When it’s time to buy a house, many different types of loans are available, depending on your status: are you a first-time homebuyer, a California veteran, or planning to renovate? This week, I’ll highlight the pros and cons of a Federal Housing Administration (FHA) 203K loan.
The FHA 203K loan is appropriate for those with good credit (a minimum FICO score of 640), a stable job, enough money for a three-and-a-half percent down payment with some money left over, and a desire to renovate the home you purchase. The loan is intended to inspire buyers to purchase properties that require some work, and the amount of the loan can be based on the future value of the property (after the renovations are done). Eligible properties include owner-occupied, single-family homes or duplexes that are at least a year old. The FHA 203K loan is ideal for people who understand the challenges of home renovation and know a trustworthy contractor who is not a family member.
There are two versions of the FHA 203K loan, the streamline and the full, and they have slightly different requirements. Big thanks to Rick Costa at Bay Equity Home Loans for helping me get the details right. The primary differences between the two versions of the loan are that with the streamline loan, less money is available for renovations and the monies earmarked for renovations must be used as planned or else used to pay down the principal on the loan but will not reduce your monthly payment. With the full loan, money left over from renovations can be released to you for any purpose. Both loans offer a maximum of $373,750, and the buyer is responsible for finding a contractor, getting bids for the renovation, and overseeing the project(s). While the FHA 203K loan doesn’t specifically require at least three bids from contractors who have done renovations similar to yours, most lenders (and common sense) require it. The loan does mandate that renovations be at “arm’s length”—meaning the contractor must be licensed, bonded and insured, and cannot be a family member.
The streamline version of the loan has a maximum renovation fund of $35,000, including a 10 percent reserve for any unanticipated expenses uncovered during the renovation. This version of the loan is intended for lightweight renovations like paint, flooring, or window treatments—nothing structural.
The full version loan can include structural work. So, to be sure the whole cost of the renovations are included in loan, the buyer should request that the contractor include any permitting or other fees in his bid. The buyer can also request that pest and fungus work be funded by the loan.
While it is great to find a home loan that allows for the cost of renovations, this benefit comes with a price. First, the interest rate on this loan is typically about a quarter of a percent higher than the going rate. Also, the full version of the loan requires a detailed plan and drawings, a Housing and Urban Development (HUD) consultant to make sure you stick to your plan, and multiple appraisals. Not cheap and rarely quick.
The success of this process often hinges on a thorough and accurate scope of work from your contractor. If the renovation is small, say less than $10,000, I don’t recommend using 203B funds. A quarter-percent increase on the entire loan will take monthly payments up significantly, and that $10,000 for renovations will cost much more to pay back over the life of the loan. There are also the additional costs of inspections and the HUD consultant. Unless you plan to go big, use a different source of money to fund renovations.
If you have questions about real estate or property management, please contact me at rselzer@selzerrealty.com or visit www.realtyworldselzer.com. If I use your suggestion in a column, I’ll send you’re a $5.00 gift card to Schat’s Bakery. If you’d like to read previous articles, visit my blog at www.richardselzer.com. Dick Selzer is a real estate broker who has been in the business for more than 35 years.