203K Program Enables Financing on Property in Need of Repair

Are you the type who can make a buck fixing up run-down properties? You might be someone who wants to buy a fixer-upper home and live in it. You might be interested in a small income property that needs work and has the makings of a nice owner’s unit. Or, maybe you have a home already and simply sense profit as an investor in below-standard properties.

Well, Uncle Sam has a deal for you! It’s an FHA mortgage program called 203(k). It’s not your standard purchase loan. With standard programs if the property needs work you have to go elsewhere for the fix-it-up money. If the property is seriously run down you can’t get any mortgage loan for it. You have to pay cash for it out of your pocket, fund the repairs yourself, then finance it later.

With 203(k) you get one loan for both the cost of acquiring the property and the repairs. The repair portion of the loan goes to an impound account that you draw upon as the work progresses. You can get an advance for some of the more expensive items like carpets and cabinetry. There’s usually a small holdback from each draw that’s released when all the work is done.

The down payment for an owner who will occupy the property is the same small amount as FHA’s regular programs, about 4.5 percent. Investors have to put 15 percent down, but that’s the lowest down payment of any investor loan program; most require 30 percent or more. The down payment is calculated on the estimated cost of acquiring the property, plus the repairs, or 110 percent of the as-repaired cost, whichever is less. If there is any money left over after the job is done it can be spent on further improvements, new appliances, interior and exterior painting, or it can be used to reduce the loan balance.

Just about any improvement qualifies. No, you can’t put in a swimming pool, bathhouse, dumbwaiter, outdoor hot tub, gazebo, tennis court or satellite dish. Aside from these luxuries, you can use the money for such things as code compliance and safety improvements, cosmetic updating, repairs to the electrical, plumbing and mechanical systems, roof work including gutters, replacement of tile, vinyl and carpet, and major landscape work. Making the home more energy efficient counts, as does providing handicapped access.

You can do the work yourself but you only get reimbursed for the materials, not your time. You build equity in the property, giving yourself a job improving it. All of a contractor’s approved billings are reimbursable from the escrow.

The program is a natural for the contractor or investor who wants to turn a property quickly after fixing it up. He or she puts up the 15 percent down, does the work, then sells the property with a loan in place that is the maximum FHA loan amount for an owner-occupant. The rehabber can take back secondary financing or get a cash down payment for the difference between the loan and the sale price.

This works nicely for a first-time homebuyer, someone who has not owned a home for three years, or a divorced or separated individual who has signed away any interest in the former home. These people can assume the loan with no down payment. What happens in practice, then, is a working partnership between the investor/contractor and the future homeowner. The homeowner finds the single family home, or duplex, triplex or fourplex. (Larger multi’s don’t qualify unless the number or units is to be reduced to four or fewer.) When the property is found, the lender works with the buyer’s investor/contractor, FHA’s fee inspector and the appraiser to see if the numbers work. If they do, the investor/contractor purchases the property, does the work, then closes with the homeowner afterward.

If the project involves loss of rental income during the rehab period, the impound account can include up to six months of mortgage payments. This helps the cash flow during the critical period of improvements.

This is a logical program for Anchorage. Most of the city’s housing stock is more than fifteen years old. Anything built before 1985 or so is cosmetically dated, at least. Yet these properties, particularly the small income units that investors have been holding, can be the new affordable housing in our changing economy.

A caution. This is a complex program. Most mortgage bankers don’t have much experience with it. HUD has been pushing the program and reportedly has goaded its field offices to lighten up on the paperwork. Nationwide more of these loans have closed in the past 18 months than in all the years since the inception of the program in the 1950’s. The Anchorage field office has a good reputation with this program.

Still, you should seek out a mortgage lender that has actually worked these loans to completion. They will know the personnel, including HUD staff, inspectors, appraisers and contractors, who have to be part of the team that’s required for your transaction to succeed.