When entering the property market for the first time the biggest hurdle for the most of us is finding lenders willing to give you a chance, this is why understanding what is a 203k loan is importnat. Lenders have little trust for first timers and can be depressingly strict when it comes to the amount they are willing to offer you. Once you can find a lender willing to give you a loan you need, you walk into the next hurdle of finding a home that suit your needs for the principal amount on offer. A popular technique used by first homeowners in the know is buying the dreaded “Renovators Delight”. These homes are normally very cheap compared with the local average and can mean you can purchase a bigger home for what others would spend on a smaller property.
But wait, I hear you say, this type of home may be cheap to buy but they ultimately cost more because you need to find more financing to fix the property up to a stage where it can be profitable. Which is true unless you know the secret…FHA 2003k loans. Essentially a 203k loan will allow you to consolidate the home mortgage and the costs of repairs into one low interest rate long-term loan. With these loans it is expected that the property will be worth more once rehabilitated than the current cost of the home and the costs of repairs combined. This means you only need to be able to prove you ability to pay off the cost of the home because the repair costs should pay for themselves.
The FHA 2003k loan has strict eligibility requirements that you need to understand before you start looking for your new home. The following will help you understand these requirements and how to make the most of this opportunity.
So what is a 203k loan
The 2003k loan is HUD’s (U.S. Department of Housing and Urban Development) primary program that deals with the rehabilitations and the repair of single-family properties, although the loan can be used to purchase multiple units and condos. The eligibility requirements for multiple apartments are quite strict so do your homework first.
HUD introduced the 203k-loan scheme in an attempt to encourage homebuyers to purchase neglected properties and help them to rehabilitate the property. HUD sees this as an effective tool for revitalizing downtrodden neighbourhoods that were becoming neglected.
Why does it exist
As I’m sure many of us have experienced before, the big banks and other lenders are not likely to offer you a loan that exceeds the current market price of the property you are looking to buy. This is true even for houses that are in desperate need for rehabilitation, despite the obvious rationale that the property—once rehabilitee—will be worth more than its current market value.
Because lenders see these types of purchases as involving more risk than the purchase of a normal home the terms of the loan that will offer you will often be a short term loan with very high interest rates, and the loan would only cover the cost of the home itself. Once you have the home you would then need to apply for another high interest, short term loan the cover the costs involved in the repair. Finally after you have rehabilitated the property you need to find a lender who will offer you a long term, low interest mortgage that will cover the costs of your other two loans.
Under the 203K scheme lenders can offer prospective buyers one long term, low interest loans that cover both the cost of the home and the costs of the rehabilitation. The amount of the loan is not based on the current Market value nor the suspected costs of repair but instead the potential worth of the property once fully rehabilitated will be professionally appraised and be the basis for the principal of the loan.
It is important to note that like other FHA programs the 203k loans do not come from HUD but from commercial lenders, to encourage these lenders to accept the risk associated with these types of loans HUD simply insures the loan in case the buyer is not able to make the required payments on the loan.
Eligibility Criteria for a 203k loan
Basically for a property to be eligible for a 203k loan it home on the building must have been built at least 12 months prior to sale, it can not contain more than four units and the property must conform to the local zoning regulations. Unfortunately under HUD regulations cooperative units are not eligible for help.
In more detail
- Any recently build properties must be attached in some way to the existing unit.
- You can use it to convert a single family dwelling into multiple units, you can also convert a multi unit property into a single family home.
- If the home is in a condition such that it needs to be demolished as part of the rehabilitation process the new building must be built upon the original homes foundation. This also applies to properties where the home has been demolished prior to sale.
- It is possible to purchase a property and move an existing home from another property to the new mortgaged property. However the loan cannot be used on the cost of the existing home and the involved transport until the new foundations of the mortgaged site has been inspected and the house is fully secured to the new foundation.
Mixed use properties are eligible if:
- The amount of the property that can be used for commercial purposes can be no more than
25% single storey
49% double storey
33% triple storey
- Any commercial undertaking cannot have an adverse effect on the people who live in the property.
- Monies from the 203K loan cannot be spent on commercial purposes. The funds can only be used to repair residential functions and areas of the property that will be used as a way to access the residential space.
Unknown to many people it is possible to use the 203K loan for the purchase of Condo’s so long as the following criteria are met:
- The property must be a single unit in the project.
- The FHA must approve the condominium project.
- The property cannot be used as an investment property, you must intend to be an owner/occupier or to use it for some other non-profit purpose.
- The funds from the loan can only be used to rehabilitate the interior of the property because all the externals are under the responsibility of the condominium association
- A maximum of 5—or 25% whichever is less—can be undergoing FHA rehabilitation at any one time.
- The amount of the loan cannot be more than the value of the unit once it has been completed.
What can the money be spent on?
Although you might have a list of repairs and upgrades you want to do to your new property, there are some tasks that must take precedent. According to the FHA your first priority once the loan has been approved is to repair issues related to health, safety and conservation. It is expected that these concerns will be completed or largely completed before you move onto other issues.
It is a requirement of the 203K loan that smoke detectors must be installed adjacent to all sleeping area.
Once you have satisfied FHA that these repairs have been completed you can then move onto the things you believe are important, these can include:
- Roof, gutters and downspouts
- New kitchen and laundry appliances
- Interior and exterior painting
- Heating venting and air conditioning
- Plumbing and electrical
- Flooring such as carpet, tiles and polished floor boards
- Windows and doors
- Improvements for people with disabilities
- Energy efficiency
- Decks, patios and porches
- Septic and well systems
- Kitchen and bathroom remodelling
- Weather-stripping and home installation
- Stabilizing and removing lead based paint
- Completion and waterproofing of basement
Although the 203K-loan scheme was originally intended to apply to first homeowners, the scheme can be successfully used to enter the property investment industry. If you are willing to put in the effort to rehabilitate the property and you are in a financial situation where you are able to wait until the property is rehabilitated before you can expect to receive any income from the property then the 203k loan is something that you should look into if you are struggling to find finance.