How Does a FHA 203K Loan Work?
Although purchasing real estate to rehabilitate and sell is often a wise investment, buying a cheap home can come with drawbacks. In some cases, the property needs extensive repairs to be habitable. If an investor cannot afford to pay the costs of home rehabilitation out of pocket, an FHA 203K loan can make paying for repairs less stressful by rolling the cost of home repairs into the investor's mortgage loan.
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Facts
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To be eligible for financing with a 203K mortgage loan, a property must be a one- to four-family dwelling built a minimum of one year prior to the borrower's 203K loan application. The additional funds for rehabilitation must remain in an escrow account that the borrower can pull from to make repairs to the property. An investor cannot borrow more than 100 percent of the projected value of the home after repairs. Thus, if the investor purchases a home for $70,000 and intends to rehabilitate the home to increase its value to $100,000, he cannot borrow more than the $30,000 difference to pay for rehabilitation.
Function
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The goal of the 203K mortgage loan program is to help rehabilitate homes in less than desirable districts. By allowing investors additional funds to repair these homes, the government hopes to attract stable buyers to previously objectionable areas. The more families that purchase homes in a given zone and properly care for those homes, the higher the property values of the surrounding houses climb. Thus, over time, 203K loans can transform an entire community, changing it from the "bad part of town" to a family-friendly neighborhood.
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Benefits
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Home loans under the 203K loan program are still FHA loans. An investor is entitled to all of the benefits of a standard FHA loan, such as a 3.5 percent down payment and lower credit requirements, in addition to a few additional perks. To obtain FHA financing, the property a borrower intends to purchase must undergo a strict evaluation to ensure that it meets safety and habitability requirements. This is a problem for borrowers who want to repair damaged homes and resell them for a profit. With the FHA 203K loan, however, safety and habitability issues won't prevent loan approval as long as the borrower prepares a repair proposal that includes budgeting for problem areas.
Considerations
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A borrower cannot simply borrow an additional $30,000, claim to need it to repair her home and then spend it elsewhere. The U.S. Department of Housing and Urban Development requires borrowers to get a professional estimate of the cost of repairs and provide that estimate to the lender. The escrow account containing the additional money loaned through the 203K program is based on a contractor's assessment of the cost of rehabilitating the house.
Effects
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The lender disperses the 203K loan in two payments. One payment arrives as soon as work begins and the final payment arrives after the repairs are complete. The repairs must be completed within six months of the date the borrower received the loan. If the borrower requested a 203K loan in excess of $15,000, the repairs and modifications must pass an inspection to ensure that the home is safe, habitable and meets all FHA standards. The U.S. Department of Housing and Urban Development and the lender holding the loan note can refuse to disperse the final 203K payment to the contractor until the work meets FHA quality standards.
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Comments
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Hi Jamie, Me and my wife currently own the home we live in now and are interested in a HUD home that is near us. The house is 73K, but will need some repairs. We want to purchase the house and use it as a rental. Do you know of any loans I can look into that do not require 25% down and/or give an allowance for repairs. On a side note do you know if you can ask for money towards the downpayment in part of the negotiating the price of the house. Thanks Chris
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So you're talking about the STREAMLINE 203(k) then. Hmmm...you might want to clarify that there, Ciele. Also, it is not for investors as you indicate in your opening and then a number of times subsequently. FHA (as well as VA, USDA and Fannie/Freddie) has a strict anti-flipping law which prohibits the fix n flip. The 203(k) is for owner-occupants only. Also, the STREAMLINE k here which you refer to only covers minor to moderate/cosmetic repairs up to a total of $35k. Nothing structural or heavy duty like roof damage, additions, foundation repairs or relocation/repair of load bearing walls. For homes in need of repairs of that type and/or for homes that need repairs in excess of $35k there is the STANDARD/FULL 203(k) which covers work of this type for FHA-qualified, owner occupant buyers. In this case a (usually 5 point) inspection and draw schedule is drawn up by a third party HUD inspector during origination and contractors are paid via this schedule (in 5 increments as work progresses). When executed properly from start to finish (meaning from the property location/type and house hunting research stage to the closing and execution of repairs stage) and especially when combined with the FHA EEM (energy efficient mortgage) and other stimuli such as the 30% tax credit for energy efficient upgrades, this can reap a home buyer (or a qualified refinancing home owner) not only long lasting comfort and appeal but literally tens of thousands in instant equity. I know; I've originated dozens of them. In many cases, the amount saved by reducing the heating & cooling by half or more combined with the 30% tax credit washes the the higher monthly loan payment immediately (having rolled in cost of repairs & fees to the purchase mortgage).
