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The FHA 203(k) Loan: A Home Repair Loan And Mortgage All In One
If you're looking at a fixer-upper, the Federal Housing Administration rehab loan may be the mortgage for you.
Are you interested in buying a fixer-upper, but don't have the cash to remodel it? Or maybe you have saved money for remodeling and you've found a house you love, but your lender won't allow you to buy it because the house isn't considered habitable without toilets.
There are always properties on the market that weren't maintained by cash-strapped former owners, were treated poorly by renters or were deliberately trashed by formers owners before they lost their home to foreclosure. Shouldn't there be a way for someone like you to fix up these neighborhood eyesores and bring them back to life?
A Gift From the Government
There is, and it's brought to you by the federal government. The Federal Housing Administration's rehab loan product, the 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, 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.
This article will describe how much money you need to save up, 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.
How Much Cash 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. You can also get up to six months' worth of mortgage payments included to cover the mortgage while you're renovating the home, so that you won't have to make a double housing payment.
As of early 2010, you only have to come up with 3.5% of the home's purchase price plus repair costs to buy a house with this type of loan. So if you were buying a house whose asking price was $150,000 and that needed repairs of $15,000, you would need 3.5% of $165,000, or $5,775, as your down payment. 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.
According to the FHA, "All persons who can make the monthly mortgage payments are eligible to apply" for a 203(k) loan. To find a lender in your area who is experienced with FHA 203(k) mortgages, use the search tool at http://www.hud.gov/ll/code/llslcrit.cfm and check the box for 203(k).
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.
For the regular 203(k) purchase loan, the maximum mortgage amount is based on the lesser of the as-is value of the property plus rehab costs or 110% of the expected value of the property after rehab. This means that you wouldn't want to buy a $150,000 house if it needed $25,000 in repairs unless you had an extra $10,000 in cash, because the most you could borrow would be $165,000. The streamlined loan allows home buyers to add a maximum of $35,000 to the purchase price to pay for improvements.
Of course, in any case, you have the income to support the mortgage--you can't just take out a loan for a certain amount because the house warrants it.
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.
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:
- Room additions
- 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)
- 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, 203k 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, but sometimes the purchase price can stand in for the as-is appraisal.
You don't have to hire professionals to do the repairs, but the FHA says that "if the borrower wants to do any work or be the general contractor, they must be qualified to do the work, and do it in a timely and workmanlike manner" and "a borrower doing their own work can only be paid for the cost of the materials. Monies saved can be allocated to cost overruns or additional improvements."
However, you can't overlook labor costs in the proposal. According to the FHA, "home buyers doing their own work cannot eliminate the cost estimate for labor, because if they cannot complete the work there must be sufficient money in the escrow account to get a subcontractor to do the work."
Some people choose to hire a specialist called a 203(k) consultant to help them complete all the extra paperwork required for this type of loan, such as preparing architectural exhibits. The fee to hire such a consultant can be included in the mortgage, provided it does not exceed limits established by HUD. For example, for a home requiring $15,001 to $30,000 of repairs, HUD does not expect the consultant to charge more than $600. However, it is perfectly acceptable to complete all the paperwork yourself, though you'll probably want some input from your potential contractors.
Completing the Rehab
Once you complete the purchase and the home is yours, you can start the repairs and remodeling. 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.
Problems to Avoid
Many lenders don't do FHA 203(k) loans, whether because they don't know how or don't want to do the extra paperwork. Working with a lender who isn't experienced with FHA 203(k) loans is something you should avoid--the process is complex enough as it is. Don't give yourself any headaches by working with someone who doesn't know what they're doing.
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.
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.
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.