An abundance of REO homes on the market presents some good buying opportunities. Purchase of these homes by owner occupants helps spur community and neighborhood revitalization. Homes needing renovation are often the best buys available, but most buyers have no idea how to finance both the purchase of the home and the needed renovations. The Federal Housing Administration § 203(k) Renovation Loan Program offers a means for turning a fixer-upper into a dream home.

What is the FHA § 203(k) Renovation Loan Program?

The § 203k is a unique mortgage loan that offers the benefits of FHA financing along with the ability to provide funds for both the purchase and renovation of a home — or to refinance a current home and fund a needed rehab project. The loans are beneficial for persons or families with low or moderate income, offering a single, long-term, fixed or adjustable rate loan that covers both the acquisition and rehabilitation of a property in a single mortgage loan.

To provide funds for the rehabilitation, the mortgage amount is based on the projected value of the property with the work completed, taking into account the cost of the work. The value of the property is determined by either (1) the value of the property before rehabilitation plus the cost of the rehab, or (2) 110 percent of the appraised value of the property after rehabilitation, whichever is less. The cost of the rehabilitation must be at least $5,000, and the total improved value of the property must fall within the FHA mortgage limits for the area (see the mortgage limits tool at https://entp.hud.gov/idapp/html/hicostlook.cfm).

What are the typical loan terms and conditions?

A § 203(k) loan will be either a 15- or 30-year fixed rate or adjustable rate mortgage with a dual purpose, single closing. At least the first $5,000 in improvements and repairs should be devoted to eliminating building code violations, modernizing the home or the garage, or performing upgrades for the health or safety of the occupants. Once basic necessities have been addressed, minor or cosmetic repairs may be added. The funds may not be used, however, for commercial features or luxury items like gazebos or swimming pools.

How can the program be used?

The extent of the rehabilitation covered by a § 203(k) loan may range from relatively minor repairs ($5,000 minimum) to virtual reconstruction. A home that has been demolished or will be razed is eligible if the existing foundation remains in place. § 203(k) loans can finance the rehab of the residential portion of a mixed-use property that includes retail or commercial space, or a one- to four-family dwelling provided it is owner-occupied, or can cover the conversion of a property of any size to a one- to four-unit structure. An existing house (or modular unit) on another site can be moved onto the mortgaged property and then rehabilitated. A § 203(k) loan may be used for interior repairs to an individual condominium unit provided the unit is in a one- to four-unit building. These rehab loans are offered to owner-occupants only and are not available for investors.

What kinds of repairs and improvements are eligible?

Buyers using § 203(k) financing can:

• Make structural alterations or reconstruct a deteriorating property.
• Modernize and make functional improvements such as remodeling bathrooms or kitchens and installing new built-in appliances.
• Eliminate health and safety hazards such as lead-based paint or mold.
• Improve appearance and eliminate obsolescence with, for example, new siding or a covered porch.
• Upgrade plumbing, heating, air conditioning or electrical wiring.
• Connect to public water or sewer systems.
• Install a well or septic system (property must be one acre minimum).
• Add or replace roofing, gutters and downspouts.
• Add or replace flooring.
• Add a family room, bedrooms or bathrooms.
• Perform major landscape work and site improvements such as grading or adding patios, decks and porches.
• Make the property accessible for a person with disabilities, for example, provide wheelchair access with wider doorways and an exterior ramp.
• Make energy conservation improvements such as installing new windows, insulation, doors or solar panels.

The Department of Housing and Urban Development requires that properties financed under this program meet certain basic energy efficiency and structural standards and have smoke detectors. All improvements must comply with HUD’s Minimum Property Standards (HUD Handbook 4905.1) and all local codes and ordinances. A property owner may also qualify for income tax credits for some § 203(k) projects, depending upon the nature of the repairs and improvements performed.

Is a contractor required to do the work?

No. However, if the buyer wants to do any work or be the general contractor, the buyer must be qualified to do the work, and do it in a timely and workmanlike manner.

What steps should a homeowner take to obtain § 203(k) financing?

1. The buyer finds a property.
2. The buyer works with his or her real estate agent to conduct a preliminary feasibility analysis that assesses the extent of the work needed, gives a rough cost estimate and projects the market value of the property after completion of the work.
3. If the repairs would be worthwhile, the buyer enters into an offer to purchase, contingent upon the buyer receiving a § 203(k) loan.
4. The buyer finds a HUD-approved lender (use the search tool at www.hud.gov/program_offices/housing/sfh/lender/lenderlist or call the HUD Field office at 414-297-3214). It may be wise for the buyer to talk with the lender first about § 203(k) loans before writing the offer.
5. The lender likely will assign a § 203(k) consultant to assist with the buyer’s planning and cost estimates (particularly if the work will exceed $35,000). These consultants typically will be general contractors or home inspectors. See the information about § 203(k) consultants at www.hud.gov/offices/hsg/sfh/203k/203khow.cfm.
6. The buyer enlists the assistance of professionals to help prepare the work description and cost estimate, including architectural exhibits (plot plan if structural additions, proposed interior plan showing contemplated changes, etc.). (See the worksheets and forms in the HUD Handbook for § 203(k) at www.hud.gov/offices/adm/hudclips/handbooks/hsgh/4240.4/index.cfm).
7. The property is appraised. The appraiser must provide an opinion of the “after-improved” value and in some cases the lender may direct the appraiser to also provide the “as-is” value. If the lender decides an “as-is” appraisal is not feasible or necessary, the lender may use the sales price on a purchase transaction, or the existing debt on a refinance transaction, if this does not exceed a reasonable estimate of value.
8. The lender issues a conditional commitment and statement of appraised value.
9. The lender pulls a credit report on the buyer, verifies employment, confirms deposits, etc., to establish the buyer’s ability to pay.
10. The lender issues a firm loan commitment, stating the maximum mortgage amount that HUD will insure.
11. The lender prepares the Rehabilitation Loan Agreement for the lender’s and buyer’s signatures. This agreement establishes the conditions under which the lender will release funds from the Rehabilitation Escrow Account.
12. At closing, a portion of the loan proceeds is used to pay the seller, or, if a refinance, to pay off the existing mortgage, and the remaining funds are placed in the Rehabilitation Escrow Account. Construction may then begin. The new owner has up to six months (depending on the lender) to complete the work.
13. After closing, the lender submits the mortgage documents to the HUD office for mortgage insurance endorsement. If acceptable, HUD issues a Mortgage Insurance Certificate to the lender.
14. As construction progresses, funds are released after the work is inspected by a HUD-approved inspector. Up to four draw inspections plus a final inspection are allowed.
15. When the work is done in accordance with the work plans and any change orders, the new owner provides a letter saying the work has been done satisfactorily. If the HUD inspector agrees, the final draw is released minus a required 10-percent holdback.

Other FHA repair and rehab loan programs

For less extensive repairs/improvements, FHA’s Streamlined § 203(k) program permits home buyers to finance up to an additional $35,000 into their mortgage to improve or upgrade their home before move-in. With this loan, home buyers can quickly and easily tap into cash to pay for property repairs or improvements, such as those identified by a home inspector or FHA appraiser.

For housing rehabilitation activities that do not also require buying or refinancing the property, consider HUD’s Title I home improvement loan programs described at www.hud.gov/offices/hsg/sfh/title/ti_home.cfm.

REALTOR^® Practice Tips: Brokers working with buyers interested in properties needing basic rehab work and brokers listing properties in disrepair may be wise to have § 203(k) informational materials on hand. You never know when that may be just what is needed for a successful transaction!

Section 203(k) resources

For additional information about the HUD repair and rehabilitation loan programs, see the resources at www.hud.gov/offices/hsg/sfh/203k/203kmenu.cfm.

Debbi Conrad is Senior Attorney and Director of Legal Affairs for the WRA.