Part 2 – Rationale:

You found the home of your dreams in a desirable neighborhood but it’s not in perfect shape. The good news is that some mortgage companies may allow you to wrap the costs of a remodeling project into the loan. This could be true when you use this type of mortgage to purchase a property, or when you decide to remodel a home you already own and refinance to access funds for your project.

One such loan is the Federal Housing Administration (FHA)’s 203(k) rehabilitation loan. This type of loan allows homeowners to roll remodeling funds into their primary mortgage.

We’ll go over the following details to explain how the 203(k) loan works:

What is a 203(k) loan?

Eligibility for using a 203(k) rehab loan

Property eligibility requirements

Borrower eligibility requirements

How to get an FHA 203(k) rehab loan

Pros and cons of an FHA 203(k) loan

Alternatives – other renovation loans

What is a 203(k) loan?

Imagine you want to purchase a $150,000 home that needs a minimum of $40,000 in upgrades and repairs to make it habitable and safe. You could purchase the home and move in until you can finance the improvements separately or you could also take out a 203(k) rehabilitation loan that covers both the initial mortgage amount and the cash you need for repairs.

While many consumers use the 203(k) loan for purchases, also note these loans work for refinancing as well. In other words, if you already own your home but need cash for important updates and improvements, you could refinance your current mortgage with a 203(k) loan and borrow additional funds to pay for the repairs.

The 203(k) loan program offers two versions that work best for different situations:

• The Standard 203(k) is perfect for updates and repairs, although there is a minimum repair cost of $5,000 and you have to work with a 203(k) loan consultant to complete the process.
• The Limited 203(k) is for modest upgrades and repairs. This loan does not require you to use a 203(k) consultant, but the maximum repair cost cannot exceed $35,000. There is no minimum repair amount for this type of 203(k) loan.

Generally speaking, 203(k) loans can be used for projects that increase the value of your home, make it safer or improve structural integrity. The FHA lists the following eligible activities for loan funding on its website:

Structural alterations and reconstruction activities

Improvements to a home’s function or utility

Improvements that improve health or eliminate safety hazards

Changes that improve a home’s appearance

Replacing or repairing plumbing, a well or a septic system

Replacing or repairing roofing, gutters or downspouts

Replacing or adding flooring

Major site improvements or landscaping projects

Improvements that make homes accessible for people with a disability

Energy-use improvements

Eligibility for using a 203(k) rehab loan

While 203(k) loans tend to offer flexible terms for both borrowers and the homes they suit, they do come with some basic requirements.

Property eligibility requirements

For a property to qualify for a 203(k) rehab loan, it must have been completed at least one year before it is assigned a case number. This means 203(k) loans cannot be used for brand-new construction that is less than 1 year old. Other property requirements for 203(k) loans include:

Must be a one to four unit building of single-family homes

Can be a condominium if it is in an FHA-approved condominium unit; improvements are limited to the interior of the unit in most cases, and the unit is in a building with no more than four units

Can be manufactured housing if the upgrades and improvements do not affect the structural components of the building

Can be a mixed-use property with one to four residential units, provided at least 51% of the unit is residential

The home cannot exceed dwelling-unit limitations for the area

The home must be located in the United States.

Borrower eligibility requirements

There are also borrower eligibility requirements for 203(k) loans. These requirements determine who is eligible and under what circumstances.

To qualify for a 203(k) loan, you must:

Have a valid Social Security number (unless you are a state or local government agency, instrument of government or nonprofit approved by the U.S. Department of Housing and Urban Development, or HUD)

Be able to provide the lender with your SSN, name, date of birth, original pay stubs, W-2s, valid tax returns and any other required information to obtain a mortgage

Have a minimum credit score of 500

Be a U.S. citizen or an eligible noncitizen

Not have any delinquent federal tax debt

Not have a delinquent FHA home loan

Must live in the property as a principal residence.

How to get an FHA 203(k) rehab loan

To determine eligibility for an FHA 203(k) loan, you’ll need to search for a lender that’s approved to offer FHA loans. Fortunately, HUD offers a tool on its website that allows you to search for FHA-approved lenders in your area. It even includes a featuring of searching only for lenders that have dealt with a 203(k) rehab loan in the last 12 months.

If you plan to apply for a Standard 203(k) rehab loan, you’ll need to work with a 203(k) consultant. This consultant, who must meet stringent requirements in terms of their work experience and licensing, will inspect the property and prepare the architectural paperwork, work write-up and cost estimate for your project.

The FHA 203(k) consultant is also charged with overseeing the renovation funds, which are initially placed in an escrow account. Your consultant is able to sign off on when these funds are released to contractors and service providers working on your project.

In my next blog, I will go into details on the Fannie Mae renovation loan type.

Editor’s note…

This is the beginning of a series of articles concerning the possibility and process of getting your dream home – through a “Renovation Loan”.

Part 1 – Rationale:

When you are looking for a home to buy, especially early in the process, you may run into this scenario. You love the community, the schools are nice, but the house looks dated and needs a lot of work. Then you want to find another property.

Under a conventional loan, that would be your best option, to move on to the next property and settle for a compromise. You convince yourself that you have found your “dream” home but it’s in an okay neighborhood with okay schools, longer commute, higher taxes, etc… At the closing, you are thinking (before you sign your life away into the conventional mortgage), if only my dream home was in the first neighborhood I looked at? Well, don’t let this happen to you. There is another option you can try if you find the home of your dreams but needs TLC. You can buy the home under a renovation loan.

There are many advantages to obtaining a renovation loan. You can finance the property and get funds to repair or improve/upgrade your home in a single mortgage loan. This is both convenient and at other times necessary to qualify for a renovation loan. Existing homeowners can also benefit from a renovation loan. These loans help them improve their homes. They can get funds for improvements, based on the after-improvement value of the property and this is helpful if they have limited equity in their homes.

There are various types of renovation loans out there, but these are two of the most popular ones…

FHA 203k Renovation Loan

There are two types of FHA renovation loans a Standard 203k and a Limited 203k. The Standard is used for larger projects, like rebuilding a home from the ground up. These projects exceed $35,000. For smaller repairs, upgrades and improvements, the Limited 203k will provide up to $35,000. Work must be completed by licensed contractors. The loan requirement is a little less attractive to DIY-ers. Money set aside for renovation work is held in a renovation escrow account and is released when repairs are completed.

HomeStyle Renovation Mortgage (Fannie Mae)

HomeStyle Renovation Mortgage provides funds for the purchase or refinances a home with accompanying funds for home improvement. Loan amounts can be up to 50% of the as-completed appraised value of the property. Approved contractors will handle most of the renovations, However, HomeStyle Renovation Mortgage allows borrowers to perform up to 10% of the project’s as-completed value.

In the next couple of blogs, I will go into details on both FHA and Fannie Mae renovation loan types in order to help educate home buyers and current owners on another possible way to live in their dream home.