- The Washington Times - Thursday, July 15, 2010

Homebuyers in today’s market are sometimes stumped when they see the potential in a home for sale but do not have the funds available for a down payment, closing costs and remodeling expenses. Homeowners sometimes find themselves in a similar bind: Home equity loans are difficult to obtain, so owners need to find other ways to fund home repairs and improvements.

The Federal Housing Administration (FHA) offers a loan product known as a 203(k) that allows borrowers to wrap the costs of home improvements into one mortgage that is also used for purchase or refinancing of the home. Designed for use by homeowners for their principal residence, 203(k) loans are limited to owners or buyers of one- to four-unit dwellings. The loans are not available to investors.

“In this market, FHA 203(k) loans are more popular than ever and almost necessary for some buyers because so many homes today are short sales and foreclosures that are in bad condition,” says Hugh Gordon, branch manager at First Home Mortgage in Frederick, Md. “These loans are one of the only ways to finance the repairs that are often needed in these homes to meet livability standards.”

Mr. Gordon recommends that borrowers considering buying a foreclosure or short sale get preapproved for a 203(k) loan and ask a lender about the program.

“The preapproval for a 203(k) is basically the same as getting a preapproval for any FHA loan,” Mr. Gordon says. “The borrowers, whether they are buying a home or refinancing, just need to find out the maximum loan that they can qualify for under FHA standards. Once the buyers have found a home they like, they will need to see if the purchase and the home-improvement costs will fit within their maximum loan qualification.”

FHA loans, including 203(k) loans, are limited to maximum borrowing amounts that vary by location. In the Washington metropolitan area, the loan limit is set to $729,750.

David Skaff, regional manager for residential mortgages in the mid-Atlantic region for M&T Bank, says, “A 203(k) loan allows people to buy a home that needs work and have the work done before they move in. This is easier on the buyers and often makes the work easier to accomplish, too. The loan is based on an appraisal of the ‘as-is’ value and contractor estimates of the cost of the repairs or improvements.

“So, for example, if someone finds a home selling for $100,000 that needs $30,000 in repairs, they will need to qualify for a loan of $130,000.”

Mr. Skaff says buyers must meet FHA standards for credit scores and debt-to-income ratios and make a down payment of 3.5 percent. Homeowners who are refinancing will need at least 97 percent equity in their home to qualify.

“Minimum credit scores for an FHA loan are 580, although even at that score, many lenders will require some additional mitigating circumstances such as excellent savings or income or low debt to qualify for the loan,” Mr. Skaff says. “In general, the debt-to-income ratio to qualify is a maximum of 31 percent for housing and 43 percent for all debt compared to the monthly gross income, but exceptions can be made for people with good assets and savings.”

Mr. Gordon says interest rates for 203(k) loans are typically about a half-percent higher than for standard FHA loans.

Both Mr. Skaff and Mr. Gordon say 203(k) loans are perfect for buyers of foreclosures because many of those homes have been damaged or lack basic appliances. The loans can be used by buyers or homeowners for almost any type of repair, with the exception of some luxury items, such as adding a swimming pool or hot tub.

FHA 203(k) loans can be borrowed for buying, refinancing and improving a single-family home, town home or condominium, although the improvements on a condominium must be internal only. Repairs and improvements on all homes can include adding or replacing a roof, gutters and downspouts; structural alterations and reconstruction; modernizing the home and making exterior changes (such as paint or siding) to improve the appearance of the home; eliminating health and safety hazards; replacing plumbing, flooring, kitchen appliances, landscaping, heating and air-conditioning systems; and updating a home’s energy efficiency. These loans also can be used to enhance accessibility for a disabled person.

In addition to overall loan limits and borrower qualifications, 203(k) loans have some other restrictions. The costs of the rehabilitation work must be at least $5,000. Borrowers who want to make more than $35,000 in repairs will need an inspection of the property by a cost consultant approved by the Department of Housing and Urban Development to generate a specification-of-repairs list with cost estimates. Loans requiring less than $35,000 in repairs are called a “streamline” 203(k).

Construction or repairs must begin within 30 days of the loan’s closing and must be completed in six months or less. Mr. Skaff says extensions can be obtained for projects requiring additional time.

“One of the only downsides to a 203(k) loan is that it can take a little longer [to close] than a standard mortgage loan,” Mr. Gordon says. “These loans require at least 45 to 60 days and sometimes longer to get to closing because the borrowers have to get estimates from contractors, and then the appraiser must evaluate both the ‘as-is’ value of the property and the estimates.”

Richard Hutchison, chief mortgage officer of Virginia Heritage Mortgage in Chantilly, Va., says while 203(k) loans can provide additional buying power for borrowers, the complications of administering the loans sometimes can be frustrating for consumers.

“I would not necessarily recommend that first-time buyers take on a 203(k) loan because of the headaches involved with taking on a rehabilitation project,” Mr. Hutchison says. “If a buyer already knows good contractors or has some experience in the building or contracting business, this could work well, but for someone never exposed before to renovation work, this may not be the best plan.”

Mr. Skaff says 203(k) loans can be complicated depending on the level of the projects involved.

“In general, the process is pretty user-friendly, but if someone is buying a place and gutting it all the way to the foundation, that will be much more complex,” he says.

“But these loans work well for someone who is buying an older home with a 40-year-old kitchen, for example,” he says. “Rather than waiting until they can afford to redo their kitchen and go through the hassle of living in the property while the work is done, they can wrap those costs into the home purchase and wait to move in until the remodeling is finished.”

Mr. Skaff says with streamline 203(k) loans of less than $35,000 in repairs, it is up to the borrowers to approve their contractors. He says borrowers can go to their local home center, such as a Lowe’s or Home Depot, to get estimates for supplies and labor costs.

The funds for construction and repair work are paid jointly to the borrower and the contractor in up to five draws. Once the project is complete, a final inspection is required. Buyers are not allowed to do the work themselves unless they are licensed.

“These loans are practically required for people who want to buy a foreclosure, and they work well for refinancing, too,” Mr. Gordon says. “The limits on what people can do are pretty lenient, so basically, consumers are limited only by their own budget. Most people stay within a strict budget to keep their monthly payments low, and of course, they need to be able to qualify for the mortgage, including both the repair and purchase costs.”

Homeowners interested in adding value to their home and buyers interested in making home improvements to a damaged or older property can find out more about the FHA 203(k) loan product at www.fha.gov.

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