Thursday, December 22, 2011

Overview of FHA 203K Rehab Loans

When looking to purchase a home in the Ann Arbor area, one option that is have available to consider is the use of what is called the FHA 203K Rehab loan. The 203K is a loan that can be taken when purchasing a property that is in need of some repair. It will combine the cost of the property and the cost of the repairs into a single loan.

The question is why anyone would want to take out a rehab loan on the purchase of a home.

The answer is simple. Homes that are at different levels of repair or in need of it are everywhere, ranging from new home construction projects that ran out of money, to foreclosures.

All of this means two things. The first: lenders that hold mortgages on these properties need to get rid of them. They face obstacles however, like the number of homes available. These homes are also more likely to be passed on by prospective buyers, due to the amount of work needed, and lenders know it.

The second point is that buyers, unless they are paying with cash, will be getting some type of mortgage on the property. Lenders, depending on what needs to be done, may have reservations toward lending money on a property in a dilapidated condition. A cash buyer will always make a lower initial offer and the lenders will sometimes accept. They will incur a huge loss sometimes, but often they see this as the better alternative.

You Are Holding the Cards.

How do you fit into an FHA 203K loan? You will have significant leverage in the transaction and be able to propose a higher offer than a cash investor might. It comes down to the fact that lenders would rather see a small loss instead of larger one on a property.

Depending on what needs to be done to the property, you may be able to negotiate to a price low enough, so that even when repairs are added in, you will have a property that is worth more than your investment.

How the 203K Work?

The 203K process is a pretty straight forward one. The first step is to find a mortgage professional that is able to originate a 203K mortgage. Many do, but not everyone does, so make sure that the one you are working with does, before you move onto the next step.

Once you have secured a lender, and a property, the next step is to get what is called a 203K consultant, assigned by your lender, to step in and help the process. This person, someone who normally has years of construction experience, will act both as an advocate, for FHA, and you, as well as someone to keep the contractors that will be doing the work on task. They will sit down with you and review your objectives with the project and review plans if there are any.

At this point you will need to get a 203K appraisal. This is a special appraisal that appraises the property as if all of the proposed improvements have been complete. These are a bit more costly and time consuming than a typical appraisal, but will give you an idea of what the place will be worth when it is complete.

Once you know what the value is after the work is complete, the next step is to get estimates from three general contractors, all of which must have their own references, and lines of credit from which to fund materials. The work must be managed by a general contractor, meaning that neither homeowners, nor people that aren’t general contractors are able to manage the project. This is to ensure quality, and to keep the project on a reasonable timeline.

The consultant will review the estimates and work with the homeowner to determine which will be in the best interest of the project.

Providing that the cost estimates are in line, the mortgage process moves forward, and is pretty much like any other mortgage at this point. Work on the property begins after the closing, at which time an escrow account is created to pay the contractors. The title company manages these draws.

Contractors are paid partial draws as the project progresses, to help ensure that work is completed. Once all work is completed, the contractor is paid the final draw. Overages are planned for in the initial cost estimates, and any money that is left over, if there is any, will pay down the mortgage. Homeowners may or may not live in the property while work is completed, depending on what needs to be done.


The FHA 203K is a great product for those looking to buy a home in need of repair. While it is a more involved process than just buying a home with a traditional mortgage, you may find benefits in going this route. Talk to your real estate agent and see what opportunities are available in the Ann Arbor area for you.

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