Sweat equity, in the context of real estate, is about adding value to a home you’re buying or selling. If you were a home buyer, can you use this for your down payment?
What mortgages accept sweat equity as a source of down payment funds? Learn how you may be allowed to use it to fund your closing costs, down payment, etc.
Sweat Equity: An Investment in the Home
It’s essentially the time, energy, and effort you put into building or developing something, e.g. a business venture or a house for that matter.
Sweat equity can be home improvement projects such as painting, landscaping or flooring, and maybe advanced work for those with prior construction experience.
This labor put into the improvements or tasks becomes your “equity” or investment in the home.
The concept of sweat equity works for Habitat for Humanity that encourages families to help in building their homes or that of other families with their own sweat.
Sweat Equity and Mortgages
But, does it work in mortgages? Can you use sweat equity to fund your own down payment?
Yes, you can. It is an acceptable source of borrower funds for Fannie Mae’s HomeReady™ and FHA-insured mortgages.
Fannie Mae does not generally allow the use of sweat equity toward down payment, closing costs, and reserves because it’s difficult to quantify the value of labor put into work.
But it takes exception for HomeReady™, Fannie’s mortgages for people with low credit scores and down payments as low as 3% of the purchase price.
That’s explains why for sweat equity to be acceptable for a HomeReady™ mortgage, the lender must have a proven ability to properly assess the value of the work performed.
If the work gets accepted to be part of the down payment, the borrower is asked to contribute 3% from his/her own funds. The down payment on a one-unit property becomes 5%.
The FHA allows the use of sweat equity toward FHA loans whose down payments go as low as 3.5%, subject to its guidelines.
These guidelines being:
1. Sweat equity is defined as the labor performed or materials furnished to a property being purchased before the closing date of the transaction.
Only repairs or improvements made on an existing construction and listed on the home’s appraisal will be considered as sweat equity.
And if the home is yet to be built, the sales contract must put down the projects/tasks to be undertaken by the borrower during construction.
2. Clean-up, debris removal, and other general maintenance work don’t fall under sweat equity’s definition by the FHA.
3. The borrower must demonstrate his/her ability to complete the work satisfactorily.
4. Sweat equity may be gifted subject to FHA gift funding guidelines.
5. This labor/material investment is only applicable to the subject property being financed.
If the borrower supplies the materials and funds for the improvement, the market value of the materials and source of these funds must be properly documented.
As you can see, your hard work can pay off and help remove an important hurdle to homeownership. Learn more about it from lenders here.