The fact and fiction about rehab mortgages

A few years ago a client called me. They had a small amount of money and a steady income.
They were searching for a home with a purchase price, which at the time was really low. It was what they could afford. A local realtor found them a home. it was a 90 year old, old style colonial. It was ugly, and needed a bit more than just TLC. Old kitchen, very dated bathrooms, a damp basement and drafty windows. The house comprised of very small rooms and didn't flow. It was the only home in their price range and neighborhood.

I put them into a loan, which we seldom hear about. The FHA 203K loan. This is a rehab loan. It is a great product for the client that wants either purchase a home or refinance their home to do construction. There are two challenges that come up when someone is in this situation

A. When purchasing, the client has enough money for the down payment and closing costs but not enough do to the repairs/addition/rehab
B. The house either appraises low or in poor condition. A bank will not lend on a house that is in less than good condition or if it need repairs. On a refinance, a bank will not lend over the as is value of the house. One may want to make an addition that will drastically increase the value of the house upon completion but right now as is, the value is lower so there is not enough equity to do a cash out. On a purchase, it’s almost the same. The bank will not lend over the purchase price because of work that will be done.

How does one finance these renovations? In today’s credit and lending climate, the builders and contractors don't have any venues for rehab/repair/construction funds. The days of the easy Home Equity Lines of Credit are gone.

The FHA 203k is a great option. Let me explain some the details of how this loan works and what are the options that you may have.

The 203K loan is a rehab/construction/repair loan. It does not finance new construction. If you buy a home and tear it down to build a new home, you must build on the original foundation. You can modify, enlarge it etc. but you cannot buy a lot and build a new home.

It will not finance luxury items like a swimming pool, hot tub etc

You can borrow from as little as $5,000 up to the FHA limits in our area. On a one family home, the limit in our area of $729,000. The home must be owner occupied, primary residence, not a second home, vacation home or investment property. It can be a 1-4 family or a mixed-use property if the applicant lives in the residential unit.

A normal mortgage has 2 steps. This loan is a 3 step process.

Step 1: Credit. Every loan has a credit portion; this is the analysis and approval of the applicants credit, income and assets
Step 2. The appraisal portion, every loan requires and appraisal. This is provided to the bank so that the bank can make a decision if the collateral is acceptable
Step 3. Construction/rehab/repair. This is unique to the 203K. The bank evaluates the scope of the job and bases the loan on an “after improved value”.

Very basically, the way this loan works is, the bank lends up to 96.5% of the after improved value, basing the loan on the purchase price + the rehab cost. For example, if you buy a home for $300,000 and then you want to do $150,000 renovation, and the after improved value is 450,000, under the 203K program you would get a mortgage of up to $434,250. At closing, the seller would get the $300,000 (purchase price) and the rest of the money would go into an escrow account to be disbursed as needed during the rehab period.

For more information on 203K loans and other loan products contact a local mortgage professional who knows the in’s and out’s of FHA financing. The key to a successful mortgage experience is the professional that you work with.