HUD Rehabilitation Part 1

This story is part of a series on the US Housing and Urban Development 203(k) mortgages for home rehabilitation.

Other parts of this story >>Eligible Improvements >> Questions and Answers

You've found the perfect home: a fixer-upper in a nice neighborhood. The house needs a fair amount of work, but you don't mind putting in the sweat equity. So you go off to your friendly local bank to get a mortgage. And you hit a wall of frustration.

Your banker is not impressed with your claims that this $75,000 house has the potential to be a $150,000 home with some repairs. Your bank won't lend you money to buy the house until major repairs are complete. But you can't begin repairs until you've bought the house. And if you buy the house with a standard 15 to 20 percent down-payment, you won't have the money you need to make repairs.

This catch-22 situation is common when homeowners try to purchase a house that needs repairs, says the U.S. Department of Housing and Urban Development. HUD's Rehabilitation 203(k) program was developed with this situation in mind. The program isn't without its costs -- both in paperwork and in slightly higher interest rates and closing costs -- but it may be the path to homeownership, especially you are a first-time buyer or have little cash for a down-payment.

house before house after

What your banker sees vs. what you envision your house can be.

The basic problem with fixer-uppers

Most mortgage financing plans provide only permanent financing. That is, the lender will not usually close the loan and release the mortgage proceeds unless the condition and value of the property provide adequate loan security. When rehabilitation is involved, this means that a lender typically requires the improvements to be finished before a long-term mortgage is made. Short-term construction or rehabilitation loans are often expensive and difficult to obtain for first-time buyers with little cash or property to secure a loan.

HUD's solution

HUD's 203(k) program allows you to purchase or refinance a property, and include in the loan the cost of making the repairs and improvements. These loans generally take longer to approve than conventional loans, up to 90 days. Available through approved mortgage lenders nationwide, 203(k) loan are available to any purchaser with enough income to make the loan payments. Approved lenders will help you with the paperwork, and HUD also has consultants available to help you with paperwork and estimating.

The mortgage amount is based on the projected value of the property, including work needed to complete the renovations. Part of the mortgage is used to pay the seller for the purchase. The money for estimated repairs is placed into an escrow account and may be drawn in up to five increments as rehabilitation work is completed. 203 (k) rehabilitation loans carry interest rates one-half percent higher than conventional 30-year-fixed loans. But that cost is offset by the low down payment requirement -- about three percent of the acquisition and repair costs of the property.

Mortgage proceeds must be used in part for rehabilitation and/or improvements to a property. There is a minimum $5,000 requirement for the eligible improvements on the existing structure(s) on the property. Rehabilitation or improvements to a detached garage, a new detached garage, or the addition of an attached unit(s) (if allowed by the local zoning ordinances) can also be included in this first $5,000.

The program is intended to help with the rehabilitation and repair of single family properties as a means of community revitalization and expanded homeowner opportunities. Unlike permanent financing, this program allows individuals who otherwise could not borrow enough to purchase and fix an existing home to do both in a single loan. Mortgage limits are set in all states.To find the limit for your area, click here.

Any repair is acceptable in the first $5000 requirement that may affect the health and safety of the occupants. Minor-or cosmetic repairs by themselves cannot be included in the first $5000, but may be added after the $5000 threshold is reached.For a list of eligible improvements, click here.

financesThere are other guidelines and requirements of these loans, and potential buyers need to be aware that the program assumes that a qualified contractor will do the work. Homeowners who are qualified may act as a general contractor or do actual work. However, homeowners can only be reimbursed for actual material costs, not labor.For other restrictions in a Q and A format, click here.

Here are the steps to getting a 203(k) loan:

  • A potential homebuyer locates a fixer-upper and executes a sales contract after doing a feasibility analysis of the property with their Realtor. The contract should state that the buyer is seeking a 203(k) loan and that the contract is contingent on loan approval based on additional required repairs by the FHA or the lender.

  • The homebuyer then selects an FHA-approved 203(k) lender and arranges for a detailed proposal showing the scope of work to be done, including a detailed cost estimate on each repair or improvement of the project. To find an approved lender in your state, click here. The interest rate and discount points on the loan are negotiable between the borrower and the lender.

  • The appraisal is performed to determine the value of the property after renovation.

  • If the borrower passes the lender's credit-worthiness test, the loan closes for an amount that will cover the purchase or refinance cost of the property, the remodeling costs and the allowable closing costs. The amount of the loan will also include a contingency reserve of 10% to 20% of the total remodeling costs and is used to cover any extra work not included in the original proposal.

  • At closing, the seller of the property is paid off and the remaining funds are put in an escrow account to pay for the repairs and improvements during the rehabilitation period.

  • The mortgage payments and remodeling begin after the loan closes. The borrower can decide to have up to six mortgage payments (PITI) put into the cost of rehabilitation if the property is not going to be occupied during construction, but it cannot exceed the length of time it is estimated to complete the rehab.

  • Escrowed funds are released to the contractor during construction through a series of draw requests for completed work. To ensure completion of the job, 10% of each draw is held back; this money is paid after the lender determines their will be no liens on the property.

Other parts of this story >>Eligible Improvements >>

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