How to Use FHA Loans to Purchase Fixer-Uppers

Posted by Matthew Lahti on Monday, March 4th, 2013 at 12:22pm

Interested in a home but it requires too many repairs to qualify for a standard FHA loan?  Consider a 203K Rehab loan

Most financed real estate purchases require an appraisal which is used to determine the fair market value of the home based on its condition and the recent sale price of comparable properties in the area. Because the lender may have the property returned to their portfolio in the event of a foreclosure, the property typically needs to be in decent condition in order for the loan to be approved. That’s why many “handyman special” properties are listed for sale as cash-only. There is, however, an alternative available to the knowledgeable buyer who wants to obtain financing for a home that needs major repairs.

The Federal Housing Administration (FHA) is an agency within the U.S. Department of Housing and Urban Development (HUD) and this agency insures FHA loans made by lenders; the lenders will be reimbursed for any losses suffered as a result of a foreclosure. FHA loans are only available for owner-occupied homes and they have a lower down payment and credit score requirements than what exists for conventional, non-government loans. The FHA 203(b) loan is the most common and requires the home to be in livable condition. The FHA 203(k) rehabilitation loan has no such requirement.

Once a prospective buyer locates a suitable property and has an offer accepted by the seller, the borrower works with the lender to draft a detailed proposal of the requested work and expense. If the loan application is approved, the 203(k) loan appraiser then values the home as if the repairs were already made. This allows the borrower to receive the necessary repair or remodeling funds as part of the mortgage and the payments can be amortized over thirty years. This type of loan is available for both new purchases and refinances.

Because construction jobs frequently cost more than anticipated, the lender may request the borrower to increase the loan amount by an additional 10-to-20 percent of the repair estimate. The money for the repairs or remodeling is kept in the lender’s escrow account after closing and the funds are accessed in separate draws as different phases of the work is completed. The lender will most likely send an inspector to approve each portion of the job before another draw is permitted.

Many lenders choose not to offer the 203(k) program to borrowers because of the burden of overseeing the progress of the work. For this reason, HUD publishes a list of 203(k) lenders on the Hud.gov website.

Real estate agents need to be familiar with this program so that the property doesn’t have to be listed in the Multiple Listing Service as cash-only. The agent wants to make it clear, however, that a “normal” FHA loan is not sufficient. The 203(k) program needs to be specifically mentioned. If this advice is followed, the home should get many more viewings then a cash-only listing. Times are tough and it’s much more likely that someone could afford an FHA 3.5 percent down payment before the majority of prospects could afford an all-cash purchase.

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