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   ARTICLE   |   From Scotsman Guide Residential Edition   |   February 2012

Rehab Loans May Lift Your Business Out of the Muck

Partner with FHA 203(k) contractors to rise above the competition

Rehab Loans May Lift Your Business Out of the Muck

A picture of the nation’s foreclosure market can be painted with a few numbers. There were 224,394 foreclosure filings on U.S. properties this past November, according to RealtyTrac. The seasonally adjusted delinquency rate for residential properties was 7.99 percent this past third quarter, the Mortgage Bankers Association reports. In addition, 4.43 percent of all mortgage loans were in the foreclosure process by the end of the third quarter.

Those working in the mortgage industry know this all too well.

The problem with these numbers is that banks are not meant to own homes — people are. And when banks own homes, they often sit idly and start to deteriorate to the point that they are no longer inhabitable. The Federal Housing Administration (FHA) Section No. 203(k) loan program may be the answer to this vicious cycle.


The 203(k) program provides funds to eligible homeowners to finance repair and renovation work within their mortgage — the goal being to stimulate homeownership and revitalize communities. Mortgage brokers and originators have begun to take notice of the business opportunities this program represents. It’s starting to gain traction among contractors, as well.

Remodelers, carpenters and handymen play an essential role in the success of 203(k), but not all skilled workers can provide the specialized work that the program’s guidelines dictate. That’s why it’s important for mortgage brokers to cultivate relationships with contractors who are knowledgeable and capable of doing 203(k) work.  
Although there might be challenges in the relationship between mortgage brokers and 203(k) contractors, upon examination the mutual benefits quickly become apparent. Here are some tips to maximize success when working with a 203(k) contractor.

Thorough inspections

The inspection is one of the first steps to any 203(k) project. It details the work that needs to be done and how much it will cost. Contractors who have provided these inspections agree that the more thorough the inspection, the better.

“Being thorough about the scope of work and costs determines whether the project can be financed,” says John Andrews, an FHA-approved 203(k) consultant and president of Andrewz Home Improvements Inc., based in Warrenton, Va. “My report dictates how much money the homeowner will get from the bank.”

The role of the consultant is to inspect the home for safety and security issues and generate a list of items that must be addressed for the home to be inhabited. Consultants also provide an estimate of the cost of those repairs. Multiple contractors can provide estimates and bid for the job based on the list of repairs outlined by the inspector. 

One requirement unique to 203(k) work, however, is that the estimate cannot exceed the appraised value of the home, unless the items are considered energy-efficient improvements, in which case they can add 10 percent of the appraised value onto the loan. In cases where the estimates exceed the appraised value, the scope of work must be reduced. The first thing to go likely is cosmetic work that can be done by the homeowner, such as painting.

Andrews says that banks are adamant about protecting these properties, so it’s important for him to make a thorough inspection and rely on his background as a contractor to determine what issues might be lurking under the surface. This is especially challenging with abandoned properties.

“[As an inspector], you need to think about unforeseen issues that are found in abandoned properties, and you need to think about costs associated with mold and lead remediation in older homes,” Andrews says. Most lenders have a contingency built into the loan for these unforeseen issues, but ideally, inspectors who build these issues into the report make the loan process easier for all involved.

For these reasons, trust between the inspector’s expert opinion and the lender is critical. Usually banks appreciate not having to lend the homeowner more money in the future.

To make the report as thorough as possible and to help communicate with mortgage brokers, Andrews recommends using photos and videos to document the inspection.

“I take photos of everything, and if it’s more involved, I will videotape what was done and where it was done,” Andrews says. For example, one home required tearing down a detached garage. Andrews used video to show the before and after of the garage and the tear down to document how it was done. The mortgage brokers he works with appreciate this additional due diligence.

203(k) challenges

The 203(k) program provides additional hurdles for contractors, including limitations, deadlines and extensive paperwork. Brokers who partner with contractors experienced in these types of projects can make sure that the loan process moves more efficiently.

Dennis Smith, a certified 203(k) contractor and president of Durango Construction Inc., based in North Las Vegas, Nev., operates in a market that’s heavy with foreclosures. The Las Vegas area is known for its volatile housing market, and contractors are seeing more 203(k) work than ever before.

“In 1988, when I started my remodeling business, we did a lot of residential and commercial remodeling and eventually moved into insurance restoration work,” Smith says. “But these days, foreclosures and short sales are more common.”

Unfortunately, many of the homes that have been foreclosed are in terrible shape. “Vandalized, missing things, mold damage — we’ve seen it all,” Smith says. After a foreclosure, the previous owners often take things out of the home that they believe have value.

“[But] no one can loan on homes that are uninhabitable,” Smith says. That’s where he comes in. His job is to fix up the homes so that they have value again — enough value that it would make sense to have a loan covering the sale of that home.

Smith has faced several challenges with 203(k) work. Often he is forced to cover the project’s financing upfront, and sometimes he doesn’t receive payment until 30 days after completion. “Some mortgage companies that I regularly work with give 50 percent upfront and the rest after final inspection, and some don’t give me anything upfront,” Smith says.

Smith has been in business long enough that he has saved funds to cover this contingency, but many one-man operations may find this difficult. Of course, the funds’ dispersal often depends on whether the loan is a Streamlined 203(k), which covers work for as much as $35,000, or a full rehab, which has no monetary limitations. 
On the upside, Smith says that when the project is completed, payment is guaranteed, which in this economic climate can be beneficial. “I don’t need to worry about where my payment is going to come from, and that takes off pressure for me to investigate the client because I’m being paid by the bank,” he says.

Other challenges have to do with the timeline of this type of work. Smith says that there’s always uncertainty that the deal will go through and that sometimes the closing of escrows can take months. “Once the escrow closes, we like to get the work done as soon as possible, especially if the clients are not living in the home. We will try to get most of it done before they move in,” Smith says. Oftentimes this requires quick reaction time for assembling a crew. 

Positioning for success

Smith and Andrews believe that these challenges can be overcome with a little effort and the right attitude. “A year ago, we didn’t even know what 203(k) was,” Andrews says. “A repeat customer wanted to buy an uninhabitable property, and we learned about the process along the way.”

Tips for working with contractors

  • Hire contractors who are certified to do 203(k) work.
  • Check that a contractor's Occupational Safety and Health Administration (OSHA) and Renovation, Repair, and Painting (RRP) certifications are active.
  • Keep lines of communication open with contractors, especially if the loan had delays.
  • Provide enough time for proper review and completion of paperwork by the contractor
  • Notify the contractor of the lender's payment policy before work begins

Smith and Andrews both opted for additional training and education on this niche market. Although the U.S. Department of Housing and Urban Development (HUD) no longer approves or endorses builders or contractors, there are several options for contractors to increase their knowledge of the 203(k) market.

Smith became certified as a 203(k) contractor by 203kcontractors.com. According to the site, the certification process “involves education and testing as well as verification of credentials, references and work experience.” He says that many of the mortgage brokers contacting him have found his name because of this certification. 

Andrews is a HUD- and FHA-approved 203(k) consultant. To be listed on the consultant roster, applicants must have at least three years of experience as a contractor or inspector, as well as the appropriate education and licensing. When approved, consultants’ work is tracked by HUD through the identification number that must be included on work documents.

This kind of extra training equips contractors with the tools needed to handle a 203(k) project. Then they can provide the standard documentation and agreements that brokers need to process loans. Industry memberships and appropriate certifications are key indicators of contractors who have the experience, licensing, insurance and education needed to be successful and reliable business partners. Mortgage brokers and originators who work with contractors certified to work on 203(k) projects can build relationships to generate referrals and exchange business to mutual benefit.


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