How to Use ‘Sweat Equity’ in Real Estate

Increased home value due to DIY improvements is called sweat equity. You can use your sweat equity in real estate as a way to cover your down payment, save money, build a home you’ll enjoy and make more money when you sell it. It’s not without risk, but your handyman skills could be as good as money in the bank.

How sweat equity works for homebuyers

Homebuyers can invest time and effort instead of cash — here are the steps you’ll need to take:

1. Get preapproved: It’s best to make sure you qualify for a loan program that allows for sweat equity — like an FHA loan or the Freddie Mac Home Possible® loan — before you start shopping. Fill out a loan application and let your loan officer know you plan to use sweat equity as a down payment.
2. Find a home: Look for fixer-upper homes advertised “as-is.”
3. Negotiate the price of the house and the repairs: Count on your realtor for help in how to negotiate a home price. You’ll need to agree what the house is worth as-is, as well as the worth of the repairs. After the repairs, the house will have an “as-completed” price.
4. Get an appraisal: An appraiser will validate the price of the material to be used and the labor that’s going to be done, and confirm or adjust what the as-completed value will be.
5. Do the work: There are no specific requirements for this process, but you must do the work you’ve agreed to in the contract. Save the receipts for the materials you buy.
6. Get a confirmation: The appraiser does a final inspection and verifies the monetary value of the sweat equity that the lender will count as your down payment.
7. Close on your mortgage and enjoy your home: Once the amount of the loan and your sweat equity is finalized, you’ll provide any remaining documentation needed for the approval and close the loan.

How to calculate sweat equity

The most conservative formula to calculate the value you add to your home is to simply add up the amount for your own material and estimate your labor costs. Another way to do it is to get a written estimate from a professional company, quoting how much they would charge to complete the job(s).

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 work, your hard work could pay off.

1. Know the work you can do and the skills you bring to the table. This way you can help identify the best real estate purchase option. Look for properties advertised “as is.”
2. 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 another part of the house a better option? What’s the timeline?
3. Get to work! After the investment property is in your hands, get started. Remember to strike a balance between getting things done and pacing yourself.
4. Consider having the home appraised. While the homebuyer will need to have a separate home appraisal, getting one yourself can solidify how much the home is worth, how much you should ask for it and how much profit you could make.
5. List and sell the home. Here are tips for selling your home.

Benefits and risks of using sweat equity in real estate

Benefits of sweat equity

• You can save money buying a fixer upper. Homes that need work are less expensive than ready-to-move-in places.
• You can have an emotional payoff. Living in a space that you put effort into designing and changing for your own or your family’s needs and enjoyment can be fulfilling.
• You can financially benefit. By doing the work yourself, you could save a lot of money and gain the value of the improvements when you sell.
• More income from tenants or guests. If you have a multifamily property, rent out units or host guests a la AirBnB, you could charge more for the upgrades.

Risks of sweat equity

• Quality of life during construction. If you and your family have to live in the residence while construction is ongoing, your quality of life may not be ideal.
• Mistakes can cost you. If you damage your home trying to do a DIY project, your insurance might not cover the repairs, whereas professionals are typically licensed and insured.
• Results may look unprofessional. There’s a reason that professional craftspeople are paid – their skills can be hard won. As an amateur, if you get tired or impatient, your results may look shoddy and not be worth as much. Plus, they could even damage the value of the home if your work needs to be removed and replaced or repaired.
• Time and money are still needed. Not everyone has the skills or tools ready to do landscaping, cabinetry, woodworking, masonry, construction, plumbing and electrical, among other tasks. You may need to spend some serious time studying and practicing. You may also need to purchase safety equipment and buy or rent tools for the job.

Programs that allow sweat equity as your entire down payment

Here’s an overview of three programs that allow sweat equity to account for all of your down payment. Each has different flexibilities and restrictions on income, credit and the type of property.

FHA mortgage

An FHA mortgage allows you to include renovation costs into your home loan. It provides more flexibility for credit and income histories, as well as a higher debt level, when compared with conventional first-time homebuyer programs that allow for sweat equity.

Here are details:

• You could be approved with a credit score as low as 500. If you have a low credit score you may still be able to qualify for an FHA mortgage.
• You only need a 3.5% down payment if you have a credit score of 580 and up (10% down payment if your score is lower).
• You can have a debt-to-income ratio (DTI) as high as 43%, and exceptions can be made.

There are downsides to an FHA loan, however: For example, the mortgage insurance is the same regardless of your credit score. And while there’s no maximum income requirement, the FHA maximum loan amounts will vary based on where you live. For most of the nation, the limit for a single-family home in 2022 will be $420,680.

Freddie Mac Home Possible®

The Freddie Mac Home Possible ® program allows borrowers to use sweat equity for the entire down payment. The down payment requirement ranges from 3% to 5%. The higher requirement applies if you don’t have a credit score and use an alternative credit history instead.

You can use the Home Possible® income and property eligibility tool to find out the specifics for a property you’re interested in.

Habitat for Humanity

Habitat for Humanity works in communities across the U.S. and requires applicants for Habitat housing to contribute sweat equity. There are no set income, debt or credit requirements, although a loan committee will evaluate your finances to ensure you can afford the payment.  Find out if this program is available where you live.