This says it all.
This says it all.
Part 5 – Rationale:
You get a phone call from a potential buyer or from a lender asking the question – Can you do a 203K Work Write Up? Normally the answer should be “Yes”. However, after getting the information on the details of the project, I ask this question, “Has the buyer selected a general contractor?”
This may sound absurd but the most important person on this process is not the lender (whom controls the loan and distributes the funds) nor the borrower (whom found the home and will be paying the mortgage) but you guess it, it’s the general contractor.
The role of a General Contractor
Most rehab lenders have a standard procedure to assess a contractor’s eligibility. A general contractor is required to submit cost estimates along with the license documentation, a copy of the commercial liability insurance policy needs to be submitted for approval. It does not hurt to have references, credentials and financial data at the ready, if asked from the lender.
Then an agreement is reached with the contractor to complete the work at the agreed price within the stipulated timeframe. An IRS w-9 form must also be collected for the general contractor and for any other vendors involved in the completion of the renovation work. This step is necessary prior to release of any fund advance to the contractor for initiation of the repair work.
A general contractor is expected to complete the proposed work in accordance with the details outlined in the written estimate, homeowner/contractor agreement and approved change orders. All the repair work and improvements should be completed under the applicable local codes and ordinances. Several permits are necessary and must be secured prior to beginning any concerned work. All payments required for permits will generally be listed in the 203k contractor’s bid sheet.
Contractors need to understand the following
The borrower is responsible for approving, selecting and hiring whichever contractor they want, however for a large construction project, I recommend at least three contractor’s bids, including the borrower’s contractor. Why? Because as the borrower, you will have to live with the results after the contractors collected their payments and the borrower will have to pay on the mortgage. During the construction process, there will be issues that we all have to agree on. In addition, each contractor bid will not come out the same price, but the scope of work will have to be the same as the Preliminary Work Write Up (Feasibility Study). The lowest bid does not mean the borrower will select that contractor. That contractor may have to explain how they got those numbers. My job as a consultant is to review each of proposed cost in thorough detail. It is my responsibility to ensure that the repair costs are acceptable and within reasonable estimates. Anything that is deemed to be excess or unnecessary is resolved on consultation with the borrower, contractor and the lender.
The compensation structure setup by these types of loans does not always permit contractors to receive pre-renovation deposits/start-up funds. This is very important, general contractors must be financially capable of affording the start-up costs and ongoing expenses with any rehab renovation project. Ample credit lines with suppliers and subs and/or sufficient capital/reserves will be verified as part of the certification process.
So, how do the general contractors get paid?
The contractors are paid in a series of draws by the borrower’s lender through escrowed funds. At closing, the lender places the rehab/improvement funds into an escrow account. The general contractors need to be as knowledgeable as possible regarding the rehab process. The exception that a general contractor will receive funds at startups is the FHA 203k Limited. The general contractor receives a maximum of two (2) payments. After closing on the home, contractors may receive a portion of the job cost (maximum 50%) as a pre-construction payment, subject to lender approval but may take weeks to arrive. Therefore, contractors must be financially capable of affording all the start-up costs and a portion of the ongoing expenses with the 203k project (ample credit lines with suppliers and subs and/or sufficient capital/reserves). Once all the work is complete, the contractors can request final payment of the remaining portion of the job cost according to the proposal that was submitted and approved by the borrower and the lender.
Part 4 – Rationale:
If you’re looking to buy a home at a price you can afford in a desirable neighborhood, you may have to consider homes that aren’t in perfect shape, or even ones that require a complete overhaul. 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. However, there are Pros and Cons going into each types of renovation loans. Here are a few of them…
Pros and cons of an FHA 203(k) loan
FHA 203(k) rehab loans come with both advantages and disadvantages. Some reasons to consider these loans are listed below, along with some of the pitfalls that make them a less attractive option.
Pros of FHA 203(k) loans
Cons of FHA 203(k) loans
Pros and cons of an HomeStyle Renovation Mortgage Pros
HomeStyle Renovation Mortgage Pros
The HomeStyle Renovation Program enables you to finance the purchase of a home or refinance plus the cost of major home renovations with one mortgage as opposed to arranging a mortgage plus a second construction or home equity loan to finance the renovations. The HomeStyle Renovation Program offers borrowers a simple and more cost-effective solution to finance the purchase or refinance of a property plus major renovations, repairs or remodeling.
Low Down Payment or Equity Position Required
For the purchase of a single unit property with a fixed rate mortgage, the HomeStyle Renovation Program only requires that borrowers make a down payment of 5% of the property purchase price or the case of a refinance, borrowers are only required to have 5.0% equity in the property, which implies a loan-to-value (LTV) ratio of 95.0%. The required down payment or equity position of 5% is lower than the 10% – 20% required by other standard mortgage or construction loan programs, although it is higher than the 3.5% down payment required by the FHA 203(k) Home Improvement Loan Program.
Applies to Investment Properties
The HomeStyle Renovation Program applies to both owner-occupied and non-owner occupied properties, unlike the FHA 203(k) Program which only applies to owner-occupied properties. Borrowers can use the HomeStyle Program to purchase rental or investment properties that require significant repairs or rehabilitation. Please note that only single unit investment properties are eligible for the program and borrowers are required to make a much higher down payment on investment properties. Borrowers, however, can use the HomeStyle Program to purchase multi-family properties with up to four units as long as they occupy one of the units.
Financing Based on Post-Renovation Property Value
The HomeStyle Renovation Program, allows you to qualify for a mortgage based on the post-renovation property value. For the purpose of qualifying for the HomeStyle Program, the property value is defined as the property purchase price plus the estimated cost of the renovations or the appraised as-completed property value, which is less. Using the higher post-renovation property value enables borrowers to qualify for a larger mortgage and also eliminates the need to arrange a separate construction or home equity loan.
No Restrictions on Mortgage Type or Loan Program
While the HomeStyle Renovation Program is typically used to buy homes that require significant renovations borrowers can also use the program to refinance their existing mortgage and finance a major home improvement project at the same time. Borrowers with high mortgage balances and limited equity in their homes may find it challenging to qualify for a construction loan, HELOC or home equity loan to finance a home improvement project. Borrowers, however, can use a HomeStyle Renovation Mortgage to both refinance their existing mortgage and finance their home renovation. Additionally, borrowers can use either a fixed rate mortgage or an adjustable rate mortgage (ARM) with the HomeStyle Renovation Program. Although the down payment or equity position required for an ARM is higher than for a fixed rate mortgage, the ability to use multiple loan programs increases your financing flexibility.
No FHA Mortgage Insurance Premium
Unlike the FHA 203(k) Program, the HomeStyle Renovation Program does not require borrowers to pay an upfront mortgage insurance fee. Additionally, borrowers that make a down payment of at least 20% are not required to pay ongoing monthly private mortgage insurance (PMI). Borrowers that make a down payment of less than 20%, however, are required to pay PMI, which is an extra monthly cost on top of your mortgage payment. Depending on your credit score, LTV ratio and mortgage program, monthly PMI may be less than monthly FHA mortgage insurance premium (MIP). Additionally, PMI is removed when your LTV ratio falls below 78% whereas borrowers are required to pay FHA MIP over the entirety of their mortgage.
HomeStyle Renovation Mortgage Cons
Higher Interest Rate
The interest rate for a HomeStyle Renovation loan is usually .125% – .375% higher than the interest rate on an FHA 203(k) loan or other conventional mortgage program. Additionally, borrowers with lower credit scores and higher debt-to-income ratios usually pay higher interest rates with the program. The HomeStyle Loan Program is offered by traditional lenders such as banks, mortgage brokers, mortgage banks and credit unions so borrowers should compare proposals from multiple lenders to find the mortgage with the lowest rate and fees.
Higher Closing Costs and Longer Closing Timeline
The HomeStyle Program requires borrowers to submit to the lender plans and specifications for the home renovation project. Preparing these plans can be costly and time-consuming. Additionally, due to the additional work required to review and process a HomeStyle mortgage, most lenders charge an extra fee which increases your closing costs. Some appraisers may also charge higher fees because they are required to appraise the property both before and after the home renovation project is completed. Additionally, because of the complexity involved, it can take more than three months to process and close a HomeStyle loan as compare to one-to-two months for a regular mortgage. Borrowers should understand the extra cost and time associated with a HomeStyle Mortgage before selecting a lender.
Mortgage and Renovation Budget Limits
The HomeStyle Renovation program limits the size of loan you can obtain through the program. The HomeStyle Program uses the conforming loan limit, which ranges from $484,350 to $726,525 in the contiguous United States for a single unit property. Additionally, please note that the value of the renovations can total up to 50% of the as-completed appraised value of the property.
No Sweat Equity
Unlike the FHA 203(k) Loan Program, the HomeStyle Renovation Program does not permit home owners to be reimbursed for the labor or sweat equity they contribute to a renovation project from the loan proceeds. Home owners can be reimbursed for any supplies or materials they purchase for the project but they cannot receive any cash proceeds from the loan.
In my next blog, I will go into details on the most important player in the home renovation process.
Part 3 – Rationale:
Have you looked at a home in a neighborhood you love, that has the perfect layout, or the spacious yard you’ve been wanting? But it needs updates or major repairs, and you’re not sure you can afford to make those changes after you buy.
You might even be living in a home you love that needs repairs because of a natural disaster or a few updates to accommodate your growing family. But the high interest rate for a home equity line of credit or second mortgage puts renovation costs out of reach.
Well, you’re not alone. A number of homebuyers and owners can see a home’s potential but aren’t sure how to pay for the renovations. HomeStyle Renovation mortgage could be the solution.
With a HomeStyle Renovation loan, eligible homebuyers and owners can renovate a home to fit their needs and personal style with just one loan that covers the mortgage and improvements.
How Does It Work?
When you buy or refinance a home, HomeStyle Renovation allows you to finance improvements for up to 75% of the property’s as-completed value. (That’s the appraised value of the home once the upgrades are completed).
This type of financing can be a more cost-effective way to renovate your home, since it combines the cost of the home and renovations into one conventional mortgage. It also addresses some common financial challenges with purchasing or renovating a home by offering:
It’s also important to mention that the renovations you’ll make have the potential to create equity in your home right away.
Just like the FHA loan, the 203(k) consultant is also charged with overseeing the HomeStyle Renovation loan, which are initially placed in an escrow account. Your consultant can 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 differences between FHA and Fannie Mae renovation loan.
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:
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
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.
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.