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203k Loan and Renovation Financing
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How to qualify for a 203k loan. A 203k loan isn’t any more difficult to qualify for a regular FHA loan or conventional loan. You have to give the same income, asset and liability documentation and as long as you have at least a 3.5% down payment you can be considered for a 203k loan. You don’t have to have any reserves (reserve money in an institution that can be used to make emergency mortgage payments) either. Being that the 203k loan allows you to buy a home and receive repair/remodeling funds-all in one loan, with a low 30 year fixed rate, you would think that the qualifying for this unique loan is much more difficult than a regular FHA or conventional loan, this is not true at all.
So what’s different about qualifying for a 203k loan? Usually your Realtor will ask you for a prequalification letter from a lender that shows that you are qualified to buy a home for say $250,000. With a 203k loan your final loan amount can not be determined until after the appraisal of the property you are looking to buy is done, which means your Loan Originator can not give you an exact prequalified loan amount upfront. This is different from the regular FHA 203b loan and Fannie Mae and Freddie Mac conventional loans. This is what confuses Realtors, sellers and home buyers which in turn scares them away from the 203k loan, but once you understand the process, and you, your Realtor and your Loan Originator do your homework upfront before you make an offer, there is nothing to be afraid of.
The 203k loan appraisal is different as well, where a value of the home is estimated, has two values: An as-is value and an after improved value. The after improved value takes into account the improvements that are to be done to the home before the repairs are actually done. So depending on what repairs are done to the property will have a direct outcome on the after improved value, which affects your final loan amount.
Once the appraisal is finished and delivered to the lender, which is a few weeks into the process after your offer has been accepted, than your Loan Originator will work the numbers for you.
Your down payment amount is figured off of the after improved value of the home as well, not the as-is value, but again if coached upfront correctly this isn’t a deal breaker. If you buy a home with an as-is value of $300,000 and the after improved value is $325,000, your minimum 3.5% down payment goes from $10,500 to $11,375. It’s best to pad numbers a bit when estimating loan amounts, down payments and repairs, so there’s no surprises later.
Having a knowledgeable group of people who know the 203k loan and its nuances is critical. The Realtor, Loan Originator and contractor should know the 203k loan process. You the borrower should also do some research on the 203k loan before applying for a loan. I have a free 203k loan video on my website, as well as a free 203k Streamline guide. Take a few minutes and familiarize yourself with the basics. The 203k loan is a worthwhile endeavor and it’s popularity is growing.
In qualifying for the 203k loan, it takes the same amount of paperwork and time, there’s no smoke and mirrors. If you get any push back from your Realtor or Loan Originator on the 203k loan, it probably means they don’t understand it or didn’t get involved with the right team of people who could get the loan done. Don’t fret, keep your vision and shop around for a team of people who understand the loan and are receptive to it.
For more information on learning on what needs to be done upfront on the 203k loan to ensure a successful transaction, feel free to contact me or click here.
Frequently Asked Questions for the FHA 203k Loan
An FHA 203k loan is basically the same as a regular FHA [called a 203(b)], but with a twist. An FHA 203k loan permits home buyers to finance repair/improvement money into their mortgage to repair, improve or upgrade their home. With this loan option, home buyers can quickly and easily tap into cash to pay for property repairs or improvements, such as those identified by a 203k Consultant, FHA approved inspector, FHA appraiser or home buyer preferences (see list below). There are two types of FHA 203k Loans: Standard (minimum rehab $5,000 up to FHA maximum loan amount) & the Limited (minimum rehab $0 – $35,000…cannot exceed FHA maximum loan amount). The FHA 203k Standard loan is more like a construction project, and the FHA Limited 203k Loan is for more minor improvements. CLICK HERE for the FHA maximum mortgage amounts for your area.
The purchase of a house that needs repair is often a catch-22 situation, because the bank will not lend the money to buy the house until the repairs are complete, and the repairs cannot be done until the house has been purchased. HUD’s FHA 203k loan program can help you with this quagmire and allow you to purchase or refinance a property and include in the loan, the cost of making the repairs and improvements. In addition, the interest on the FHA 203k loan qualifies for the mortgage interest tax deductions like all other mortgage loans. Therefore, the interest that the borrower pays on this “construction” can be all tax deductible! The FHA 203k loan program improves the real estate market because it requires a property to actually be improved….not just purchased. Because of the improvement requirement with the FHA 203k loan program, real estate values are increased, which helps other homeowners in the same neighborhood, invigorates communities and creates work for contractors and commerce is conducted by the purchasing of goods and services. Simply put, the FHA 203k loan program improves everything associated with it.
Any owner occupant primary residence borrower or qualified non-profit group who qualifies for an FHA loan can also qualify for an FHA 203k Loan. No investor purchases using the FHA 203k loan have been allowed since 1996.
An FHA 203k Loan can be used for one-to-four unit dwellings, such as Single Family Detached Homes, Duplexes, Triplexes, 4-plexes, Condominiums (certain restrictions apply) and Mixed-Use Residential (certain restrictions apply).
It depends on the county where the property is located. CLICK HERE for the FHA maximum mortgage amounts for your area. Or you may contact your FHA lender for this information.
Any repairs/improvements/modifications/modernizations that add value to and/or improve the property are acceptable for an FHA 203k Loan. The improvements must comply with HUD’s Minimum Property Standards (24 CFR 200.926d and/or HUD Handbook 4905.1) and all local codes and ordinances. Structural modifications and any work in excess of $35,000 are NOT allowed for the FHA 203k Limited, but the FHA 203k Standard does allow for structural modifications, landscaping and for work in excess of $35,000. Luxury items such as swimming pools, BBQ’s, Gazebos, spas, etc. are not allowed for any 203k loan. However, pool repair (subject to lender approval) is allowed on an FHA 203k loan. Examples of allowable repairs/modifications/renovations for the FHA 203k loan (not an all-inclusive list):
- Energy Efficient upgrades (windows, insulation, solar systems, etc.)
- Repair/Replacement of roofs, gutters and downspouts
- Repair/Replacement/upgrade of existing HVAC systems
- Repair/Replacement/upgrade of plumbing and electrical systems
- Repair/Replacement of flooring
- Kitchen remodeling
- Painting, both exterior and interior
- Weatherization, including storm windows and doors, insulation, weather stripping, etc.
- Purchase and installation of appliances, including free-standing ranges, refrigerators, washers/dryers, dishwashers and microwave ovens
- Accessibility improvements for persons with disabilities
- Lead-based paint stabilization or abatement of lead-based paint hazards
- Repair/replace/add exterior decks, patios, porches
- Basement finishing and remodeling
- Basement waterproofing
- Window and door replacements and exterior wall re-siding
- Septic system and/or well repair or replacement
- Structural repairs/modifications (moving walls, repairing foundations, etc.)
7. Is there a minimum or a maximum rehab amount for an FHA 203k Loan?
FHA 203k Limited: $0 minimum – $35,000 maximum*
FHA 203k Standard: $5,000 minimum – no pre-set maximum*
* The maximum is always limited by lesser of the borrowers approval limit, the FHA maximum mortgage limit for the area or 110% of the improved appraised value.
8. Will my mortgage lender inspect the repairs/improvements?
According to HUD, for the Standard 203k version, all work must be inspected by the 203k Consultant or the FHA appraiser prior the contractor receiving each draw/payment. According to HUD, on the Limited 203k version, for repairs in excess of $15,000, the Lender must perform or obtain an inspection of the completed work by a third party. For repair costs not exceeding $15,000, the Lender is not required to perform, or have others perform, inspections of the completed work. However, the Lender or borrower may choose to obtain or perform inspections if it believes such actions are necessary for program compliance and/or risk mitigation. Lenders may also ensure that the repairs and/or improvements have been completed by obtaining contractor’s receipts or by a signed Mortgagor’s Letter of Completion. If the Lender determines that an inspection(s) by a third party is necessary to ensure proper completion of the proposed repair or improvement item, the Lender may charge the borrower for the costs of no more than two inspections per each contractor. To eliminate the need and cost for an inspection of the completed repair(s) or improvement(s) when not exceeding $15,000, the Lender may accept receipts or proof of completion of the work to the homeowner’s satisfaction from the contractor. Before a final release is made, the homeowner must sign a statement acknowledging that the work has been completed in a professional and satisfactory manner.
9. What is a contingency reserve?
A contingency reserve is a percentage of the repair/renovation amount (0%-20%) and its purpose is pay for any potential cost overruns or unexpected repair items. A contingency reserve is usually required for the FHA 203k Standard but none is required for the FHA 203k Limited, but it is recommended to have one. Any monies saved or not spent may be used to complete additional work (subject to lender approval) or a one-time principle balance reduction in the mortgage amount at the end of the project.
10. Do I need to hire a HUD approved 203k Consultant?
For the FHA 203k Standard, a HUD-approved 203k Consultant is generally required but is NOT required for an FHA 203k Limited. However, you are allowed to hire anybody you think will help you to make good real estate decisions. It is always recommended to utilize the skills and expertise a 203k Consultant for all 203k loans, because they can add an extra layer of protection and information that only they can provide. For the Limited 203k, a 203k Consultant can be and should be used for a Feasibility Analysis and/or the home inspection for the main purpose of determining the FHA Minimum Required Items that must be addressed . CLICK HERE for a list of all 203k Consultants in your area.
11. Can I do the work myself on an FHA 203k Loan?
YES, subject to your lender’s approval. However, 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. This means that if you want to do the work yourself or be your own General Contractor, then you MUST be skilled and licensed to do such work. It is very important that the work be done in a time frame that will assure the completion of the work that will be agreed upon in the Renovation Loan Agreement (signed at closing). A borrower doing their own work can only be paid for the cost of the materials…never the labor. Contractor estimates are still usually required and the loan amount is usually based on those estimates. Monies saved or not spent can be allocated to cost overruns, additional improvements, or a one-time principle balance reduction. Because of lender overlays (internal additional rules and guidelines), a contractor will be required to perform the work the majority of the time.
12. What is a Certified 203k contractor?
Because neither HUD nor FHA certifies, approves or endorses remodeling/general contractors, there is no such thing as a remodeling or general contractor being an FHA approved contractor for the FHA 203k loan. In 1995, HUD stopped approving builders/contractors, eliminated this approval process and the associated database, according to Mortgagee Letter 95-57. Instead, HUD/FHA allow the borrower to hire whomever they want and require the lender to determine that the selected contractor is acceptable for 203k work by verifying their license, insurance, references, experience, education and understanding of the 203k (Mortgagee Letter 00-25). Since HUD/FHA, borrowers and 203k lenders do not educate contractors on all of the intricacies of the 203k, contractors complete the 203k Contractor Education course to receive their 203k education, which is a prerequisite to becoming a Certified 203k Contractor. Earning the designation as a Certified 203k Contractor is a validation that contractors present to 203k borrowers, lenders, 203k Consultants and Realtors® to validate their competency, understanding and experience with the 203k [HUD’s guidelines, time lines, paperwork, compensation structure, etc.. as well as the contractor’s ability to afford the start-up costs of each 203k project]. The 203k Contractor Certification Program is mainly education and partly an approval process where a contractor is educated on the 203k, their knowledge/understanding of the FHA 203k is verified and tested and business and customer references have been contacted and verified, as well as verification of licensing, insurance and financial stability. This education-based approval process exceeds all FHA lender underwriting guidelines and assures FHA lenders, Realtors® and consumers that these Certified 203k Contractors are as knowledgeable as possible on the 203k loan. All Certified 203k Contractors will be listed in this directory, should display the Certified 203k Contractor logo on their Websites and can provide you with a copy of their Certificate of Approval. Go to the Homepage to use the map or the Contractor Search page to manually search for all the Certified 203k Contractors.
13. How does a contractor get involved with the FHA 203k loan program?
Contractors need to understand the following:
- The consumer/borrower is responsible for approving, selecting and hiring whichever contractor s/he wants
- There cannot be ANY conflict of interest between the consumer/borrower and the contractor — no family relationship and no financial relationship
- HUD/FHA does not approve, endorse or certify remodeling/general contractors or builders. In 1995, HUD eliminated the database of HUD approved builders/contractors (Mortgagee Letter 95-97). Since 1995, there has been no such thing as a HUD/FHA approved builder/contractor.
- The lender does not approve contractors (see item #1), according to Mortgagee Letter 00-25 . However, the lender is responsible for determining that the selected contractor is acceptable to do the 203k project in a timely and workmanlike manner and in accordance with HUD’s guidelines by verifying the contractor’s license, insurance, references, credentials, work experience, as well as the contractor’s understanding of and competency with the 203k.
- The compensation structure set by HUD does not always permit contractors to receive pre-renovation deposits/start-up funds. Contractors must be financially capable of affording the start-up costs and ongoing expenses with any 203k renovation project. Ample credit lines with suppliers and subs and/or sufficient capital/reserves will be verified as part of the certification process.
- Contractors need to be as knowledgeable as possible regarding the 203k (HUD’s guidelines, time lines, paperwork, processes, compensation, etc.) The 203k Contractor Certification program, which includes the 203k Contractor Education course, is how contractors can receive their 203k education. Earning the designation as a Certified 203k Contractor is the validation that contractors present to consumers, lenders and Realtors® of their competency, understanding and awareness of the 203k [HUD’s guidelines, time lines, paperwork, compensation structure, etc.. as well as the contractor’s ability to afford the start-up costs of each 203k project].
- How do contractors earn the designation as a Certified 203k Contractor:
- Proceed to the Certification page to start the process and submit the online application request.
If I am a contractor, how can I earn the designation as a Certified 203k Contractor?
Proceed to the Certification page to start the process and submit your online application request.
14. How do the contractors get paid?
The contractors are paid in a series of draws by the borrower’s lender through escrowed funds. At closing, the lender places the rehab/improvement funds into an escrow account. More detailed information is available in the 203k Contractor Education Course.
FHA 203k Limited
Contractors receive maximum two (2) payments. After closing on the home, contractors may receive a portion of the job cost ( maximum 50%) as a pre-construction payment, subject to lender approval but may take weeks to arrive. Therefore, contractors must be financially capable of affording all the start-up costs and a portion of the ongoing expenses with the 203k project (ample credit lines with suppliers and subs and/or sufficient capital/reserves). Once all the work is complete, the contractors can request final payment of the remaining portion of the job cost according to the proposal that was submitted and approved by the borrower and the lender.
FHA 203k Standard
Contractors receive by default, four (4) draws plus a final for payment. If the rehab exceeds $10,000, more draws can be authorized by approval from the borrower and lender before the loan closes. After closing on the home, there is no upfront money paid to contractors to offset the start-up costs. Therefore, contractors must be financially capable of affording all the start-up costs and a portion of ongoing expenses with the 203k project (ample credit lines with suppliers and subs and/or sufficient capital/reserves). Contractors receive payment after stages of work are completed and inspected. For each draw request on the 203k Standard, an inspection is required.
15. What costs/fees are involved with an FHA 203k Loan?
The borrower will incur the fees normally associated with an FHA loan (contact your lender and/or real estate agent for more detailed information). In addition, other costs may include:
- additional origination fees charged by 203k lenders (optional and not required by FHA)
- fees charged by contractors and consultants (estimates, inspections and re-inspections, etc.),
- slightly higher interest rate (typically 1/8%-1/2% more than traditional FHA loans) and
- a 10%-20% renovation contingency reserve (added into the loan amount)
16. Can an investor use the FHA 203k Loan?
No. The borrower must be a primary residence owner occupant or a qualified non-profit group. Since 1996, there has been a moratorium on non-owner-occupied investors using the FHA 203k loan (Mortgagee Letter 95-97). However, the 203k is eligible to be used on 1-4 family dwellings. So, if a 203k borrower uses a 203k loan to purchase and renovate a multi-family dwelling, the non-owner-occupied unit(s) are permitted to be rented out. So, as long as the borrower will occupy at least 1 of the units of a multi-family dwelling (4-unit max), FHA still considers this borrower an owner-occupant even though the borrower rents out the remaining units.
17. Can I refinance my existing mortgage loan into an FHA 203k Loan?
Yes, you can refinance your existing mortgage into either version of the FHA 203k loan. The FHA 203k loan is also available for mortgage refinance transactions for those where the property is owned free-and clear. For the FHA 203k Limited Loan, only credit-qualifying “no cash out” refinance transactions with an appraisal are eligible. If the borrower has owned the property for less than a year, the acquisition cost must be used to determine the maximum mortgage amount. The requirement to use the lowest sales price within the last year does not apply to the FHA 203k Limited Loan.
18. What are the recommended steps to purchase a property using the FHA 203k Loan?
There are NO required steps or any specific order that items must be completed. However, to ensure a smooth real estate purchase, these are the recommended steps to purchase a home using an FHA 203k loan:
- The Home Buyer/Borrower selects an FHA-approved 203k lender and real estate agent knowledgeable with the FHA 203k loan and then applies for the loan.
- The Home Buyer/Borrower locates a home and after doing a feasibility study of the property with their real estate agent and 203k Consultant, a sales contract is executed. The contract should state that the buyer is seeking an FHA 203k loan and that the “contract is contingent on loan approval and buyer’s acceptance of additional required repairs by FHA/HUD or the lender.”
- Then, during the inspection period …
- On the Standard 203k, the Home Buyer/Borrower should obtain a Work Write-up from a HUD approved 203k Consultant showing the scope of work to be done, including a cost estimate on each repair or improvement of the project and then obtain a proposal from a Certified 203k Contractor showing the exact pricing and detailed analysis of work that will be completed. Then have the appraisal performed to determine the after-renovation value of the property.
- On the Limited 203k, a HUD approved 203k Consultant should provide a Feasibility Analysis or the 203k Consultant or an FHA approved inspector should perform the home inspection and detail the HUD minimum property requirements. Then obtain a renovation proposal from a Certified 203k Contractor and submit the proposal to the lender so that the lender can order the appraisal.
- On both versions, the appraisal, contractor’s proposal and the 203k Consultant’s work write-up (required only on Standard 203k) and Specifications of Repairs (Standard 203k only) are submitted to the lender for approval.
- If the borrower passes the lender’s credit-worthiness test, the loan closes for an amount that will cover the purchase or refinance of the property, the remodeling costs plus any required contingency reserves, any allowable closing costs and mortgage payments (only on Standard 203k–up to 6 months).
- At closing, the seller or previous mortgage of the property is paid off and the remaining funds are placed in an escrow account to pay for the repairs/improvements and any allowable closing costs and/or mortgage payments during the rehabilitation period.
- You now own the home (or refinance is complete) and can begin the renovations.
- Escrowed rehab funds are released to the contractor during construction through a series of draw requests for completed work. To ensure completion of the job, 10% of each draw is usually held back; this money is paid to the contractor after the lender determines there are no liens on the property.
- For the 203k Limited – The rehab work must start within 30 days after closing/funding, property must be livable within 30 days after closing, work may not cease for more than 30 consecutive days, the owner/borrower may not be displaced from the property for more than 30 days, and all work must be completed within 6 months after closing (subject to lender’s guidelines). For the 203k Standard– The rehab work must start within 30 days after closing/funding, the owner/borrower may be displaced from their home for more than 30 days (max 6 mortgage payments can be included in loan), work may not cease for more than 30 consecutive days, and all the work needs to be completed within 6 months (subject to lender’s guidelines).
19. Where is the FHA 203k loan available?
An FHA 203k loan is available in all 50 US States. The 203k Contractor directory for the FHA 203k loan program serves the following areas: