Hidden away in the deep recesses of the federal government is a one-shot financing plan which will allow you to not only buy foreclosures but also to pay for repairs and upgrades.
The FHA's 203(k) program has been on the books for decades but over time it's been rarely used. That's changed recently, in part because the program is ideal for many foreclosure buyers.
How It Works
With the 203(k) program you get financing to purchase or refinance an existing home (it has to be at least a year old) plus additional dollars to fix it. Since the government doesn't want you to take that extra money and just go to Vegas, it provides the construction money in draws as the repair work is completed after closing.
This program, of course, works perfectly for foreclosure buyers because it covers both the cost of acquisition as well as the expenses that may be required to improve the property's condition.
Unfortunately, the 203(k) plan does not work perfectly for everyone.
In basic terms there are three groups of foreclosure buyers: Those who want residential property for themselves, those looking for investment real estate and those who want both. Two of these three groups are possible users of the 203(k) program.
- Yes, you can use 203(k) financing to purchase a home which you will use as a personal residence.
- Yes, you can use 203(k) financing to purchase a home with one to four units, provided that you physically occupy one of the units as your personal residence.
- No, you cannot use a 203(k) to acquire or refinance a pure investment property, one you do not use as a personal residence. Investors have been banned from the program since 1996.
Why would you want FHA 203(k) financing?
Those after-closing draws and inspections represent additional work for lenders, thus you can expect to pay somewhat higher fees. That said, the 203(k) program is still a good deal because it's far cheaper to get acquisition and construction money in one loan rather than two. This is because there's a single settlement and thus only one set of closing costs, one set of taxes, one origination fee, etc.
The 203(k) program also comes with attractive terms. For instance, HUD says you can get financing equal to the "as-is" value or the purchase price of the property before rehabilitation, whichever is less, plus the estimated cost of rehabilitation. Alternatively, you can get a loan equal to 110 percent of the "after-improved" value of the property.
Lastly, the 203(k) program is an FHA loan. That means no prepayment penalties and no surprise rate increases. You'll need to fully document income, debts and assets, but that's a low barrier for anyone who pays taxes and has financial records.
To come up with the right loan amount you need to know the value of the property and you need to have a good sense of what the improvements will cost. Not all improvements can be financed under the program and the maximum available for repairs in $35,000.
“Luxury items and improvements are not eligible as a cost rehabilitation,” says HUD. “However, the homeowner can use the 203(k) program to finance such items as painting, room additions, decks and other items even if the home does not need any other improvements. All health, safety and energy conservation items must be addressed prior to completing general home improvements.”
Bring Back Investors
In 1996, when investors were banned from the program, HUD explained that its “restrictions are in response to audit findings issued by the Office of the Inspector General and are in effect until further notice.”
“A lot of things have changed in 13 years,” said Jim Saccacio, chairman and CEO at RealtyTrac.com, the nation's leading source of foreclosure listings and data. “One of the most important is this: We're overwhelmed with a vast inventory of foreclosed homes. It is this inventory which makes it impossible for local home values to rise. We need to get more buyers into the marketplace and for this reason HUD's investor restrictions need to be reconsidered.”
Why should HUD open the 203(k) program so investors can pick up foreclosed properties? One very good reason is to reduce HUD's overall marketplace risk.
HUD has insured loans for millions of properties. Anything which reduces the foreclosure inventory can help increase the value of all properties, including those with FHA insured loans. Allowing more investors into the market generally increases demand and hopefully stabilizes or even grows local home prices. In the event of foreclosure HUD benefits because with higher market values insurance claims will be smaller.
In other words, the reason to broaden the 203(k) program is not because HUD suddenly has a warm tingly feeling when investors need mortgage insurance, rather the reason is self-interest: HUD can cut its costs and liabilities by getting more investors into the marketplace.
“Ten years ago, certain lenders and nonprofits stigmatized the 203(k) program by using the program for fraudulent purposes,” says the Treasury Department in a just-issued report. Well, yes, certain lenders and nonprofits did just that — but investors are not lenders or nonprofits. We're blaming the wrong folks.
Rather than restrict an entire program to investors because of the misdeeds of a few lenders and nonprofits back at the dawn of time, why not do a better job underwriting loans? That could solve the creepy program of “stigmatized” loan applications. Or, why not restrict lenders and nonprofits since they — not investors — were responsible for the moratorium in the first place?
It's time that the 1996 investor “moratorium” comes to an end. Times have changed — and so should HUD.
For more information regarding 203(k) speak with local FHA lenders before considering a real estate purchase. Be sure to work with an experienced 203(k) lender, one who can help with the complexity of draws and inspections after closing. Also, if possible, get practical ideas and information from local borrowers who have recently used the 203(k) program.
Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.