This is an exciting time to be a home buyer, whether a first timer or a seasoned pro! Why? Fixer-uppers are now financed with a special FHA loan, called a 203K loan. It offers all the positives of FHA loans: lower down payment, first time buyer friendly, permanent fixed rate, with the ability to buy a home 'as is'.
The typical FHA loan requires an appraiser to verify that certain standards are met, or requires them to be met, as conditions to the appraisal value. This would essentially stop a lender from final approval so such items as peeling paint, broken glass in windows, functional heat, good roof, handrails and the like, could be addressed, and then the loan would go forward.
Because of this, investors were the only ones (with few exceptions) able to buy fixer uppers, and they made a profit from the equity gained between the condition they purchased the home at, and the condition they renovated to. This averages around 20%.
What used to be the sole domain of investors, and a great tool for making money in real estate, the "Renovation Loan", is now easily attainable by buyers who intend to occupy their home, and want build equity into their purchase, through a 203K loan.
You will likely not attain a 20% "instant equity" when your renovation is done, it will more likely be around 7-10%. This is because you must use licensed general contractors to manage your job, per the loan requirements, and most renovators manage their own projects and hire sub-contractors. This is the biggest negative to attaining equity, but a huge safe-guard for a first time renovator. The lender overees the process to protect their interest in the property and of course, the buyer as well.
Besides equity, you will also have a home customized to meet your dreams and goals. If you can envision it, and the budget will allow it, you can accomplish it, with a great team of pros to help you.
GOOD TO KNOW: 5 FINANCIAL KEYS TO A 203K FHA LOAN:
1) Your purchase price and the renovation costs should not total more than 90% of the after repaired value, which would generate a MINIMUM 10% equity when work is done.
2) With all FHA loans, you will be paying what's called MIP or Mortgage Insurance Premium. This is an insurance policy that you will pay each month on the property until you have 20% equity. In the $150K example, purchased as a regular FHA loan, 10 YEARS OF MIP at $118 month for a total of $14,160 paid out in mortgage insurance premiums. The only way to avoid this is to put 20% down.
3) With a 203K FHA loan, the potential for saving adds up! If you have 10% equity immediately upon completion of work (typically a 1-2 month process) and since you must put in 3.5% down payment, unless you use a down payment assistance program to lend or grant you that down payment, you will have 13.5% equity within a few months of home ownership. You would meet the 20% in a little over 5 years, which would save you about $7000 in morgage insurance premiums.
4) If you add your 10% equity ($15K) plus the $7K in saved MIP, that's $22K in value accomplished through a 203K loan! Very smart!
5) You also have the option of obtaining a new appraisal, should the market values in your neighborhood improve. For more information about rules and time requirements for requesting MIP be removed, please talk with your lender.
GOOD TO KNOW: KEYS TO SUCCESSFUL 203K LOANS:
1) Keep in mind, you will not be allowed to do the work yourself. The lender will require you to use approved general contractors who are experienced with the 203K process. Occassionally, the contractor will allow you to do simple items like painting or landscaping but they are not allowed to pay you to do the work, even if it is your profession. They can budget for materials, such as paint and supplies, plants and mulch, without including your labor, and provide them on site for you to do the work.
2) Many lenders are not experienced with 203K loans. If you choose to this route, make sure the lender you choose has successfully closed several 203Ks recently, and has a good selection of approved general contractors to recommend for you to interview. It's a good idea to interview 3 lenders with 203K experience, and ask for referrals of some satisfied clients.
3) The General Contractor you choose must be approved by the lender and agree to the process. They must submit bids and plans, and be willing to rewrite them if the lender requires it. They will also not be paid until inspections are completed, and must have correct licenses and insurance. It is vital that the general contractor be accessible for last minute changes, and patient. They will meet with you and your Realtor several times to plan the project, including budget and schedule, and then present the plans to the lender. Ask any recommended General Contractors for names of recent 203K clients. Do follow up and talk with them!
4) The biggest reason 203K loans don't go through is because of the contractor failing to provide the necessary items on time, or getting frustrated with the process and giving up. The second biggest reason is a lender who does not know how to prepare a 203K loan for approval. To avoid frustration, seek experienced pros for your 203K loan.
5) 203K loans require that a contract be written differently to allow for multiple planning and inspection meetings, a longer time to close. If you choose to go this route, be sure your Realtor is familiar with 203K loans, has renovation and construction experience, and can assist you with interviewing your lender and their recommended Contractors.
A 203K loan is a great opportunity, but it is not the best buying strategy for everyone. You need to have a problem-solving attitude with flexibility and patience. If you can budget to avoid moving into your new home until the work is completed, that will be ideal for both the contractor, and you and your family. You will save money and time by allowing the property to be a worksite. It is a messy undertaking, and trying to work around a family schedule and needs will slow things down. Either way, be prepared for challenges and disappointments, delays or work-order changes. The buyer who is prepared to weather these inconveniences will find that the rewards will be worth it!
If you have questions about 203K loans, or any other real estate topic, or a suggestion for a future blog, please send us a note!
Onward!
Sher 