Irvine, 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.”
Once a contractor is chosen, the property is appraised to determine the value of the home after the work is completed. “Because we get the plans and specs, we know what work is going to be done and we know how much it’s going to cost,” the bank executive says. “Once a remodeler makes the home livable, it should be worth $200,000, for example, and we’ll loan the borrower that amount even though the house is not worth that much today.”
In addition, the lender is involved with inspecting the work done on the property. “We hold the money, so we’re going to inspect the work and ensure it’s done appropriately before we release the money,” the bank executive says.
As is the case when getting involved in any unfamiliar program, it is important remodelers surround themselves with others who are familiar with 203(k). “Because lenders are responsible for the compliance of the program, they deal with the most difficult pieces of putting and holding things together,” Linville explains. “This is why it is critical that remodelers carefully evaluate the lender’s proven success record of processing these loans. With leaner markets, a loan officer might try to do a 203(k) loan, but their inexperience with the product could lead to a disaster, which could ultimately reflect poorly on the service the remodeler provides, diminishing the opportunity for additional referrals. It also is important the realtor is very knowledgeable of how this program works.”
Mike Nagel, CGR, CAPS, and Scott Sevon, CGR, CAPS, GMB, CGP, GMR, partners at MAW Chicago, Palatine, Ill., have worked on many 203(k) projects and urge other remodelers to take on these projects. However, they caution remodelers to be ready for anything, including program novices.
“We were part of a small 203(k) job, about $14,000, in Carpentersville, Ill., and we lost the job because the realtor didn’t understand the program,” Nagel remembers. “We constantly run into realtors and loan officers who aren’t prequalifying their people. We lost this particular job because the buyer was 1 point under in his FICO score.”
Now that MAW Chicago has proven success with these jobs, it often is contacted by lenders and homeowners for 203(k) projects. No matter who contacts the firm, the turnaround for its services must be quick. “A lot of buyers call us after they have been involved with a lender and loan for a month or two months, so they want to meet us at the home tomorrow and get our price for the repairs by tomorrow night,” Sevon says. “It’s extremely difficult to pull all the things together in a short amount of time and gather a responsible price.”
Linville says this quick turnaround often is a point of confusion. He explains: “A plan review must occur before the work write-up is done and an appraisal is ordered. Borrowers need to have a variety of items prepared for the plan review, such as an existing plan of the structure, a proposed plan if any structural changes are involved, certain inspection reports, specifications of the repairs, descriptions of the materials and a plot plan if there are any site improvements.”
In addition, Linville emphasizes a remodeler’s need to understand the 203(k) mortgage loan amount cannot be increased to cover any additional expenses. “It is very important that when a remodeler is estimating the costs of improvements, he must be very accurate so he is able to complete the work at or below the estimate.”
However, in construction, unforeseen problems often arise. “In Southern California, Las Vegas or Florida, a property that sits vacant may only have minor damages. When you’re working in Illinois, Minnesota and cold country, you run into more problems,” Sevon says. “Mike and I were on a $1 million house in Naperville, Ill., that had the water drained and sat vacant for a winter or two. We were prepared that there could be some damaged pipes behind the walls, which we couldn’t know for sure until we charged the system with water. Once the system was charged, we had 16 leaks—there was water coming out of everywhere. Anything not covered by the contingency came out of the homeowner’s pocket.”
Another challenge tends to be the permitting and inspection processes. According to Nagel and Sevon, some cities require permits for the work done under the streamline 203(k) and some don’t. “If they require permitting like one of ours did, the city inspector came in after the HUD inspector walked the entire house, and the city inspector added seven things to the list that totaled about $4,000. The homeowner was flipping out,” Sevon remembers.
“You may think you go into some towns and are just going to patch holes in the wall and put a few outlets back, and then the inspector walks in and says, ‘I want interconnected smoke detectors and extra railings.’ It can get expensive and sometimes goes beyond the contingency.”
Buying a home can be an overwhelming process, and trusting a realtor and attorney can make a difference. The same is true when buying a foreclosure with a 203(k) loan: A lender who understands the program and an experienced contractor who is willing to patiently navigate the process are invaluable resources.
“Finding a lender who is comfortable with the program and has a process in place is helpful,” the bank executive says. “You can imagine each different house has a different scenario: one may need a roof, another had its HVAC stolen, or another needs to be hooked up to public utilities. 203(k) could be used for all of these scenarios, but if a lender hasn’t been through these situations, it probably isn’t going to be as good as one who has.”
Despite the challenges, Nagel and Sevon think 203(k) loans are a tool for improving the housing industry. “Conventional loans today require 20 percent down, which I totally disagree with and think is going to hinder our industry even more,” Sevon says. “It’s going to be very difficult for young couples who buy a house that might need remodeling to come up with that down payment. FHA and 203(k) allow much lesser down payments.”
Sevon adds the immediate increased appraisal is a benefit of 203(k). “If a house is being bought for $170,000 and you’re putting in $30,000 worth of work, the minute you sign the loan, that house’s value is $200,000. That helps the economy because it gives value to these appraisals that other loans can’t do. It is an inherent benefit for the entire country because low appraisals are hurting remodelers and others across the nation.”
Lastly, Linville thinks 203(k) is a great tool for remodelers to grow their businesses. “I want to continue to emphasize that remodelers develop strong relationships with a couple of loan officers who really understand how these loans work and have a strong appetite to originate them,” he says. “Using a knowledgeable lender and loan officer makes all the difference in your customer’s experience and will lead to additional referrals, for which you should always ask.”
Nationally, in 2010, HUD endorsed 22,491 203(k) mortgages.
FAQs about 203(k)
Q: Can remodelers use 203(k) to purchase investment properties?
A: In 1996, HUD put a moratorium on investor participation in the 203(k) program. HUD has been talking about bringing it back for years; this is a great market for it because we have so many foreclosures and more coming. There’s always a possibility it might come back but nothing definitive. — bank executive for a major U.S. financial institution
Q: Why don’t more people know
A: We’ve recently done a lot of research with realtors, consumers and loan officers, and education and awareness seem to be the constant theme. Some realtors know about 203(k) because the program has been around for awhile, but there are and have been some lenders who don’t do it well, which tends to give it a bad reputation. — bank executive
Q: Are three bids required for 203(k)?
A: Using a HUD consultant is recommended on the streamline 203(k) loan and mandatory on the consultant version. The HUD consultant, who often is an inspector who has broadened his expertise, is responsible for advising clients about the complex 203(k) process. When a HUD consultant is used, only one bid is necessary. — bank executive
Q: With regard to RRP, HUD requires third-party lead testing. Does this supersede EPA’s requirement if a homeowner is using a 203(k) loan for repairs?
A: The 203(k) program can be used for lead-based paint stabilization or abatement of lead-based paint hazards, but my understanding is a state or EPA-certified lead-based paint inspector, certified risk assessor or sampling technician must perform the clearance examination. Because of the complex nature of this issue, I would suggest remodelers discuss this with the lender and HUD to ensure they are receiving the most current and accurate information. — Steve Linville, NAHB director, Single Family Finance