Navigating the FHA's Streamlined 203(k) Limited Repair Program
I recently assisted clients of Erika Davitoin purchasing their first home with financing secured through the FHA's Streamlined 203(k) Limited Repair "Rehab" Program. This loan program is a great resource for some buyers, blending together purchase and construction financing into one loan. But the process is definitely far more involved than with conventional or even regular FHA loans and there is greater potential for fall out. It's therefore important to be aware of potential pitfalls in order to improve the odds of a favorable outcome and I thought I'd share a few thoughts. (For a more general outline on the Streamlined 203(k) loan program, please refer to my earlier post.)
First, although the Streamlined 203(k) Limited Repair Program (which I will now refer to as "203(k)") allows for up to $35,000 in financed repairs and updates, most lenders will reduce this figure by 10% to 20% for reserve contingencies to cover any potential cost overruns. This means you can really count on only $28,000 of financed repairs. The 203(k) is layered on top of standard FHA financing so borrowers need only 3.5% of the purchase price for their down payment. The required Mortgage Insurance Premium (MIP), currently set at 1.15% in this example, can be rolled back into your loan. So, on a $500,000 purchase, the down payment of $17,500 would reduce the base loan to $482,500, to which $5,548 could be added back for a new loan amount of around $488,048. You could then add 203(k) financing of as much as $28,000 for total credit of $516,048.
203(k) loans are typically the only practical financing option for defunct homes in need of repair or significant updating, as is the case with many REOs or short sale properties. Step one as you enter into contract is to negotiate an extended escrow period of at least 45 days and, ideally 50 to 60 days. Remember that the loan process is far more demanding and that the marketability of the subject property is compromised by a state of disrepair (leaking roof, torn out bathrooms, gutted kitchen) or outdated condition (1920s era kitchen, linoleum flooring, etc.). You should not be shy in requesting an extended close period as this is needed to address the deficiencies of their property. In most cases this is the only loan option available and, short of an all cash offer, you have no competitors.
Once in contract, my advice is to be fast and organized. It is extremely difficult to envision what amounts to remodel work (new flooring, kitchen, bathrooms, etc.) on a property you do not own and have likely spent only an hour or two examining. You must quickly define the scope of the work to be done as well as items such as the materials and appliances you want and have all bid out to work within budget. All of this should be accomplished within the first week of contract and the bid must be fully line-itemed, with all materials and labor fully accounted for. The contractor must be licensed and insured and there are numerous forms for all parties to fill out. It is therefore essential to find a qualified contractor who is organized and up to the task. My clients settled on Bill Johnson of Design Build Specialists in Novato, CA and I highly recommend him for work in Marin. Bill was extremely organized and responsive, providing everything we needed without delay. His contact number is (415) 892-3932.
Once your itemized bid and paperwork are completed, they are included with your full loan credit package and sent to the underwriter. The full bid is then sent to the lender's appraiser who will inspect the subject property and create a future valuation based on all upgrades, remodel attributes, and materials listed in the bid. This process obviously takes more time and it is only once the appraisal is delivered to the lender that your loan package will be fully underwritten. Keep in mind that during this same timeline you will be conducting your own, standard property and pest inspections. Should these inspections turn up necessary work, you might need to get additional contractor bids -which would then need to be examined and commented on by the appraiser and underwritten by the lender. All of this work typically takes at least one month to complete.
The final stage of the loan process involves addressing lender conditions, ordering loan documents, signing papers and, eventually, funding. This process takes approximately 3 weeks. The base loan is disbursed to finalize the purchase transaction and the lender will retain the construction money in a separate account. A portion of the construction money -usually around 50% of the itemized cost of materials -can be advanced to get the project started. Construction work should begin within 30 days of close of escrow and the project should be completed within 6 months. Naturally, everything has a cost and the 203(k) typically increases FHA rates by .5% to .75%. But for buyers interested in homes requiring or updating they cannot afford, the Streamlined 203(k) Limited Repair Program is a bargain.