The 203k Loan and How it Works

Before the 203k Loan.

When a buyer wanted to buy a home that needed repairs, those repairs usually had to be completed prior to the close of escrow. Plus, those repairs normally were the responsiblity of the seller.

But with so many foreclosures in today's market, the bank is the seller...and banks are exempt from having to disclose any of the property's shortcomings. Therefore, the home in need of repair is listed "as is". In the past, such transactions required out-of-pocket cash expenditures from the buyer - even just to bring the property up to where it is habitable, or up to code.

Today's 203k Loan.

203k loans allow you to FINANCE the cost of the repairs in the new loan amount. (Not to exceed 110% of the after improved value determined by the appraiser and 203k consultant.) In other words, if you buy a property $200,000 that needs $50,000 in repairs, you can borrow the extra $50,000. Too good to be true? NOPE. That's it in a nutshell.

The Math

Your down payment is basesd on the sale price PLUS the final cost of the repairs x 3.5%, so for example:

Sale price is $200,000 (DO not calculate 3.5% on this) + $50,000 in repairs/costs (which includes certain costs and reserves the lender will require), so your loan is actually for $250,000. To calculate your down payment, $250,000 x 3.5% = $8750.00. (You will also have to pay out-of-pocket for Closing Costs, as usual.)

The Process

You, the buyer, will hire (lender may recommend) a HUD approved FHA 203k Consultant to accompany you to the property to determine the required repairs. This is your "wish list" of repairs.

The bad news is: The fee charged by the consultant can range from $400 to $1,200 depending on the extent of repairs needed. (Check with your consultant prior to scheduling your appointment.)

The good news is: The HUD-approved FHA 203k Consultant's Fee may be included in the mortgage, so go back above to The Math and add the Consultant's Fee into the amount you will borrow in your FHA Loan, and recalculate your downpayment.

Once the Consultant has itemized the list of repairs, you, the buyer, will obtain bids (estimates) from several licensed contractors for the work that needs to be completed. Three estimates are recommended for each contractor, but three is not a fixed or mandated number; it is just good practice to always get at least three bids.

You, the buyer, can act as your own general contractor but only if you are experienced and licensed. (FHA says experienced, but most investors require the buyer to be licensed.) The contractors must provide documentation that needs to be approved by the lender prior to the final loan approval.

The Consultant will determine the "required" repairs versus the "wish list repairs". Start with the required repairs and then move on from there to your wish list.

This is an important step for the Consultant and the Appraiser. You do not want to over-improve the home and exceed the condition of the comparable properties in the area.

Once the Consultant completes his report of required - and wish list - repairs, the lender will forward it to the Appraiser for an "After Improved Value" appraisal. This is where you may run into problems if you plan to over-improve the property. The Appraiser's report will be based on similar properties in this similar market. If you have a lot of short sales or foreclosures occurring in that neighborhood, take care because the appraisal will be lower than you might otherwise expect.

The Final Appraisal Report

The Final Appraisal Report will be a product of "tweeking" between the Consultant, the Appraiser and you, the Buyer. The final result will define exactly what the Contractor(s) will perform and how much they will be paid.

Next, the entire file is submitted to underwriting for approval. Of course, YOU WILL NEED TO QUALIFY FOR THE FULL LOAN AMOUNT BORROWED, even though you may be living in the home during the rehab period. The normal steps for closing will occur.

A Big Pluses

You, the borrower, can include 6 months' of mortgage payments in the new loan amount since it's assumed that you will have TWO housing payments during the rehabiliation of the new home. This money will be deducted each month during the reahab process. This is optional.

Closing occurs, and the work begins within 30 days of closing/funding. (This is when your mortgage payments start since this is when you started borrowing the money - however, if you included the 6 months' mortgage payments, they will be deducted it from escrow, starting when your first payment is due.)

Disbursments are made throughout the following 6 months from the Escrow Account (normally 4 draws with one final inspection, but this can be increased for higher repair amounts) as the work is completed.

Summary

You already paid the seller the purchase price of the home. Then you borrowed an additional amount which sits in an Escrow Account to pay the contractors. Your total loan is the total amount you borrow: 96.5% of the Purchase Price + Repairs.

Once the last disbursement is made and the final inspection showing COMPLETED AS PER THE CONTRACT, you are done!