203K – Is it for Me?

“Fixer-Upper”

What does that phrase really mean? By definition:

Some people shy away from these types of listings because they do not have funds available up front to complete repairs and renovations. Sometimes, repairs and renovations are required for the house to even be habitable.

If you have found a fixer-upper that you are interested in purchasing, but don’t have the cash to remodel it; consider the 203(k) mortgage program.

What Exactly Is It?

The Federal Housing Administration’s rehab loan product, the FHA 203(k) loan, was designed for individuals who want to rehabilitate or repair a damaged home so they can live in it as their primary residence. These loans are endorsed by the government to encourage lenders to offer what would otherwise be considered a risky loan product. Because of the risk and expense involved, most rehab projects are normally handled by professional real estate investors who can buy properties with cash and therefore don’t need any bank to approve the property’s condition. For those who don’t have cash, the FHA 203K loan is for you.

Following is general information about the two different types of 203(k) loans, eligible properties, eligible repairs, how to apply and more–in short, what you need to know to determine whether this
type of loan is right for you. Keep in mind that you will want to check with a trustworthy mortgage banker to see if all of the information below is still the case since program changes are made occasionally.

How Much Cash Do You Need?

The FHA 203(k) loan lets you include the money needed for repairs and related expenses in the loan, such as materials and labor. If you wanted to buy a home in which the kitchen had been ripped out, you could include in the loan the price of new cabinets, counter tops, flooring, a fridge, stove, oven, microwave, sink, dishwasher, garbage disposal, and the cost to design, permit and install it all. The loan can also include a 10-20% contingency reserve for expenses above and beyond your repair estimates.

Of course, you’ll also have to meet the usual borrower requirements for an FHA loan, like having a steady, verifiable income and a good credit score.

Types of 203(k) Mortgages

There are two types of FHA 203(k) mortgages: regular and streamlined (also called “modified”). Regular 203(k)s are for properties that need structural repairs; streamlined are for those that need only non-structural repairs. Either can be used for purchase or refinance.

Eligible Properties

FHA 203(k) loans are intended for owner-occupants, not investors. The following types of properties are eligible:

* Single-family to four-family dwellings
* Existing construction that has been completed for at least one year
* Tear downs, as long as part of the existing foundation will remain
* Moving an existing house to a new foundation
* Rehabbing the residential portion of a mixed-used (commercial/residential)
property
* FHA-approved condos

With such a wide range of qualifying properties, almost anyone can find the right property for their tastes, and one that will also qualify for a 203(k) loan. Again, please check with a trusted mortgage banker to make sure no program changes have occured.

Financing Conditions and Allowable Rehab and Repair Expenses

Regardless of what work you may think the house needs, the lender and FHA have their own requirements that you’ll also have to meet. The U.S. Department of Housing and Urban Development (HUD) “requires that
properties financed under this program meet certain basic energy efficiency and structural standards” to “comply with HUD’s Minimum Property Standards (24 CFR 200.926d and/or HUD Handbook 4905.1) and all local codes and ordinances.”

The energy efficiency standards include caulking, insulation and ventilation as well as using the correct size heating and air conditioning systems for the home. The home is also required to have smoke detectors adjacent to each sleeping area. You might be surprised by the variety of home repairs and improvements that can be financed with the 203(k) loan. These include, but are not limited to:
* Painting
* Room additions
* Decks
* Patios
* Site grading and drainage
* Bathroom remodeling
* Kitchen remodeling, including appliances
* Finishing an attic or basement
* Structural alterations and repairs
* Adding or decreasing the number of units in a dwelling (e.g., single family to
duplex)
* New siding
* Second story addition
* Elimination of lead-based paint problems
* Heating, ventilation and air conditioning systems (HVAC)
* Plumbing
* Roofing
* Flooring
* Energy conservation
* Disabled access

The FHA does not allow “luxury items” such as tennis courts, swimming pools, hot tubs and barbecue pits to be financed with a 203(k) loan, but some items that you might think of as luxuries, such as whirlpool bathtubs, are actually allowed. Talk to your lender about the specific improvements you want to make to see what you can finance.

Applying for an FHA 203(k) Loan

In addition to the usual mortgage loan application requirements, such as proof of income, proof of assets and credit reports, the 203(k) loan application requires the following:

–The creation of “a detailed proposal showing the scope of work to be done, including a detailed cost estimate on each repair or improvement of the project.”

–An appraisal. The home is appraised as it would be for any loan, except that the appraiser must estimate what the value of the home will be once the repairs and improvements are made. An as-is appraisal may also be required.

Completing the Rehab

Once you complete the purchase and the home is yours, your contractor can start the repairs and remodeling.  Whether or not the contractor must be licensed and/or insured varies per state. Check with your  loan officer to be sure. The FHA require all repairs to be completed within six months, although lenders can require a shorter time frame. You’ll begin making mortgage payments right away, like you would on any home. After all, you own it–it doesn’t matter if you’re living in it yet. However, as mentioned earlier, you can finance your first few mortgage payments. The rehab and repair money is placed in an escrow account and released as the work is completed and inspected to ensure HUD approval. HUD must also approve the finished product once all work has been completed.

Also, make sure you don’t over-invest in the home–don’t spend so much on repairs and improvements that you won’t be able to recoup your costs if you sell the house one day. Look at the average sale prices of move-in ready homes in your neighborhood and try to put your home within this range. You don’t want to own a $300,000 home in a neighborhood of $200,000 homes, because most people who can afford a $300,000 home will want to live in a nicer neighborhood where all the homes are comparably valued.

Drawbacks

FHA 203(k) loans have a longer closing period. These loans usually take 60 to 90 days to close, which is longer than the 30 to 45 days that are common for other types of loans, including regular FHA loans. If you’re in a hurry to move, this is not the loan product for you. You can also expect to pay a higher interest rate because of the increased risk associated with home-improvement loans. These loans are also more work for lender and require specialized loan knowledge, so it can be harder to find a lender that will work with you. The application and renovation processes are lots of work for the homeowner, and there is lots of red tape involved. Some borrowers have reported delays in receiving their rehab funds, which adds additional stress to the process.

Bottom Line

Though it can be more work to find a lender who does FHA 203(k) loans, and to complete both the application and renovation processes, the extra effort can pay off. This loan product can enable you to buy that perfect house and give it the TLC it needs. It can also make it possible for you to make the leap from renting to home ownership, since there might be a fixer-upper out there in your price range when there aren’t any move-in ready homes out there that you can afford.