Home-rehab dream ruined? Try an FHA loan


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Hordes of hopeful homebuyers dream of buying a foreclosure at a rock-bottom price, fixing it up and living happily ever after.

The dream heads south, however, when many of them realize they don’t have the cash needed or learn that available financing won’t cover the extensive repairs.

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A longtime FHA program and a more recent streamlined version of it can make those dreams come true.

“The problem is, many homes have damage or have been stripped down,” says mortgage broker Dave Vance, president of Lifetime Financial Partners in Bloomingdale, Ill. “In those cases, the home is not eligible for traditional financing.”

“Most banks sell (foreclosed) homes as-is and will do no repairs whatsoever,” explains Leslie Mosier, a Seattle-based ZipRealty agent.

Mortgage financing plans typically provide only permanent financing, with the lender not closing the loan until the condition and value of the property provide adequate loan security, according to the Federal Housing Administration, part of the Department of Housing and Urban Development. When a rehab is involved, the lender typically requires improvements to be complete before a long-term mortgage is made.

So what’s a buyer to do? Some look to the FHA’s 203(k) loan program.

Through a 203(k), a buyer can obtain the money to acquire a property and have it repaired in a single transaction, says Gerry Glavey, director of the processing and underwriting division of HUD’s Philadelphia Homeownership Center. “Money for rehab work is set aside, placed in escrow, at the time of closing.”

Two options

The original program, or standard 203(k), starts with the homebuyer choosing a lender from an FHA list. The lender selects an FHA-approved consultant, who develops a description of needed work to the property. Then an appraiser determines the repaired property’s value.

The work should be completed within six months, and after a final inspection, all parties sign off that the program is complete. In effect since the 1970s, standard 203(k) loans have no limit on the amount of repairs, although the maximum mortgage amount must meet certain loan-to-value ratios and cannot exceed 110 percent of the final (after-improved) value of the property.  

Since 2005, buyers have had another option, the streamlined 203(k), which eliminates the need for a consultant. The borrower obtains contractor bids for the repairs, which can total up to $35,000. “We’re doing a lot of streamlined 203(k)s,” says Glavey. In the 16 states under his center’s domain, 727 203(k) loans were insured in January of this year, 534 of which were the streamlined version.

A few years back, the subprime lenders with products such as no-doc loans ruled, and buyers didn’t look to programs like the 203(k). “We never changed our credit standards like they did. Now those folks are gone — we’re still here. We’ve always been self-supporting with mortgage insurance premiums,” says Glavey. Now, conventional lenders have needed to get strict, but the FHA hasn’t changed, other than raising the minimum investment from 3 percent to 3.5 percent.

In January 2009, the Philadelphia Homeowner Center — one of four in the country — insured about 40,000 FHA loans, while in 2007 the center averaged 11,000 loans per month. All four centers totaled 144,000 loans that month.

“A lot of Realtors and lenders are saying, ‘Thank God for FHA,'” says Glavey. “We’re the lender of last resort in a lot of communities right now.”

But as a last-resort destination, there aren’t many signs helping people find it. On both the seller/Realtor side and the buyer’s side, “few people really know or understand the loan,” says Vance, who has a few clients currently going through the program’s underwriting process.

“I believe that the program is very confusing for consumers in general,” says Renee Porsia, an associate broker with RE/MAX Action Realty in Maple Glen, Pa. “I know that my clients, even after having the program explained to them, still didn’t fully understand what needed to be done.”

OK on 203(k)?

Glavey sees this program as a “win-win-win for the buyer, the lender and the FHA — and ultimately the community.” Which buyers should get into the game?

“This is a wonderful program for buyers who don’t have the required 10 (percent) to 20 percent down payment required for a conventional loan,” says Mosier.

Libby Sosinski, a Realtor with Keller Williams Realty in Pittsburgh who specializes in selling foreclosures and investment properties, believes the program “is an excellent way for many buyers to purchase properties in poor condition. It also helps them to afford the repairs that they may have struggled to do without this specialized loan.”

Porsia likes that the program fits a variety of property types. According to HUD, the property can be a one- to four-family dwelling that was completed at least a year earlier. It could be used to convert a one-family dwelling to a two-, three-, or four-family home or vice versa. A 203(k) mortgage may also be originated on some mixed-use residential properties. In addition, homeowners who need to refinance and rehabilitate their own dwelling can look to the 203(k).

The program is “great for first-time homebuyers who couldn’t otherwise afford to purchase a home that was in need of repair,” Porsia says.

But Vance doesn’t see the program as good for first-time homebuyers. “This is geared for someone who’s looking at their home as an investment and is willing to put in the time and effort,” he says.

Unfortunately, for those who want to pursue a 203(k), the number of lenders that work with the program has been limited, so the interest rate is usually a little higher, Glavey says. “Not every lender wants to roll up their sleeves and get involved in repair work.” But this may be changing, as he says the FHA lender approval division in Washington, D.C., now has record numbers of lenders seeking FHA approval. (A lender with FHA approval doesn’t necessarily have to participate in the 203(k) program.)

But Porsia knows of lenders that “hate to use the program because they get bogged down in paperwork.” That paperwork can mean a longer waiting period before closing, so she wouldn’t recommend the program to impatient buyers. But Glavey says, “It shouldn’t be an inordinate amount of delay,” provided the buyer uses good contractors.

That has been Sosinski’s experience. Buyers of her properties who used the streamlined 203(k) typically close in the normal 30-day period, she says. “However, buyers do need to be persistent in getting their bids together. If you have a buyer who is lax about doing their part of the loan, it can delay things.” Since buyers can be charged $100 to $150 a day for not closing on a foreclosure property on time, there’s some built-in incentive to keep moving on the bids.

Buyers must also be prepared to fork over the minimum down payment based on the total of the sale price, plus the estimated cost of repairs, Mosier points out.

She also cautions about the lender’s right to build in a “just in case” fund, with the buyer paying interest on it during the first six months, whether it’s used for repairs or not. HUD refers to this as a “contingency reserve,” and a 10 percent add-on to the estimated rehab cost is required for properties older than 30 years. But when the scope of work is “well-defined and uncomplicated, and the rehabilitation cost is less than $7,500, the lender may waive the requirement for a contingency reserve.”

If you’re 203(k) ready

A visit to the HUD website’s 203(k) page is a good starting point for more information on the program. The resources include a detailed description of eligible properties and improvements. While 203(k) loans can’t be used for luxury items and improvements that do not become a permanent part of the property, items such as painting, room additions and decks are allowed, even if the home doesn’t need any other improvements. Information on maximum mortgage amounts, fees and the application process can also be found at that site or by phone at (800) CALL-FHA.

Getting in touch with an FHA-approved lender is the next step. It can be helpful to find a real estate agent who is experienced with 203(k) loans, Porsia suggests.

And while dreaming of your new home, just be sure to keep it real. In Glavey’s experience, “buyers sometimes have a false expectation that they’re going to get the Taj Mahal after the work is done.”