A Quick Overview Of a 203(k) Loan
What are the benefits of this program?
- Great Deals: You can purchase a "fixer upper" at a lower price and qualify for the home purchase that many other programs would not allow. A hard-to-sell property can turn into a "dream home".
- More $$ in your pocket: You can hang onto your savings while fixing up a worn or broken-down house.
- Low interest: by dealing with the FHA, you will get a better than average interest rate on the money you need to borrow. Many rehab loans in the commercial marketplace can be very expensive.
- Simplicity: There is one loan closing and one monthly payment.
- Upgrades: You can include upgrades such as repairing a swimming pool, kitchen appliances, adding a room addition and/or rearranging existing floor plans.
In simple terms, the 203(k) loan is a type of home improvement loan program insured through FHA allows homebuyers to finance the purchase price and the costs of repairs or upgrades with one single mortgage. The 203(k) loan can also work as a refinance option for homeowners who want to add basic cosmetic or structural improvements to their home.
It is important to remember that neither the FHA or HUD actually loans money to a borrower. Instead, the FHA “Insures” a loan that is provided by an FHA approved lender.
While the borrower’s eligibility requirement for a 203k loan follows standard FHA lending guidelines, there are a few extra steps involving a contractor, inspector and HUD consultant to ensure the property meets FHA’s insurance standards and minimum property standards (MPS).
The Renovation and Loan Process
The primary steps in how the 203k loan process works are outlined below to serve as a general reference guide, so please don’t worry about if you don’t understand it to begin with.
Step 1 – Meet With A 203(k) Mortgage Lender
Many home buyers rush out to look at properties before speaking with a qualified 203k Rehab Loan Specialist, which can present some future challenges once a purchase contract has been accepted by a seller.
A lenders initial conversation with a borrower starts with the basic loan qualifying questions, such as budgeted down payment, total loan amount, employment, income and credit history.
Once they get a picture of the borrower’s financial and employment history, they will discuss property and home improvement requirements to determine which loan program best suits a buyers short and long-term financing goals.
Some very good advice would be to have your real estate agent contact the lender and 203k Consultant first to ensure you fall in love with a property that qualifies for this program. With a little insight, your agent may even be able to help you find a better deal on a home that can be renovated to your specific needs and wants.
Step 2 – Preliminary Market Analysis
With your loan pre-qualification letter prepared stating the terms and a maximum loan amount that you qualify for and fits your budget, it is time to start looking for properties.
Once you’ve found a potential property, a Preliminary Market Analysis (PMA) can be completed by your real estate agent and with the help of a contractor and 203(k) Consultant you can get an “Guesstimate” of what repairs or rehab is needed and what the property’s projected value might be after the renovation is complete. If possible this should be done BEFORE signing the sales contract and BEFORE you commit funds for an appraisal.
The PMA (preliminary market analysis) should include:
- The extent of the rehabilitation work required (Contact a 203(k) Consultant)
- The rough cost estimate of the work (Contact a 203(k) Consultant or a Contractor)
- The expected market value of the property after completion of the work (Contact a Real Estate Agent)
Step 3 – Writing The Sales Contract
A provision should be included in the sales contract that the buyer has applied for FHA 203(k) financing, AND the contract is contingent upon loan approval and the buyer’s acceptance of additional required improvements as determined by HUD, the 203k Consultant, the Appraiser, and/or the Mortgage Rehab Lender.
Step 4 – Work Write-up, Cost Estimate and HUD Case #
What is included in the work write-up?
First, the work write-up includes repairs needed to ensure the property is safe and habitable. Second, the report includes additional repairs or upgrades desired by the buyer. Want to upgrade the kitchen with new appliances? Want a new roof OR deck? Want to add another bathroom or bedroom? This and more is possible through this program! With the 203(k) 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 a bid for repairs.
At this point 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 Streamline 203(k) loan (a rehab with minor repairs that total less then $35,000 and 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 the service.
Step 5 – 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.
Step 6 – Mortgage Loan Closing
Note To Real Estate Agents – This is a typical closing where the buyers would sign final loan documents and the close of escrow date is met, which is also when the real estate agents are paid and technically done with the transaction. To meet the COE deadline with as little anxiety as possible, it’s best for agents to let the lender run the show from steps 4-6.
Note To Buyers – The mortgage closing is where 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 these conditions include the construction draw schedule, fees schedule, work item change orders and identity of interest statement.
Step 7 – 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.
Step 8 – Funds are Released from Rehab Escrow Account
Funds are disbursed to the various contractors according to the Rehab Lon Agreement. Changes to the work write-up are ONLY 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.