When you go to get conventional financing, a lender won’t close on the loan unless the condition of the property is enough to ensure the loan. What this means is that a property that needs work (maybe as simple as toilets and fixtures) would be out of reach for many buyers because they don’t have the cash to buy and rehab the house.
I’m going to get into the details of these loans but I want to be clear that 203(k) loans are for Owner-Occupied Property. The exception to this rule is if you are a HUD approved Non-Profit Organization.
There’s an advantage for investors to understand how these loans work. If an investor can purchase a property for all cash and sell it to a buyer who will use a 203(k) loan to fix up the property, that’s a win win.
The section 203(k) HUD loan is the department’s primary program for the rehabilitation and repair of single family properties. It is an important tool for communities and neighborhoods to revitalize and expand homeownership opportunities. HUD is still very committed to this program.
So how does it work? When a homebuyer wants to purchase a house in need of repairs, modernization, or energy efficient upgrades the homebuyer usually has to obtain financing first to purchase the dwelling and additional money is needed for rehabilitation and construction. With a section 203(k) loan the borrower (homebuyer) can get just one mortgage at a long-term fixed rate to finance both the acquisition and the rehabilitation of the property. 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.
203 (k) loans are not made by HUD. They are endorsed and fully-insured by HUD.
What kind of property is eligible? The property must be a one-to-four unit family dwelling that has been completed for at least one year. The number of units on the site must be acceptable according to the provisions of local zoning requirements. Condominiums must be approved by the FHA. There are three ways in which the program can be used:
- To purchase a dwelling and the land on which the dwelling is located and rehabilitate it.
- To purchase a dwelling on another site, move it onto a new foundation on the mortgaged property and rehabilitate it.
- To refinance existing liens secured against the subject property and rehabilitate such a dwelling.
What improvements are eligible? Luxury items and improvements are not eligible as cost rehabilitation. Things that can be financed are painting, room additions, decks and other items even if the home doesn’t need any other improvements. The property doesn’t have to be in tear down condition, it can even just need to be updated. The property just has to appraise for below market value when purchased and then at market value with the repairs.
There are standards to which the construction and repairs will have to meet. Energy conservation standards are also being implemented.
How is the value of the property obtained? An appraiser will be asked to provide an opinion of the After-Improved value of the subject property and in some cases, may be asked by the lender to also provide the As-is value. The lender can lend on up to 110% of the after improved value.
After-Improved Value is defined as: the expected market value of the property determined upon completion of the proposed rehabilitation and/or improvements.
Where as as-is Value is defined as: the value of the property in the current condition “with all faults.”
How is the money for the rehabilitation disbursed? When the loan is closed, the proceeds designed for the rehabilitation or improvement, including the contingency reserve, is to be placed in an interest bearing escrow account insured by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA).
This is a very basic outline of the section 203 (k) loan program; if you want to find out more of the details visit www.hud.gov website.
This loan isn’t for everyone or every situation but it’s an important tool to have in your tool bag.