FHA 203K Loans: Blessing or Nightmare
Good news for people who don’t own a home. There is an opportunity through FHA to buy a home and rehab it immediately. The loan is called a 203k and the benefits of financing your first home or your first home in more than 5 years in this way are numerous. First, you can buy a house with a 3% down payment plus closing costs, which you can estimate as another 3%. One of the difficulties in buying a home is the ability to save for a down payment. Conventional loans require a 20% down payment, and that can be a hefty sum. The second benefit is that you can rehab the house immediately. Understand that under normal conditions, a homebuyer is limited to buying a home. Banks usually won’t let you borrow above the value of the house, and so you’ll have to wait to make that ugly house a place you want to call home. This is where FHA is brilliant. They realize you don’t want to live in unpleasant conditions and they also want to help old neighborhoods clean up and become neighborhoods of choice. In Florida, it’s common to have torn-down-looking houses and McMansions located on the same street or in the same neighborhood. So you can find the worst house in the best neighborhood and rehab it. Your value after rehabilitation in most cases should put you in a position to have equity in your home. This means that once the house is complete, in a perfect world, you could sell the house for more money than you invested in it.
FHA limits what you can borrow in your area. The amount is different in each county, so knowing the loan guidelines is essential when buying your home. Keep in mind that the guidelines change as the price of an entry level home rises. In St Petersburg, FL, as of summer 2017, FHA limits you from borrowing up to $274,000. This means you need to buy a house for around $200,000 if you want to have enough money for rehab to turn the house into a gem. So once you’ve determined that you can finally take the step of becoming a homeowner, there is some planning involved in buying and rehabbing through FHA.
The first step is to find a banker who does FHA plus 203k loans. Your real estate agent should be able to help you with this or you can google it or just call the bank you use and ask if they do this type of loan. Once you have chosen the banker, you need to find out who is pre-qualified to borrow. Once you have your prequalification letter, you can begin your search for the perfect distressed home. This can be challenging. The home price you are looking for is in high demand. Investors are paying cash, buying and selling these properties. After a cash buyer arrives and picks up the home you are considering, you will learn 2 things. The first is that cash buyers pay close to or more than full price depending on the location. Second, you’ll need to act fast and immediately make an offer at your first glance. The good news is that you can research the property online, so when you drive through the neighborhood and physically view and inspect the property, you should know exactly how much to offer for the property and also know how much it will cost to bring the house back to the condition it is in. would venture as move-in and deliverable. Realtor.com is the place to start. It shows everything that is for sale through mls and there are usually about 20 photos of the interior of the house. Once you’ve selected a home, look it up in the county tax records or property appraiser’s site. This site will tell you how much the last owner paid for the property and when they bought it. You’ll know if the previous sale was a qualifying sale or a non-qualifying sale. This means that if the property was acquired as a non-qualifying sale, it may have been a gift, a transfer of title due to death or divorce, or a foreclosure. You can also ask your real estate agent for comparable sales in the neighborhood. Look at the condition of those houses because they will still be on Realtor.com and calculate the price per square foot. Finally, start gathering the costs of new kitchens and new bathrooms. Know the difference between “builders grade” (lower end) and what you want. Also price off the ground. Find out the price of a new roof and new air conditioning.
When doing a 203k, keep in mind that the rehab should be done with a minimum amount of movable walls or expanding space. Construction is expensive, very expensive. Therefore, reconfiguring the space will eat up your budget. You want to return the property to its original glory. Always keep in mind that it is important to maintain the integrity of the original architecture. Don’t try to take a square hole and turn it into a round peg. It will look weird and the post-rehab value of the home won’t be there. If it’s a mid-century modern home, keep the elements of the home modern and sleek. If it’s an old Sears craftsman bungalow, keep all the hardwood floors, crown molding, and interesting features. Look at the app on your phone called houzz. It will become your go-to for any design question.
Once you’ve made an offer to buy and it’s been accepted, there are a few important things you’ll need to do before closing. A 203k loan includes what is known as “a scope of work.” the scope of work is what the rehab money will pay for and is part of the closing paperwork. This scope of work must be nailed down to the last detail because after the loan is closed it becomes a nightmare to change anything. Once the loan closes, you can’t change your mind and say that instead of adding a walk-in closet to the master bedroom, we want to take that space and make it part of the bathroom. You’ll be told, “No, it’s not in the scope of work, I can’t do it.” To pin down the scope of work, you will need to find a contractor who does and is qualified to do and is approved to do 203k construction. In my area I could only find 3 contractors that did 203k stuff. Here’s the bad news. You end up paying full price for the rehab. If your plan is to move a wall or tear down a wall, an architect will need to draw the plan so the contractor can get the permits. Drawings must be held prior to loan closing and the cost of the plan must be paid in advance.
You are a captive to your contractor and they are going to make money on everything in the field of work. I asked the 203k contractor what the profit expectation was for the scope of work. 15%, 20%? He said no, more like 25%. I then asked him, if my rehab loan is $100,000, after you get your $25,000 win, I will have $75,000 real dollars to spend on the rehab, right? He said: Well, it doesn’t work like that. There is a shortage of contract labor, so contractors use their employees and keep them busy year-round to maintain loyalty. The days of receiving 3 offers and choosing are over. You’re lucky if the worker actually shows up and does the job. This is especially true in Florida, where the demand is off the charts. Also, everything has to be authorized and then inspected multiple times. All subcontractors are licensed or work for the licensed contractor. You as the home owner can do some work and if you don’t want your budget to be spent on things you could have done, then decide what you can do and do it to keep costs down. The good news is that there is a time line that the contractor is responsible for. You have to finish the job within so many months and a part of the money is withheld in case you haven’t paid all your subcontractors.
Even though the rehab is limiting major areas like the new kitchen, new flooring, and new bathrooms, they are within reach and more than make up for any limitations you may have when making a 203k loan. It’s a great way to buy a house and make it a place you can call home.