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   ARTICLE   |   From Scotsman Guide Residential Edition   |   June 2015

The Thrill of Renovation Loans

It takes a team to guide borrowers through an FHA 203(k) adventure

The Thrill of Renovation Loans

Federal Housing Administration (FHA) loans have a recipe all their own. The vanilla FHA loan is the current flavor of the month with the decrease in annual mortgage insurance premium instituted earlier this year creating a run on Streamline refinances. The FHA 203(k), however, with its hint of renovation spice continues to be a viable product for purchase and refinance loans. It is a unique product that allows a borrower to finance the cost of repairs and close the loan prior to any work being completed.

Every 203(k) loan is an adventure, however, and some have more ups and downs than others. FHA 203(k) Streamlines have fewer moving parts: They don’t require renovation consultants, cannot involve structural work and are limited to $35,000 in total renovation costs. At the other end of the spectrum, the full 203(k) is like a Streamline on steroids.

It offers the ability to add rooms and complete structural improvements, requires a 203(k) consultant and may exceed the $35,000 renovation-cost limitation up to the maximum loan to value. It can be a real beast of a ride.

Prepare for adventure

So what do you need to know to originate and underwrite FHA 203(k) loans? Loan officers and underwriters should be proficient in FHA 203(k) guidelines and know how to use the FHA 203(k) Maximum Mortgage Worksheet. Being familiar with construction terms also is helpful. Here are some typical characteristics to help you better understand FHA 203(k) loans:

  • The 203(k) is not for every buyer. Some buyers just want to move in, and renovation loans are not for them. The FHA 203(k) is for borrowers who want to put their finger-print on a property and make it their own. With the advent of do-it-yourself shows, more and more people are apt to purchase less expensive homes and finance renovations, but this takes vision, planning and organizational skills throughout the process. Most important, mortgage brokers should help clients get preapproved for the maximum FHA loan before they even make an offer.
  • It takes a dedicated team. A successful and timely 203(k) transaction requires that all parties — Realtor, loan originator, appraiser, underwriter and renovation consultant (for Full 203(k) loans) — be knowledgeable about the product and work together toward completion.
  • Not all homes are created equal. Every real estate office has at least one property listing that is structurally sound, but is in desperate need of some TLC. The 203(k) can be used to update any home, but is often used to bring homes back up to minimum property standards. Ideally, the Realtor will work with a contractor or 203(k) consultant before marketing the home so potential buyers have some idea of the costs needed to meet those minimum standards.

As you can see, Realtors play a key role in the success of an FHA 203(k), so it is important to find a real estate partner versed in renovation deals. One of the key roles for your Realtor partner is to determine the “after-improved value” of the home. This element is important, because buyers obviously don’t want to purchase homes for more than they are worth once the sale price is combined with the cost of repairs.

The after-improved value is often based on recently renovated homes. Descriptions of renovated homes that have sold can be found in the Multiple Listing Service. These descriptions are a vital factor in determining the after-improved value for a 203(k) loan because they may be used as comparables in the FHA 203(k) appraisal.

The adventure begins

For many, the adventurous part of the FHA 203(k) process is the loan calculation and all the moving parts of the property analysis. The 203(k) maximum mortgage worksheet may allow a borrower to finance the total cost of repairs depending on the value. The worksheet walks you through the calculation step by step.

Your underwriter will be responsible for checking the accuracy of the costs of repairs from bids or work write-ups, as well as fees and total loan calculations, so be sure you’re working with an underwriter who understands the worksheet. It takes into consideration the sales price, the as-is value and after improved value of the home, as well as a 110 percent calculation of the after improved value. The worksheet also includes the following costs or fees:

  • Repairs. The costs of repairs are based on a contractor bid for the Streamline, or on a contractor bid and a specification of repairs or work write-up prepared by the  required renovation consultant for a Full 203(k) loan.
  • Contingency. Home remodels typically run into unforeseen work discovered during the renovation, so the form provides for a contingency reserve of 10 percent to 20 percent of the cost of repairs.
  • Inspections. The cost of inspections to confirm that repairs and/or renovations have been done in a workmanlike manner is included in the form.
  • Title updates. The cost of title updates is also included to make sure no mechanics liens remain on the property as the work progresses and gets completed.
  • Loan payments. As many as six months of mortgage payments may be placed in escrow if the home is uninhabitable during a Full 203(k) renovation.
  • Architectural plans. Any architectural costs for plans and specifications are included when doing a Full 203(k) renovation
  • Consultant fee. An FHA 203(k) consultant is required on a Full 203(k) loan.
  • Permits. Many repairs will require permits and the cost for these must be included in the worksheet.
  • Escrow administration. A supplemental origination fee may be stipulated for lenders to administer the renovation escrow account.
  • Discount points. The maximum mortgage worksheet allows for a portion of the dis-count points charged on the total loan to be financed as part of the cost of repairs.

Hire a good guide

The most adventurous part on the 203(k) is dealing with contractor bids and consultant work write-ups in conjunction with the after-improved value appraisal. Contractors and borrowers don’t always incorporate all the needed work on their Streamline applications, so appraisers may call for more work, which can then require a change to the loan amount.

What happens if the after-improved value isn’t sufficient to support the repairs the borrower wants or needs? What happens if an appraiser calling for more work impacts the value of the home or the borrower’s ability to qualify? These scenarios lead to revisions, which can be like putting a square peg into a round hole. The entire loan process could go back to the beginning. A good knowledge base on the 203(k) product by all parties is essential.

One advantage of the Full 203(k) loan is the requirement of a consultant who knows minimum property standards. This can drastically cut down on the number of revisions required on the bids. Working with renovation consultants or contractors well-versed in housing standards and the requirements of 203(k) renovation loans can help mortgage originators guide their clients through underwriting to a successful closing.

•  •  •

For those borrowers up for an adventure, there’s nothing like buying a house that no one wants, adding their own touches to create a home and ending up with equity to boot. Many satisfied borrowers have gone through the 203(k) process. Some embrace it fully and understand the perils and pitfalls they may encounter. Others, however, are unprepared for what lies ahead. It is the job of mortgage brokers and bankers to pull together a team of renovation experts to guide these clients through the FHA 203(k) adventure. 


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