A FHA 203k rehab loan is a hybrid loan that combines regular FHA financing with a construction loan. A buyer can purchase a home in need of repairs and/or one that needs updating/remodeling. The best thing about the 203k is that you’re able to buy a home and pay for the construction costs all in one loan that only requires 3.5% down. You’re also able to include up to six months of mortgage payments in the new loan so you can live in your current residence until the construction is completed.
In this example buyer X purchases a home for $400,000 that needs $75,000 in repairs.
-Down payment is based on the sales price PLUS the final cost of the repairs.
Sales price is $400,000 PLUS $75,000 in repairs/costs (475,000 x 3.5%). Down payment is $16,625 (closing costs are additional)
-Buyer will hire a HUD approved 203k consultant to go to the property with them to determine the required repairs along with any upgrades they wish to do. The consultant’s fees vary, but generally are $600-$1500 for most projects. The consultant will go over these costs before being hired. It’s customary for the buyer to pay half the fees upfront and the rest can be paid through the loan.
-Buyer will then obtain an estimate from a licensed contractor. This is where the HUD consultant is so useful. They can estimate what they think the job will cost to make sure the bids you’re getting are within reason. I recommend getting several bids, but it’s not a requirement. The buyer can act as their own general contractor only if they’re licensed. The contractor will need to provide documentation to be approved by the lender prior to loan approval.
So what kind of repairs can you do with a 203k loan?
- Structural alterations and additions
- Garage (attached /detached/new)
- Remodel kitchen or bathroom
- Install appliances
- Changes to eliminate deterioration and reduce maintenance
- Repair swimming pool (up to $1500)
- Modernize plumbing/heating/air conditioning/electrical systems
- Install or repair roofing /gutters/downspout
- Install flooring /title /carpet
- Energy conversation improvements
- Major landscaping /decks/fencing
- Improvements for accessibility ( e.g. handicapped ramp)
- Interior and exterior painting
- Improvements that are a permanent part of the real estate
- Generally anything considered a luxury addition such as spas, new swimming pools, outdoor BBQ, etc.
One thing to be cautious of is to not over improve the property so it won’t appraise. The 203k allows the loan amount up to 110% of the appraised price. Be cognizant of the surrounding neighborhood and the values it’ll support.
-Once the consultant completes a report of required and optional repairs, the lender will forward it to the appraiser for an after improved value.
-The file is then submitted to underwriting, approved, and closes like any other loan. In most cases anticipate 60 days escrows. Once the loan closes work begins within 30 days.
-For a listing or buyers agent your work is done once the loan funds. The home is now buyer X’s. So the $400,000 house has been purchased and the remaining $75,000 is placed into an escrow account. Disbursements are made throughout the following 6 months; normally 4 draws with one final inspection as the work is completed.
If there is any money left over in the escrow account after the work has been completed, that balance is applied to the loan amount.
The rates on 203k’s are about a half to a full percent more than traditional FHA loans. This program is underutilized but the more you know about it, the more you realize what a great deal it is.
Here are a few other blogs on the FHA 203k rehab loan:
Michael Regan (NMLS #275695) is a mortgage banker who specializes in Marin, Sonoma, and Napa counties. You can reach him at 415-672-2499 or 707-508-8473 for all your financing needs.