Buy a Home That Needs Repairs with an FHA 203(k) loan
Editor’s note: FHA Mortgage Insurance Premium Changes starting April 9, 2012. Single Family Mortgage Loan: Starting April 9, 2012 the Mortgage Insurance Rates increase for new home purchase loans and anyone who takes out an FHA refinance loan for a non-FHA loan. The Up-front Mortgage Insurance Premium increases to 1.75% instead of 1%. The annual MIP will increase by 10 bps.(That means an additional $8.33 per month for every $100,000). The increase in the rates was a result of the Temporary Payroll Tax Cut Continuation Act of 2011 signed by President Obama on Dec. 23, 2011.
Buy a Fixer-Upper
If you are in the market for a home, some of the houses you look at may need home improvements. If you are interested in purchasing a fixer-upper, it can be hard to find the right kind of mortgage loan or any mortgage loan at all. This is because most lenders will not offer you a loan for a home that needs repairs. They are concerned that it is too risky; they want the repairs made before the loan is made. There is one product, however, that is designed for borrowers looking to purchase a home that needs repairs or rehabilitation, the FHA 203(k) loan.
The FHA is the U.S. Federal Housing Administration which is a division of the Department of Housing and Urban Development (HUD). The FHA does not make loans directly, but guarantees loans that other lenders make that meet FHA guidelines. Among its many loan programs, the FHA states that the Section 203(k) loan is “an important tool for community and neighborhood revitalization and for expanding homeownership opportunities. "
Good Option for Purchasing Distressed Properties
Given the huge number of foreclosed homes and the length of time that the foreclosure process often takes, many homes have fallen into disrepair. The homeowner who is worried about losing his or her home is not going to be spending money on upkeep and repairs. This has created the market conditions which make the 203(k) loan even more attractive, opening up opportunities for borrowers to buy and rehabilitate a home for less than they would spend on home that was in stellar condition. 203(k) loans can be used for single-family residences, one-to-four unit properties, and for condominiums, though the restrictions on condos are greater.
An FHA 203(k) loan allows borrowers to finance the home purchase and also include the cost of repairs and improvements in their mortgage loan, while taking advantage of the low down-payment requirements of an FHA loan. The loan can cover the costs for the materials and for the work needed to complete the renovation. The loan amount is based on the value of the home after the repairs are completed. Because of this, a property in disrepair, one that would not qualify for a standard FHA loan, is an ideal candidate for a 203(k) loan. 203(k) loans may be the only financing available for distressed properties, allowing purchasers who lack the means to purchase a home in cash a way to access the large number of foreclosed properties on the market.
Use for Repairs and for Other Improvements
For instance, someone interested in a home where the bathroom had suffered water damage and needed to be replaced, could use the money from a 203(k) loan to cover the cost of a new shower, toilet, sink, flooring, all the materials, and the costs for someone to provide design plans, as well as to pay for the structural alterations and reconstruction to repair the water damage to the floor or walls.
203(k) proceeds can also be used for a wide range of other work, including, according to the FHA, “elimination of health and safety hazards, changes for aesthetic appeal and elimination of obsolescence (e.g., new exterior siding, adding a second story to the home, covered porch, stair railings, attached carport), energy conservation improvements, and improvements for accessibility to a disabled person.” A Section 203(k) can even be used to move an existing house onto another site. Because there are restrictions that govern all the work done through a 203(k) loan, make sure to review the 203(k) guidelines at the FHA Web site.
A borrower can also include up to six months worth of mortgage payments in the loan, to cover the mortgage payments on the home being repaired. This prevents the borrower from having to make two housing payments at the same time, one on the home being repaired and another for either a mortgage payment or rent on the current residence.
Low Down Payment
One of the best things about the 203(k) program, and FHA loans in general, is the small down payment required. While standard loans are more and more requiring a 20% down payment, the 203(k) program only require a down payment of 3.5% of the home's purchase price plus all the repair costs. For someone looking to purchase a home for $165,000 that needs $35,000 worth of renovations, the down payment required would be 3.5% of $200,000, or $7,000!
203(k) Loan Restrictions
- The 203(k) loan requires a reserve fund of at least 10%, in case the actual costs of the repairs exceed the estimates.
- The application must include a detailed proposal showing the scope of the work, and a detailed cost estimate for each repair. The appraisal estimates the value of the home after the repairs, rather than the current value.
- The cost of the rehabilitation must be at least $5,000, but the total value of the property must still fall within the FHA mortgage limit for the area. The value of the property is determined by either the value of the property before rehabilitation plus the cost of rehabilitation or 110% of the appraised value of the property after rehabilitation, whichever is less.
- The amount of a 203(k) loan cannot be increased during construction. It is crucial, therefore, to get an accurate estimate for all the work to be done. It is recommended that a borrower receive an estimate from a HUD-approved contractor or fee consultant. You can locate a HUD approved consultant in your area at the HUD's Web site.
- The work must begin within 30 days of execution of the Agreement. The work must not cease prior to completion for more than 30 consecutive days and be completed in no more than six months (or less, if specified by agreement).
- Luxury items and improvements are not eligible.
- Borrowers need to qualify for the loan by meeting FHA credit and income requirements.
- All improvements must comply with HUD's Minimum Property Standards as well as all local codes and ordinances.
The list above is not a comprehensive list of the restrictions. As you can see, just from the partial list, 203(k) loans are complicated. For this reason, it is wise to seek a loan officer who has experience with this kind of loan who will advise and guide you through the process. An experienced loan officer will not only know the process, but will likely have useful recommendations when it comes to locating contractors that are also experienced in working on 203(k) rehabilitation and improvement projects.