Have you been searching for the perfect house ? As a Realtor do you have clients forever looking at properties only to find a reason why each is not perfect for them ? As much as we all wish it were true, there may not be a “perfect property” to be found for everyone searching for one.
A solution is purchasing the property with one loan that also has extra funds for repairs, updating, rehab, etc. Two such loans are available. One is FHA 203K and the other is Fannie Mae HomeStyle. Each offers funds wrapped into the loan to purchase a 1 to 4 unit property and renovate it. I often hear Realtors find these loans complex and time consuming so they do not educate their buyers about them. In speaking with buyers I discover buyers either have never heard of these loans or have heard negative information about them. What I’m trying to do is educate everyone on the tremendous advantages of using these loans to purchase property. I have written Blog posts recently on the particulars and examples of what clients have done. Here I want to give an overview of the 7 steps involved and what to be aware of as a buyer or a Realtor.
- Buyer is pre-approved for the amount of mortgage possible given their specific circumstances. For example if a buyer is pre-approved for a $300,000 loan it will include both the purchase money and funds to rehab apart from the required down payment. The example buyer may find a home for $200,000 that needs a $100,000 gut rehab – perfect, since the total loan needed is the $300,000 the buyer was pre-approved for.
- Contract is signed and buyer does a home inspection as per usual process. I recommend an inspection done by an FHA Consultant who is trained to review a property for defects, code violations, etc. This approach fully educates the buyer about what the property needs at minimum to be up to local and FHA standards for healthy and safe use of the property. The FHA Consultant can write up a Scope of Work document estimating the cost of repairs and specifics the buyer may wish to complete on the property.
- Buyer tours the property with a licensed contractor(s) of choice to secure a proposal to execute the required and desired rehab work. The expertise provided by the FHA Consultant will be valuable in selecting a contractor and determining a fair price. The FHA Consultant has already presented an estimate to be used as a guide to guard against under or overpriced bids by contractors. I recommend the buyer visit the town Building Department to educate themselves on exactly what building Permits will be required for the property. This way the cost of such Permits can be known in advance and exactly what type of work and inspections the town may require can be built into the rehab budget.
- The loan is processed and approved with the amount of funds needed for renovation. Given a final contractors work proposal is required before an Appraisal of the property can be conducted, the process may take longer depending upon the time the selected contractor takes to send out a detailed work proposal. Then the property is Appraised to its value when fully rehabbed. This is one of the greatest features of these loans as the property may show increased value even beyond the dollars spent for purchase and updating.
- The loan is fully approved and a closing occurs. Here it’s important to note the Realtor is paid the agreed upon commission on the purchase price of the property. All construction work begins after the closing which does not involve the Realtor in any way. I always tell Realtors these are the best loans to recommend to buyers as they will sell more homes and take more listings in a shorter time frame. I tell buyers these loans allow for the property to become exactly what they want it to be.
- The rehab funds are held by the lender and released in one of two ways after closing. If the rehab work is a 203k for $35,000 or less, then about half the funds can be released shortly after closing. The funds are always sent in a check made out to the buyer and contractor. The check goes to where the buyer is living and never direct to a contractor. In my experience it is best to be sure the contractor has secured the local work Permits required before any funds are released. This way everyone knows the work is Permitted correctly and will be executed according to local codes and subject to local building inspector’s approval. In larger rehab projects with HomeStyle or 203K, the FHA Consultant or other construction inspector will monitor the process and authorize funds to be released to the contractor as work is progressing. Here the contractor never receives any funds at all in advance and must be financially capable of funding the project phases with their own funds initially.
- Work is fully completed, signed off on by the local Building inspector and the FHA Consultant if one is required, and of course the home owner. The final check is issued to pay the contractor and close out the rehab loan.
I hope this post has been helpful and encouraging to those that may have thought a Renovation project was too complex or beyond their ability to manage. My intent is always to inform, educate, and generate discussion. Please call me or email me directly or visit my website for more information on renovation loans. I welcome your comments and questions!
Hi, what would happen if you failed to complete the renovations? Would you default on the loan? Or as long as you kept paying the mortgage there would be no problem?
Chris,
Sorry just saw this. We don’t see any incomplete rehabs projects as a rule. We endeavor to be certain they can be finished within the given budget up front and with at least a 10% emergency reserve for cost overruns we have all the tools we need to always finish.
Hi what happens if you the owner decides to move out after a year and renovations are complte and use the property as a rental? Will the loan need to be re-financed?
Gus
It is fine with either 203K or HomeStyle for the owner to do the rehab and then move out after a year to lease it to a tenant. With HomeStyle the owner may buy it with the intention of leasing the house right away with a 20% down payment. HomeStyle is designed for an investor to buy, rehab and flip/sell or lease the house to tenants.
Hi,
What happens if a streamlined 203k is processed and the work is complete, using all the contingency funds, but the home is still not up to fha standards. I’m currently is this situation. Can I lose the home I’ve been living in for 6 months?
HI,
On a Streamlined there Is no FHA consultant to check over the contractor unfortunately. I don’t like doing them this way for that reason so I often make small jobs Full Standard 203k to have oversight. If the home is still not up to FHA standards you can pay for the work yourself if the Contingency Reserve is depleted. If there are minor issues you can front the money for that’s my advice. Ideally you are gaining equity in this process so you perhaps refinance out of the 203k when all work is done and even perhaps get cash out to replenish your out of pocket costs ?
Is there a list of approved FHA Consultants for particular areas of the country?? For example Charlottesville, VA?
You can find a local FHA approved 203k Consultant at https://entp.hud.gov/idapp/html/f17cnsltdata.cfm
Do you only pay on the funds disbursed and then does it convert to an end loan the way a construction loan works?
With 203k and HomeStyle, if at completion there are unused funds then the funds are subtracted from the final loan size. In other words you do pay only on the funds disbursed. Some borrowers elect to use unused funds for extra work as an option.
I’m confused about the order of the steps. How can the bank pre-approve the loan (current value + improvements) BEFORE having a contractor look at the house? How do they know how much the renovations will cost without the contractor?
HI,
In fact the HUD Consultant does do an initial estimate of what the rehab will or should cost in the local market. We do sometime order appraisals off these to save time. Later when the contractor exact numbers are in we can adjust. Or sometime we wait to order an appraisal with the final contractor numbers.
Perry,
How long does this type of mortgage take to close? Is it like a normal home purchase 30-45 days or 90 days from execution of the Purchase and Sale Agreement?
what happens if you are the buyer and the contractor. Can you renovate your own home and have the reno loan come directly to yourself.
If you are a buyer and licensed contractor then yes you can have the renovation done. But as a back up you must have another contractor submit an identical cost bid to act as a back up should you fail or do not have the time to do the work yourself. Meaning that the lender will want to be sure your own business does not suffer a gap in income if you are working on your own project. You cannot pay yourself for labor when acting as your own contractor. Meaning you make no profit in this situation as a contractor.