Buying a fixer-upper? Here’s the mortgage to do it
Buying a piece of distressed real estate can be a great way to snag a dream home at a steep discount. But these homes are often in need of repair to bring them up to date. Since 1978, the Federal Housing Administration's ( FHA) 203(k) mortgage program has been available for homebuyers who want to purchase and immediately renovate a home.
"FHA 203(k) loans are the best-kept secret in the mortgage industry," says Susan Barber, senior vice president for new construction and renovation programs for Wells Fargo Home Mortgage in Marlton, N.J. "Consumers really should know about this opportunity for renovation financing because the loans are not just for foreclosures. You can use them on all types of properties, even just an older home that needs updating, and they are available for both purchases and refinancing."
Rick Sharga, executive vice president of Carrington Mortgage Holdings in Santa Ana, Calif., says FHA 203(k) loans can help solve some of the current problems in the housing market.
"There are tens of thousands of properties in disrepair out there, a lot of which are not even on the market because they are in such bad shape," says Sharga. "An FHA 203(k) could allow an owner-occupant to buy a home and fix it up, which could slow down the depreciation in the market. Right now, only investors are buying these properties and they are buying with cash at the lowest possible price."
Sue Pullen, vice president and senior mortgage advisor for Fairway Independent Mortgage in Tucson, Ariz., says FHA 203(k) loans were less popular when home equity loans were readily available. But she adds that, they are a good option for today's market.
FHA 203(k) options
FHA 203(k) loans are available as standard or streamlined products.
The streamlined FHA 203(k) is limited to a maximum of $35,000 worth of repairs, with no minimum repair requirement, Pullen says. Repairs for both standard and streamline loans must start within 30 days of the closing and must be complete within six months.
"The streamline loan limits the types of repairs to nonstructural renovations and nonluxury items, so you can't add a pool or move walls," says Pullen. "This loan is great for replacing the HVAC or the carpet, replacing the appliances or the windows."
The standard FHA 203(k) allows for structural repairs, requires at least $5,000 of renovations and also requires a HUD consultant to supervise the renovations.
Both loan types must meet requirements for the FHA loan limit in your area.
FHA 203(k) requirements
As with all FHA loans, borrowers must make a down payment of 3.5 percent and pay mortgage insurance premiums. Borrowers must qualify for the full loan amount, including the purchase price and the renovation costs, with standards similar to those set by other FHA mortgage lenders. Such standards include a credit score of at least 620 and a debt-to-income ratio of 41 percent to 45 percent.
Pullen urges borrowers to work with a lender experienced with FHA 203(k) loans, because the rules about the repair work and appraisals must be followed.
"An FHA 203(k) loan requires the buyers to make an offer on a home and then to get at least one bid, but sometimes two or three bids, from a contractor for the repair costs," says Pullen. "The number of bids required is up to the lender. So, for example, if you put an offer on a home at $100,000 and the contractor bids for the repairs that you want are $20,000, you'll need to qualify for the loan and make a down payment based on a $120,000 loan."
Mortgage lenders experienced with FHA 203(k) loans can suggest several contractors who are have worked with the loan program before. Pullen says that most mortgage investors require the contractors to be licensed professionals to ensure quality renovations.
Appraisal and fees
In addition, says Sharga, the lender will need an appraisal of the current home value and the as-repaired value, which is based on the estimated value of the home improvements. The mortgage amount will be based on the as-repaired value.
The fees for an FHA 203(k) loan are slightly higher than for a traditional FHA mortgage, says Pullen. Such fees include a supplemental fee of $350 or 1.5 percent of the cost of repairs, whichever is higher, which can be wrapped into the loan. Once repair work is complete, requirements call for an additional inspection and title policy update to make sure no liens have been filed. Pullen estimates that the extra fees average from $500 to $800.
Conventional renovation and financing loans
Conventional renovation and financing loans are available for owner-occupants, buyers of second homes and investors, but these loans typically require a down payment of 25 percent or more and a higher credit score than what is required by most FHA lenders.
"Borrowers who think they want to use the FHA 203(k) loan program should ask their Realtor and their lender if they are familiar with it and to help them decide if it is a good option for them," says Sharga.
Michele Lerner, author of "HOMEBUYING: Tough Times, First Time, Any Time", has been writing about personal finance and real estate for more than two decades for a variety of publications and websites including Investopedia, Insurance.com, HSH.com, SavingsAccount.com, National Real Estate Investor magazine, The Washington Times, Urban Land magazine, NAREIT's REIT magazine and numerous Realtor associations.