority of the work themselves, though they can sometimes do a percentage of work themselves (generally up to 10% of the home's value).

Some rehab loans, such as the ones provided by Fannie Mae, have a list of allowed properties. Rehab loans may also have higher-than-average credit or financial restrictions.

Your home loan company can tell you more about the programs that are available to you. Most rehab loans have restrictions on both borrowers and the properties they can purchase, but when acquired, they can make it easy for you to buy a home under market value and customize it for you and your family.