FHA 203k Home Loan
FHA 203k Home Loan
A type of federally insured mortgage product for individuals who want to rehabilitate or repair a damaged home that will become their primary residence.
What Is an FHA 203k Loan?
An FHA 203k Loan is a government insured mortgage program that allows borrowers to wrap the cost of property upgrades into a new home loan.
Since many homebuyers are finding that most of the foreclosures and short sale listings they are interested in purchasing require a minimal number of repairs to bring them up to personal or bank standards, a 203k loan provides a perfect financing program for borrowers who have a limited budget for down payment + home improvement repairs.
According To HUD’s Website:
When a homebuyer wants to purchase a house in need of repair or modernization, the homebuyer usually must obtain financing first to purchase the dwelling; additional financing to do the rehabilitation construction; and a permanent mortgage when the work is completed to pay off the interim loans with a permanent mortgage.
Often the interim financing (the acquisition and construction loans) involves relatively high interest rates and short amortization periods.
The Section 203k program was designed to address this situation. The borrower can get just one mortgage loan, at a long-term fixed (or adjustable) rate, to finance both the acquisition and the rehabilitation of the property. To provide funds for the rehabilitation, the mortgage amount is based on the projected value of the property with the work completed, considering the cost of the work. To minimize the risk to the mortgage lender, the mortgage loan (the maximum allowable amount) is eligible for endorsement by HUD as soon as the mortgage proceeds are disbursed and a rehabilitation escrow account is established. At this point the lender has a fully-insured mortgage loan.
The main benefit of a 203k loan is that the FHA program was specifically created help borrowers repair, remodel or renovate homes without having to come out of pocket with a bunch of money.
HUD’s primary goal is to help potential buyers purchase a home they may not otherwise be able to afford, by providing mortgages with favorable loan terms, higher loan limits, and flexible down payment options. The 203k program is unique, because it facilitates homeownership for borrowers and houses that may not be able to qualify for a conventional loan program. The popular 203k can be used to purchase a home or refinance an existing mortgage, and at the same time cover the cost of a remodel or necessary upgrades and repairs.
Basically, a 203k loan is a regular FHA loan with an added component that allows for repairs, remodels and renovation. All 203k programs allow borrowers to finance the purchase price of the home along with the extra funds needed for repairs and closing costs. Once the home purchase transaction is closed, renovation funds are held in escrow and released through a draw process to pay for pre-determined renovation work completed by approved contractors.
FHA’s low down payment requirements help borrowers obtain an affordable loan that allows them to rehabilitate a neglected or distressed property. 203k loans are an important tool to increase home ownership, as well as a significant community resource for neighborhood revitalization.
Renovation Funds and Permanent Financing in A Single Loan
Most mortgage financing programs only provide permanent financing. That means lenders will not close a loan or release mortgage funds unless an appraisal demonstrates that the current condition and value of the home provides adequate security for the loan.
If a property requires repair or rehabilitation, most lenders will stipulate that the improvements be completed before they will offer a long-term mortgage. This means banks are not able to fund a conventional home loan until repairs are complete, and repairs can’t be made until the house has been purchased.
FHA’s 203k renovation loan is distinctive in that it allows the borrower to purchase the home and provides additional funds to cover the costs of the proposed remodel or rehabilitation. Prior to the 203k inception, borrowers interested in a distressed property were forced to obtain separate loans to cover purchase, construction, and long-term financing.
The 203k loan programs have filled an important void by providing affordable financing for poorly-maintained properties such as short sales and foreclosures. Potential homeowners who may not have adequate funds for a conventional down payment plus the additional rehab costs this type of distressed property often requires will find a perfect fit with the 203k.
How Renovation Loans Work?
Before you worry about the details, remember that having an experienced 203k Loan Contractor and lender on your team is the key to a successful renovation project.
Most lenders and real estate agents shy away from renovation loans due to their lack of knowledge or understanding of the benefits to buyers, which is unfortunate.
However, a full-time renovation loan expert can lead you through the process and make the experience of buying and fixing up a property exciting.
Rehab Loan Purchase Process
Once the home is chosen, the following process illustrates the steps required to obtain an FHA 203k Home Renovation Loan. Included are the roles played by:
HUD…You’re Real Estate Agent…You’re Mortgage Lender…The 203K Consultant/Plan Reviewed…The Contractor…The Appraiser
Preliminary Market Analysis
To help determine the property’s projected value, the real estate agent can help determine a projected value via a market analysis. This should be performed after a property has been identified prior to signing the sales contract and before you commit funds for an appraisal.
The market analysis should include:
The extent of the rehabilitation work required (Contact a 203K Consultant) …The rough cost estimate of the work (Contact a 203K Consultant or/and Contractor) …The expected market value of the property after completion of the work (Contact a Real Estate Agent)
Writing the Sales Contract
A provision should be included in the sales contract that the buyer has applied for FHA 203k financing, and that the contract is contingent upon loan approval and the buyer’s acceptance of additional required improvements as determined by HUD, the Appraiser or the Rehab Lender….Work Write-up, Cost Estimate and HUD Case #
With the Consultant’s help a feasibility study and preliminary cost estimate is used to produce the SOR – Specification of Repairs. After having refined and determined the specification of repairs the Contractor submits the bid for repairs or/and rehab. Next the lender will request the HUD Case number and the project will now move quickly to the appraisal stage.
Note: HUD does not require a Consultant on a Streamlined 203k loan (a rehab with minor a repair that total less than $35.000 and/or that does not include structural repairs). However, the experience and value of the consultant’s advice can often save more than the fees charged for his/her service…. Lender Prepares/Issues Firm Commitment Application
After the appraisal and the contractor’s bid have been accepted the lender will issue a Conditional Commitment and Statement of Appraised Value to establish the maximum insurable mortgage amount for the property…. Mortgage Loan Closing
The lender prepares the Rehab Loan Agreement and other pre-closing documents required for the mortgage closing. The Agreement is executed by both borrower and lender, and establishes conditions under which the lender will release funds from the Rehab Escrow Account.
A few of those conditions include the construction draw schedule, fees schedule, work item change orders and identity of interest statement…. Lender Obtains Mortgage Insurance Endorsement
After the closing, the lender submits copies of the mortgage documents to HUD for mortgage insurance endorsement. HUD reviews the submission and issues a Mortgage Insurance Certificate to the lender…. Construction Begins
At closing, mortgage proceeds are disbursed and the Rehab Escrow Account is established. Construction may begin immediately, and must begin with 30 days of closing.
During the rehab period, work is not allowed to cease at any time for more than 30 days. And depending on the extent of work to be completed and the type of 203k loan, the homeowner has up to six months to complete the repairs/rehab.
Note: Some lenders may require work to be completed in less than six months…. Funds Are Released from Rehab Escrow Account
Funds are disbursed to the various contractors per the Rehab Lon Agreement. Changes to the work write-up are made through written change orders and are typically inspected by the Consultant or Lender’s Fee Inspector. A final release of the funds confirms the substantial competition of the rehab.
Getting Approved for An FHA 203k Loan
If you are purchasing a home in with FHA 203k financing, there are a few steps and responsibilities you should be aware of to ensure your closing process goes as smooth as possible.
Obviously, you can trust that the experienced team at Rehab Loan Network will be paying attention to all the details along the way.
FHA’s primary goal is to help borrowers purchase a home they may not otherwise be able to finance based on the down payment requirements of most conventional loan programs. To further that goal, FHA offers favorable loan terms, higher loan limits, and flexible down payment options to qualified buyers.
While candidates are not required to have as large a down payment or the income amounts mandated by many conventional loan programs, they will need to show evidence of a steady, verifiable income and a good credit score.
Credit qualification, loan limits and other requirements for all FHA 203k loans are the same as regular FHA loans. Borrowers must demonstrate the willingness and ability to repay the loan. Like regular FHA loans, maximum loan amounts depend on the property’s location.
The distinct difference between regular FHA loans and the 203k programs is that 203k rehabilitation loans are specifically designed to offer loans on distressed, outdated, uninhabitable or poorly maintained properties that may be unable to qualify for conventional loan programs.
In addition to the purchase price of the home, the FHA 203k loan allows the borrower to project costs and include the funds needed for the rehabilitation and related expenses, such as materials and labor.
You can also assure your real estate agent that our 203k Lending Team will keep them in the loop at every step, as well as notify them via phone, email or smoke signals when there are important documents or details that we need.
Most real estate agents and buyers are apprehensive about purchasing a home with an FHA 203k Loan due to their lack of experience with these great rehab loan programs, and the fear that they’ll accidentally mess something up.
Don’t worry though, most experienced 203k Lenders prefer to take control over the entire process to guarantee things get done right. Basically, if you’re working with a Rehab Loan Expert, you’re going to be just fine.
Either way, we have outlined below how the typical 203k loan advances, beginning with the location of a qualified property and ending with the last inspection and Final Release Notice.
Step 1: Buyer Locates the Property and Performs Preliminary Feasibility Analysis
Once a property is identified and before entering a sales contract, the buyer and their real estate agent should perform an analysis to determine the extent and a rough cost estimate of repairs, and the market value of the property after completion.
Note: A good HUD Consultant can simplify this step for the borrower.
Step 2: Sales Contract is Written
The sales contract should include a provision that the buyer has applied for FHA 203(k) financing, and that the contract is contingent upon loan approval and buyer’s acceptance of additional improvements that may be required by HUD or the lender.
Step 3: Buyer Selects Mortgage Lender
The borrower provides information for the lender to request a credit report, verifications of employment and deposits, and any other documentation needed to establish the ability of the borrower to repay the mortgage.
Step 4. Buyer Selects the HUD Consultant
The HUD Consultant will inspect the property and prepare a Work Write-up and cost estimate.
Step 5: Lender Requests HUD Case Number and Appraisal
Once the lender accepts the Work Write-up and cost estimate, they will request a HUD case assignment number and an appraisal.
Nearly all lenders require that both the borrower and the property qualify for the mortgage, and a property’s value is established through an appraisal.
The lender must be certain it can recover the investment if a borrower defaults on the loan. Lenders rely on a real estate appraisal to demonstrate a property’s current, after-repair market value.
This value is used to support the purchase price or determine the equity held by a current homeowner. Final loan approval will depend in part on a satisfactory appraisal.
The critical difference between a traditional loan appraisal and an FHA 203k is that the 203k appraisal is based on the projected value of the home after repairs are complete. This means the 203k appraisal reflects an estimation of how much the property will be worth after the renovation.
A traditional appraisal is based on a property’s current value in the real estate marketplace.
This is another important reason why the scope of work established by your HUD 203k Consultant and the contractor’s subsequent bids are critical.
Detailed contractor bids are an essential element of the appraisal process for an FHA 203k loan. The 203k appraisal is based on the value of the property once the renovations are finished. The appraiser will consider the scope of the work and use it to determine an after-repair value, based on the sales price of comparables in the area that have similar upgrades.
Once the bids and a final, detailed list of proposed improvements are available, an experienced appraiser can evaluate the scope of work and compare the estimated value of the completed property to recently-sold comparable sales nearby.
Remember, the FHA 203k allows a potential homebuyer to borrow up to 110% of the after-repair value of the home.
As soon as the appraisal has been completed, the lender will review all documentation and the appraisal and determine the maximum mortgage amount.
Step 6: Lender Issues Firm Commitment
If all aspects of the borrower’s application, the Work Write-Up and appraisal are acceptable, the lender will issue a firm commitment and prepare a Rehabilitation Loan Agreement, which establishes the conditions under which the lender will release funds from the Rehabilitation Escrow Account.
Step 7: Transaction is closed
At closing, the Agreement is executed by the borrower and the lender, mortgage proceeds are used to pay off the seller, and the Rehabilitation Escrow Account is established with the remainder of the funds.
Note: Once the transaction is closed, the borrower is required to make payments on the entire…mortgage amount, including the funds that have not yet been disbursed.
Step 8: Construction Begins
Depending on the extent of the project, the homeowner has up to six (6) months to complete the work, although the lender may require that repairs be completed sooner.
Step 9: Funds are Released from Rehabilitation Escrow Account
As construction progresses, the work is inspected and approved by a HUD-approved inspector and funds are released through draws to the contractor. A maximum of four draw inspections plus a final inspection are allowed.
Note: If repair costs exceed $10,000, additional draw inspections may be authorized provided the lender and borrower agree in writing.
Step 10: Completion of Work/Final Inspection/ Final Release Notice
When all work is complete, compliant and approved, the borrower provides a letter indicating they are ready for the final inspection. With sign-off from the HUD-approved inspector and the Final Release Notice, the last draw is paid out, less the required 10% holdback.
Unused contingency funds or mortgage payment reserves are applied to the mortgage principal or used to complete additional repairs as per the borrower and lender’s agreement.
FHA 203k Eligible Properties
FHA’s 203(k) loan program can be used to finance a single-family home, as well as 1-4 unit properties.
While most people consider a 203k loan to fix up a foreclosure or distressed short sale that needs serious renovation work, FHA 203k loans can be applied to any property that meets loan limit guidelines.
Updating a kitchen, adding fresh carpet or making energy efficient upgrades are a few examples of how you can take advantage of a 203k loan.
Following specific guidelines, it can also be used to convert a building from a larger number of units down to 4 or less, as well as improvements (interior only) on an FHA-approved condominium unit.
Although FHA 203(k) loans are only offered for owner-occupied properties, provisions allow for the financing of mixed-use buildings, such as those with retail or commercial space combined with residential. In these cases, the 203k loan can only be used for the residential portion of the building.
Eligible Projects Include:
1-4 Unit Properties Family Homes…Conversion of a larger number of units down to 4 or less…Interior renovations on an FHA-approved condo (subject to specific guidelines) …Renovation of the residential portion of a mixed-use building, which combines retail or commercial space with residential…Uninhabitable properties (a tear-down), if part of the existing foundation will remain…Relocation of an existing house to a new foundation
*All properties are subject to specific guidelines…. …Using FHA 203(k) To Purchase HUD Foreclosures:
FHA 203(k) loans can also be used to purchase HUD-owned foreclosures that have been designated by HUD as eligible for the 203(k).
If an eligible HUD foreclosure has been purchased through other means, a 203(k) loan can be made up to six months after the close, and repair funds made available to the owner.
FHA 203k Eligible Improvements
For all properties financed with a 203(k) loan, both the lender and FHA have repair requirements that must be addressed, in addition to the type and extent of work the borrower would like to complete.
FHA requires that properties financed under the 203(k) program meet certain basic energy efficiency and structural standards to comply with HUD’s Minimum Property Standards and all local codes and ordinances.
FHA’s energy efficiency standards include correctly-sized heating and air conditioning systems, as well as the type and extent of caulking, insulation and ventilation. The home is also required to have smoke detectors adjacent to each sleeping area.
Eligible Improvements Under the Streamlined 203(k)
Repair or replacement of roofs, gutters and downspouts…Repair, replacement or upgrade of existing HVAC systems…Repair, replacement or upgrade of plumbing and electrical systems…Repair or replacement of flooring…Minor remodeling, such as kitchens, which does not involve structural repairs…Painting, both exterior and interior…Weatherization, including storm windows and doors, insulation, and weather stripping…Purchase and installation of appliances (free-standing ranges, refrigerators, washer/dryer…)…Accessibility improvements for persons with disabilities…Lead-based paint stabilization or abatement of lead-based paint hazards…Repair, replacement or addition of exterior decks, patios, porches…Basement finishing and remodeling, which does not involve structural repairs…Basement waterproofing…Window and door replacements and exterior wall re-siding…Repair or replacement of septic system and/or well
Eligible Improvements Under the FHA 203(K)
Major rehabilitation or major remodeling, such as the relocation of a load-bearing wall…New construction (including room additions) …Repair of structural damage…Repairs requiring detailed drawings or architectural exhibits…Landscaping or similar site amenity improvements…Any repair or improvement requiring a work schedule longer than six months…Rehabilitation activities that require more than two (2) payments per specialized contractor
Streamlined 203k (k) Vs. Full 203k (K)
Properties that require these documents or services or that will take longer than six months to complete will also require the full, regular FHA 203(k) loan:
A Consultant to develop a specification of Repairs/Work Write-Ups…A plan reviewer, plans or architectural exhibits…Any reason work might not begin within 30 days after loan closing…The homeowner’s displacement from the property for more than 30 days during the time the rehabilitation work is underway
FHA 203k Down Payment Requirements
The down payment requirements for an FHA 203k loan are the same as a standard FHA, 3.5% of the total loan amount.
The difference between the down payment on a regular FHA loan and a 203k is that the 203k loan requires a minimum 3.5% down payment based on the total amount of the home’s purchase price plus the cost of repairs….Obviously, figuring out the exact amounts for rehab costs and loan fees will be something that your 203k Lender and Rehab Consultant will need to be a part of, especially since there may be before and after repair values, mortgage insurance premiums and interest rate discounts to consider.
Bottom line, the main point to pay attention to when figuring your budget for a down payment on a purchase that is using an FHA 203k loan for home financing is that the total amount you will be responsible for is 3.5% of the total loan amount, which will be due at the time of closing.
Receiving Gift Funds for A 203k Rehab Loan
Will you can use gift funds as the down payment for your FHA 203k mortgage?
If so, FHA guidelines require that you provide transfer documentation for both the source and receipt of the gift. In addition, a borrower must provide the lender with a gift letter that includes the donor’s name, address and telephone number, the dollar amount of the gift, the donor’s relationship to the borrower, and a statement that no repayment of the gift funds is required.
The gift letter must be signed and dated by both borrower and donor.
Acceptable Sources of Gift Funds For 203k Loans:
A relative of the borrower…A charitable organization…The borrower’s employer or labor union…A close friend with a documentable relationship to the borrower…A government agency or public entity that provides home ownership assistance
Unacceptable Sources of Gift Funds For 203k Loans:
Cash that is not documented…Funds from the seller…Donation from the real estate agent or mortgage officer…Builder kick-backs…Any party to the transaction
Questions about Documenting Gift Funds:
Are the gift funds already present in the borrower’s bank account?
If so, a copy of the document showing the withdrawal from the donor’s account is required, as well as the deposit slip and bank statement reflecting the deposit of said funds into the borrower’s account.
Will the gift funds be provided at closing in the form of a check or money order?
If so, the donor must provide a document or canceled check showing the amount of the gift funds and their withdrawal from the donor account.
Will the funds be provided at closing as a wire transfer?
The donor must provide documented evidence of the transfer.
Will the funds be provided at closing via a loan to the donor?
The donor must provide written documentation that the funds were borrowed form an acceptable source and NOT from any party to the transaction, including the 203k lender.
FHA 203k Closing Costs
Many borrowers and real estate agents have a fear that the closing costs will be too high with a 203k loan.
While there may be extra attention and service work necessary, the fact is that a 203k loan is one of the least expensive ways to renovate a home.
An experienced Rehab Loan Officer will be able to provide a complete accounting of costs and fees, as well as the dollar amount you will need to close your FHA 203k transaction.
The services presented here may or may not be required for your mortgage, but the list will give you an overview of various costs involved in a typical 203k loan.
Per the Federal Reserve Board’s mortgage compensation rule, a loan originator may not receive compensation that is based on the interest rate or other loan terms. This will prevent loan originators from increasing their own compensation by raising the consumers’ loan costs, such as by increasing the interest rate or points.
Depending on the mortgage company’s government regulated compensation plan, a typical origination fee may range from 1-2% of the total loan amount.
A key point of this new FED rule is that the mortgage company must charge every borrower the exact same lender related fees, for every transaction, regardless of the scenario, interest rate or “relationship” they have with their client.
One of the major consumer benefits of this mortgage compensation law is that it relieves any anxiety that a borrower may feel in thinking that they need to shop around or negotiate for a better deal.
Basically, now a borrower can spend their time pre-qualifying a mortgage company based on their experience and service vs. closing costs and rates.
If the borrower uses or is required to use a HUD Consultant, the borrower and the Consultant must enter a written agreement that completely explains services the consultant will perform for the borrower and the fee charged.
Prior to the appraisal, a HUD-accepted fee consultant must visit the site to ensure compliance with program requirements…. Appraisal
The lender may charge a borrower no more than the actual amount the lender pays to have an appraisal done. Costs vary by area and property, and the fee may be either an upfront charge or included in the closing costs…. Inspection
Fees for a maximum of five draw inspections will be allowed.
Title Update Fee
To protect the mortgage from mechanic’s liens filed by contractors working on the property, reasonable title company fees may be included as an allowable cost, not to exceed $50.00 per draw release.
To see if you qualify for a FHA 203K loan use my quick quote to tell me more about your situation so I can get back to you and see if it is the right loan program for your specific home loan needs. You can always call me direct at (516)-206-0000. Please do not hesitate.