As banks continue to seize more and more properties from defaulting borrowers, the number of vacant properties in the U.S. has now gone up to 18.8 million. Despite the low prices and availability of large number of homes in the market, buying a foreclosed property can often be difficult for buyers as the home may not meet safety or structural requirements, which can affect the lending process.
In the current environment, the Federal Housing Administration’s (FHA) 203 (k) Loan program, first established in 1978, becomes even more important. The program’s main goal is to make it easier for buyers to refinance existing mortgages and cover additional rehabilitation costs for single home properties. Very often, home buyers who want to purchase property need to take three separate loans – short-term loans to purchase the home, another one to cover rehabilitation costs and permanent financing to repay the first two loans. The 203 (k) Loan program allows home buyers to take out a single mortgage loan at a long-term fixed or adjustable rate that covers both rehabilitation and purchase or refinance costs.
According to the FHA, the program can be used for rehabilitation and/or improvement of an existing one-to-four unit home in the following ways:
- To finance the rehabilitation of an existing property;
- To finance the rehabilitation and refinancing of outstanding indebtedness (mortgages) of a property; and
- To finance the initial purchase and rehabilitation of a property.
Many lenders have been using the FHA 203(k) Loan program in combination with other programs such as the U.S. Department of Housing and Urban Development (HUD)’s HOME, HOPE, and Community Development Block Grant Programs to help homeowners rehabilitate their properties.
The following are the highlights of the 203 (k) Loan program:
- Applicable for one to four unit family homes, condominiums (subject to conditions).
- There is a minimum requirement of $5,000 in repairs. Some of the eligible improvements include structural alterations and reconstruction, elimination of health and safety hazards, reconditioning or replacement of plumbing, flooring, tiling, carpeting, roofing, gutters and downspouts.
- The loan amount is based on what the U.S. Department of Housing and Urban Development believes the home will be worth after the rehabilitation is complete, including the cost of the repair work.
- The total value of the property must be within the FHA mortgage limit for the area in which the property is located. The value of the property is determined by a) the value of the property before rehabilitation plus the cost of rehabilitation or b) 110 percent of the appraised value of the property after rehabilitation, whichever is less.
- To reduce the risk borne by the mortgage lender, the mortgage loan is fully insured as it is eligible for endorsement by the HUD as soon as the mortgage proceeds are paid and a rehabilitation escrow account is set up.
Streamlined 203 (k) Limited Repair Program
In 2005, to supplement the existing 203 (k) loan program, the HUD introduced a new 203 (k) Streamline Loan program, which is a limited repair program that allows homebuyers and those looking to refinance to borrow up to an additional $35,000 into their mortgage to rehabilitate their home before they move in. This allows them to secure more funds to pay for property repairs and improvements, which can be suggested by a home inspector or FHA appraiser.
With an increased maximum limit from $15,000 to $35,000 in rehabilitation costs, the Streamlined 203 (k) program recognizes the increasing cost of materials and allows homeowners to make more extensive improvements and also make their homes more energy efficient. The Streamlined program also removes the minimum repair requirement of $5,000. However, for repairs over $15,000, the borrower is required to undergo an inspection to determine that all listed repairs have been completed.
The Streamlined 203 (k) program is also available for mortgage refinance transactions including those where the property is owned “free-and clear.” Only credit-qualifying, “no cash out” refinance transactions with an appraisal are eligible for the Streamlined 203 (k) program.
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