203k loans: the best secret for fixer-uppers
JoVon Sotak | Improvement Center Columnist | May 16, 2012
Sometimes, you can't pick why you're famous. The three-bedroom, one-bath house at 1960 Lake Drive in Independence, Mo., is located in Gold Acres subdivision, which is the former home of granddaddy sire Anxiety 4th, the famous Hereford cow responsible for perfect beef in America. Despite this claim to fame, at the time of this writing, no one has scooped up 1960 Lake Drive, priced at $82,000. The listing, which boasts the property's endless potential, describes the home as a "perfect 203k FHA property."
What is a "203k"?
A 203k is a type of Federal Housing Administration (FHA) mortgage program for homes in less than ideal condition, and the loan includes additional repair or renovation funds that can be paid back over time. Lisa A. Snead, renovation specialist for Plaza Mortgage Services in Leawood, Kansas, explains that a 203K loan is basically a home improvement loan issued by the Federal Housing Administration (FHA) mortgage program. A borrower finances both the purchase of a home and the amount needed to complete the repairs and improvements.
The type of repairs, the total cost and the amount you have available for a down payment are some factors considered when determining which type of loan is best for a homebuyer. "If someone wants to put on an addition, it may be necessary to go with a conventional," says Snead, noting that the "streamline" FHA 203k, which is typical for homes that will cost less to fix, in many areas, that figure is $35,000 or less, can't cover structural issues. However, the conventional renovation loan requires 15 percent down, a detail that may cause buyers to reconsider their repairs and improvements in favor of FHA's 3.5 percent minimum down payment.
The loan process is similar to a traditional conventional mortgage or FHA loan, but much more complicated. Here's a breakdown of the typical process involved:
- Get pre-approved, just as you would with any home purchase
- Gather loan documentation. Some of the documentation you will have already provided during the pre-approval process. Ask your bank which additional docs are required. It's helpful to have these ready when they are needed.
- Make sure the property you'd like to buy qualifies for the type of loan for which you have been pre-approved.
- Make your offer on the house. Indicate that the FHA 203K loan is the product you intend to use in the purchase contract
- Once the offer is accepted you'll give the purchase contract to your renovation loan specialist, along with any other necessary documents. You loan should go into underwriting now.
- Home inspection. It's always smart to get a home inspection, especially in cases involving 203k financing.
- Gather contractor bids. You will not be allowed to do the work yourself with a 203k loan.
- Pick your contractor, and have a detailed, itemized plan. Most lenders will have some documentation for the contractor to complete. Include it with the bid to your renovation loan specialist.
- A HUD consultant will provide a write-up. (A HUD Consultant is not required for streamlined loans). They will need finalized paperwork from the contractor.
- Home appraisal. 203K loans are based on the value of the house after repairs are made, so a home appraisal is necessary to proceed.
- Loan approval. If your appraisal looks good and works with your loan amount (usually the total loan amount cannot exceed 10% beyond the estimated value of the house after repairs) you will be ready to close.
- Loan closes.
- Contractor can pull permits, and start work. In some cases the lender will ask to see the permits before distributing funds, so best to start the permit process as soon as possible.
- If using a streamline 203K you'll likely get 50% of the funds shortly after your closing (often within a week). For a regular 203k, the draw schedule should be outlined in the work write-up and can vary.
- Final inspection and title update. The work is completed and you're ready to get your final draw. Usually an inspector will be sent to make sure everything has been done as specified. If everything is as planned, your renovation escrow will be closed and you'll have a standard FHA loan.
One thing to keep in mind is that the interest rates tend to be slightly higher for 203K loans because these are higher risk loans. FHA also has a slightly higher credit requirement of 620 for 203k loans. Buyers pay for inspections and need to coordinate with contractors throughout the ever-evolving loan process, which typically take longer (45 to 60 days) to close. Repair funds go into a separate account to ensure that work gets started within 30 days and is completed within a set period, typically six months.
"Most homeowners don't know about this program," says Snead, who spends a lot of time educating real estate agents about 203k loans. "The 203k isn't new -- it's been around a long time but it wasn't used much before our current mortgage conditions." Snead notes that that not all mortgage lenders offer these loans, so you may need to shop around.
Refinance with a 203k, too
203k loans aren't only for new home purchases. Old-house owners needing to make those often-spendy improvements, such as converting the oil furnace, upgrading the electrical or finishing a basement, can refinance at today's historically low interest rates and get funding for repairs.
203k loans are also a great solution to repair homes that were damaged by natural disasters, such as Hurricane Irene, which the New York Times reported to be one of the top 10 "costliest catastrophes" in America's history because flooding wasn't covered by many homeowners' insurance policies.
203k loans for homes that "need love"
Audrey Elder, historic homes specialist and the listing agent for 1960 Lake Drive, says many people don't realize the amount of work involved when rehabilitating an old home, especially if they are restoring it to strict preservation standards. "I feel there is trepidation among potential buyers that would love to dive into the lifestyle of owning and restoring a historic aged home, but are scared of the initial costs that are needed to make it modernized for things like electricity and heating and cooling, let alone sometimes the costs to make it livable." 203k financing is a great solution for most properties that "need love," according to Elder.