rvine, Calif.-based RealtyTrac reports 2.87 million properties received notices of default, auction or repossession in 2010—a 2 percent increase from 2009. Vacated properties often become victims of looters or even the evicted owners who vandalize the house or steal anything that can be reused or sold. When systems and features, such as copper pipes, appliances and HVAC equipment, go missing and homes are left with gaping holes in walls, they are considered unlivable. Unless a prospective buyer can pay cash, the house will sit vacant because it must pass the U.S. Department of Housing and Urban Development’s minimum property standards to be mortgaged.
However, the Federal Housing Administration’s 203(k) Mortgage will provide the financing to restore the home so it can pass appraisal and receive a mortgage. 203(k) is HUD’s primary program for the rehabilitation and repair of one- to four-unit dwellings. Despite being around since 1961, 203(k) is largely unknown among consumers, realtors and even lenders. Therefore, remodeling contractors who understand the basics of the program can create their own opportunities to garner work rehabilitating foreclosures and revitalizing neighborhoods.
The 203(k) program allows a borrower to get just one mortgage, at a fixed or adjustable rate, to finance the purchase and rehabilitation of a property. The mortgage amount is based on the projected value of the property with the rehab completed while considering the cost of the work. To minimize the lender’s risk, the mortgage is endorsed, or insured, by HUD. Endorsements typically run 30 to 45 days after the closing because the lender must go through its processes before sending the paperwork to HUD to be insured, which takes additional time.
Two versions of the 203(k) loan exist: streamline and consultant. The streamline version primarily is used to bring a property up to minimum property standards, so it can obtain a certificate of occupancy. “It does not allow any structural improvements to the property, and because the loans are limited to between $5,000 and $35,000, a remodeler’s margins for profit could be limited,” explains Steve Linville, director of Single Family Finance for the National Association of Home Builders, Washington, D.C. “The consultant 203(k) program has more potential for remodelers because it allows improvements up to the completed value, which could be substantially more than the $35,000 limit imposed by the streamline version.”
According to a banking executive for a major U.S. financial institution, qualifying for the 203(k) program is the same as qualifying for any FHA loan. If a buyer has a good enough FICO score, has had his job for two years and has enough money for a down payment, he’ll be approved. However, he must be able to afford the house and repairs and qualify for that total amount.
The borrower is approved for the purchase price of the home, the remodeling and closing costs, as well as a contingency reserve of about 10 to 20 percent of the total remodeling costs. This is designed to cover any unexpected construction problems that arise.
The borrower must work with an FHA-approved lender and make a down payment of about 3.5 percent of the home’s purchase price and repair costs. The home buyer then seeks bids for the necessary repairs. How many estimates and who the buyer ultimately chooses to do the work is entirely up to him though the lender may have a prequalified group of contractors from which to choose. Because the lender is taking a risk, it will require the remodeler to sign a contract. “The lender must review credentials, work experience and client references,” Linville says. “An agreement between the contractor and the borrower also must outline the responsibilities of each party.”