Everyone likes a discount but in the world of real estate discounts have become less common. Home prices have risen sharply in the past year but distressed sales continue to be available with significant write-offs.
The catch is that distressed homes — foreclosures, short sales and REOs — are sometimes not in pristine condition. That’s a kind way of saying that some distressed properties need a lot of tender loving care as well as paint, updates and repairs. The general “rule” is the worse the condition of the property the bigger the discount, a rule which can mean huge savings for those who purchase with FHA 203(k) financing.
A 203(k) loan is not like your ordinary mortgage. It’s a combination of acquisition financing plus money to fix up a property, all bundled into a single loan. For many borrowers the result of 203(k) financing for distressed property are several distinct benefits:
First, the property is acquired at a below-market value. According to the National Association of Realtors in May the typical foreclosure sold with a 15-percent discount while short sales nationally were available with a 12-percent discount. That’s one discount.
Second, instead of two loans — one mortgage to acquire the property and a second loan in the future to finance repairs — the 203(k) program has one closing. Rather than paying for two closings borrowers pay for one — that’s a second discount.
Third, FHA rules say that up to six mortgage payments may be included in the loan amount. This is an option for 203(k) borrowers who cannot occupy a property for several months while it’s being repaired. This is not a “discount,” but it can help financially while borrowers live somewhere else during a complex reconstruction.
With a 203(k) mortgage you don’t just get financing at closing. Instead a 203(k) loan is best seen as a process:
To start, the amount available for financing cannot exceed the FHA loan limit for the local area where the property is located. Because the mortgage is FHA-insured only 3.5 percent down is required, plus closing costs.
Also, because the loan is FHA-insured no investors are allowed. HUD has banned investors since 1996; instead, 203(k) financing can only be used to acquire property which will be used as a prime residence. Generally a “prime residence” is seen as a single-family home but it can be a property with two-to-four units provided one is owner-occupied.
The value of the property must be established by an appraisal to show both its current “as is” value and its value after rehabilitation. The loan amount can be equal to the as-is value of the property or the purchase price — whichever is less. Alternatively, the loan can be equal to as much as 110 percent of the after-improved value of the property.
With a purchase, part of the loan is used to pay for the property’s acquisition and the balance is set aside to assure the completion of repairs. To get through the process borrowers must hire a 203(k) consultant, generally someone with construction experience. A list of 203(k) consultants can be found on the HUD site.
The work is then authorized and payments to contractors by the lender are made as the work is completed and inspected.
In the end the borrower winds up with a better and more-valuable property, 30-year financing and big discounts for acquisition and closing. Altogether, a good approach for many would-be buyers.