FHA 203k Loans
Officially known as FHA 203(k) loans, this loan program allows you to buy a house in need of repair and fix it up before you move in. All of the rehab expenses are included in the loan amount so you don’t have to pay for them out-of-pocket, and you can do all the rehab before you move in so you won’t have to live in a construction zone.
There are two types of 203(k) loans: streamlined and full rehabilitation. The streamlined 203(k) must have a rehab budget between $5,000 and $35,000 and is primarily used for cosmetic upgrades like new paint, window repair, furnace upgrade, etc.
The full 203(k) rehabilitation loan must require more than $35,000 in rehab expenses and is used for larger upgrades, like new kitchens, new rooms, new bathrooms, change of layout and walls, new windows and doors, new roof, etc.
This loan program follows all of the typical FHA guidelines, with the addition of several for the rehab portion of the loan. Before you’ll be allowed to underwrite the loan, you’ll have to get an official bid from a licensed and insured contractor who’ll do the work for you. This means you’ll need to document exactly what needs to be done to the home, in excruciating detail.
You’ll also have to hire a HUD consultant who’ll review your bid(s) and guide you through the documentation and construction process. The consultant will create the official documents used by the underwriter to process the loan, and you can expect to pay between $400 and $1,000 for the service, depending on the dollar amount of the rehab. The consultant also controls the contractor draws used to pay for the rehab.
Once the final budget is set for the renovation, you’ll be required to include a contingency reserve to cover the unexpected. You never know what the contractor will find once the demolition starts, and the contingency budget is intended to cover these surprises.
The contingency reserve percentage ranges from 10% to 20% and can be used for just about anything, whether it’s a surprise or not. In fact, you should have a wish list ready in case the entire reserve isn’t used. Since the remaining amount will get applied to the principal of your loan, which won’t reduce your monthly mortgage payment, you may want to use every last penny on the rehab. If you apply the remaining contingency to the principal, it will increase your equity in the home and you may pay off the loan a month or two early, 30 years down the road, or you may decide to enjoy the additional improvements for the next 30 years, or at least while you live there. It’s your call, but keep this in mind as your project progresses.
When the home is appraised for the loan, you’ll get an “as-is” appraisal value and a “subject-to” or “after renovation” appraisal value. The “as-is” value is what the home is worth today in its current condition. Your goal is for this amount to be equal or more than your negotiated purchase price. For instance, if you’re under contract on a home for $100,000, you’ll want the “as-is” appraisal to be at least $100,000 and ideally more.
The “subject-to” appraisal value refers to what the home will be worth subject-to the renovation. Each lender has different guidelines on the amount they’ll loan compared to the “subject-to” appraisal value, but as a general rule, you’ll want the purchase price plus the renovation costs to be equal to or more than the “subject-to” appraisal value. If you’re under contract for $100,000 and you estimate the rehab to cost $50,000 with a $5,000 contingency buffer, the subject-to appraisal should be at least $155,000 and ideally much more.
Each county has a different FHA loan limit for this type of loan so you’ll need to make sure your loan amount falls within the limit before you fall in love with a fixer-upper. You can find your county’s loan limits on the FHA website: http://www.fha.com/lending_limits.cfm.
For complete details on the 203k loan program, refer to the HUD website at http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/sfh/203k/203kabou.
A 203(k) loan may be right for you if the home you want needs to be fixed up before you can move in and you don’t have the time, money or desire to fix it up while you’re living in it.
