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   ARTICLE   |   From Scotsman Guide Residential Edition   |   March 2010

The Art of Rehab

FHA's 203(k) program offers lending options for properties in need of repair

The Art of Rehab

Homebuyers could be wondering about how to borrow funds for property purchase and rehabilitation simultaneously. Especially with more real estate owned properties (REOs) coming on the market, and with these and similar properties needing repairs, these potential borrowers seek strong financing options.
Mortgage brokers who master the Federal Housing Administration's (FHA's) section No. 203(k) program could provide an option for these clients.

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FHA's 203(k) program is designed to help finance properties that need updating, rehabilitation or expansion. It can be complex and time-consuming for mortgage brokers. But it can pay off.

Brokers who hope to work with the program, which offers mortgage insurance to FHA-approved lenders, must coordinate with an array of building and real estate professionals and deftly manage a multitude of paperwork. They also must understand when a standard 203(k) and Streamline (or Streamlined) 203(k) are necessary and how.

Brokers who help borrowers set appropriate expectations and follow a professional and predetermined process can increase their success and develop a lending niche that continues to grow in need.

Some of the keys to success include:

  • Strong upfront preparation;
  • A vision for how the loan puzzle will look upon completion, which means being well-grounded in all aspects of the program; and
  • Effective time management to benefit the borrower and the lender with an efficient process that won't waste time.

Key program facts

Picture a 203(k) loan as a jigsaw puzzle. Your responsibility as a mortgage broker is to oversee its completion, and experience can be vital to understanding when specific puzzle pieces must fall into place.

The first step is to be up-to-date on FHA guidelines. The borrower's property loan must meet FHA rules before you consider the 203(k) element. These rules include new regulations such as stricter standards and documentation requirements for the FHA streamline refinance program and the prohibition of brokers ordering appraisals for FHA loans.

Other FHA changes also are in the works, and brokers working with FHA loan programs must remain attentive to all developments (see sidebar).

Beyond remaining current on all FHA rules, brokers who work with 203(k) loans should understand key facts specific to the program:

  • The loan only is available for primary residents, not for investors.
  • One- to four-unit homes and condominiums are eligible. Townhomes count as a single unit regardless of how many units are attached, as long as a 90-minute firewall separates each unit from foundation to roof.
  • Buyers can renovate a property that has as many as seven units. But after rehabilitation, an individual building must not contain more than four units.
  • 203(k) loan limits may not exceed FHA county loan limits, which vary.
  • The maximum renovation amount for the 203(k) loan is 110 percent of the property's as-completed value.
  • No luxury items are allowed under the 203(k) program.
  • Properties must require a minimum of $5,000 in repairs to qualify with a standard 203(k). HUD doesn't require a minimum for Streamline 203(k) loans, though investors might. Different specifics apply to HUD-owned homes.

How it can help

Other Options

Although the Federal Housing Administration section No. 203(k) program can be the most-effective program when dealing with real estate owned properties needing rehabilitation, approved mortgage brokers can consider working with other lending instruments, as well. These include:

  • Fannie Mae's HomePath (home, which offers special financing on Fannie Mae homes needing light renovations; and
  • Fannie Mae's HomeStyle Renovation (, a conventional product. Financing is based on the home's as-completed appraised value, of which borrowers can use as much as 50 percent for improvements or repairs.

Despite these rules and others, the 203(k) program offers many benefits. For many borrowers, a 203(k) loan allows them to buy a home and customize it to fit their needs and desires. The program also can benefit those who wish to purchase foreclosed homes that require repairs and FHA-mandated renovations.

As such, the program comprises an important tool for neighborhood revitalization and for expanding home-ownership opportunities. Financing for the purchase and renovations also is rolled into one loan with one closing and one payment.

Increasingly, 203(k) loans play a major role in the disposition of REOs. Often, REO properties are in poor condition. This is because the bank or lender that now owns the property only will conduct some minor repairs to prepare them for resale. Meanwhile, banks still want to avoid "dumping" properties at a low price.

If the new homeowners must make repairs, they can apply for a 203(k) loan. It can be a tool for mortgage brokers in the REO niche, as well.

Executing a 203(k) loan

After identifying a potential property they would like to renovate, buyers must decide which repairs or upgrades they would like to complete. As their broker, you should let them know that if the total repair escrow is greater than $35,000 or structural work is necessary, a U.S. Department of Housing and Urban Development (HUD) consultant will be needed, and the program will change from a Streamline 203(k) to a standard 203(k).

Next steps in the process include the following:

  1. A mortgage broker tells the buyers to expect the process to take time and explains to them the importance of being ready at all necessary junctures.
  2. The buyers contact an approved FHA 203(k) broker or lender to provide a detailed proposal. It's often wise for them to use a broker or lender focused on renovation loans full-time. Often, those not specializing in such loans may not have the experience to drive the process.
  3. The borrowers provide the information to become preapproved for themselves and the property. After preapproval, the potential scope of the work is determined.
  4. The borrowers inform their real estate agent about their preapproval and sign a purchase contract.
  5. The lender requests documents to validate the initial information on the preapproval application along with homeowners insurance, title work, a HUD consultant's write-up (for a standard 203(k) only), contractor documents and bid for the repairs.
  6. The lender orders an appraisal to determine the future value of the property.
  7. At closing, the lender releases all funds and places the renovation funds in escrow. These funds are released upon draw requests or inspections with a two-party check made payable to the contractor and borrower.

Cutting through complications

There are many people involved in this process -- from the buyer and lender to a title company, appraiser, HUD consultant and contractors. Remember that each can slow down the process.

In today's real estate market, where foreclosures abound, there are other complications that affect mortgage brokers working with the 203(k) program. The biggest of these is finding a lender that will purchase 203(k) loans.

Brokers must contact their wholesale representatives to discover if specific lenders offer the 203(k) program. If so, brokers should work with a lender representative to become approved to offer this product.

To combat potential issues, it's important that at least one person in your office is trained on the interlocking pieces involved in the 203(k) program. Training programs are available through the FHA and various online services.

Those who undertake proper training will get to know the totality of the program and start gaining the experience necessary to lead borrowers through the process comfortably.

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When 203(k) loans are completed successfully, all parties involved should feel satisfied with the outcome. Brokers who master this specialty product -- and who nurture a passion for helping rehabilitate properties and neighborhoods in need -- can establish themselves as top professionals in a growing niche.


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