Straight Up with Jocelyn Predovich: The Truth about FHA 203k Loans

by 01 Mar 2012

I promise you and other real estate agents have lost numerous transactions and will continue to lose more transactions because you just don’t understand what will become your most favorite loan program.

No matter how much the government drops rates, people just are not buying as expected.  Try this on for size: You set out shopping for a new wardrobe, expecting to get the perfect clothes at a discounted price. You walk into store after store only to find clothing that is twenty-plus years old, worn, torn and full of holes.  No matter how much the clothing is discounted, or how inexpensively you could finance your purchases, it does not matter:  You are not buying this ugly clothing!  You are better off to keep the clothing you have.

Agents are pushing worn-out, broken-down, outdated properties to an impatient generation seeking immediate gratification in a “buyer’s market.”  We hear it every day from our clients, “I’ll buy if I can find the perfect house at the perfect price” (nails on a chalk board).

The perfect house just does not exist, they never existed (but at least they were visually pleasing).   Being an agents is exhausting, and you should be exhausted.  You FINALLY get a motivated AND qualified buyer.  After showing them hundreds of houses, you somehow get them under contract without offending anyone.   So why aren’t you celebrating?   Because you know the seller is broke and will not be paying to repair any discovered issues with the property, so you cross your fingers and say a few prayers that the condition of this outdated, twenty-year-old home doesn’t require any repairs that will freak out the buyer or, worst case, eliminate it from surviving the appraisal and underwriting.  Sound familiar?  No wonder you’re about two problems away from re-inventing yourself in a new career.  You would have to be delusional to remain hopeful under these circumstances.

The problem is easy to see.  We need money to revitalize, to renew our existing properties, but no one has any money.  The good and bad news is that history repeats itself.  This isn’t the first time our real estate market has faced these challenges.  Luckily, the government launched a program back in 1978 that solves the issues of today’s real estate market.

The program I am referring to is the FHA 203k Loan Program.  I am going to tell you my best-kept secrets on how this program was designed to work and how you can use this program to substantially increase your business.  Finally, the truth about FHA 203k loans.

What Is the FHA 203k Program?

The FHA 203k loan program provides home buyers the opportunity to buy and fix up a property, without exhausting their personal savings.  Home buyers can purchase a property and include whatever costs to make required repairs or desired updates, or to fully renovate the property, all into one simple thirty-year fixed loan.   ALL work starts AFTER purchasing the property, using the money set aside by the bank.

Show Fewer Properties

I love that house, but ____________.  I’m sure you’ve heard this statement at least once or twice.  I love that house, BUT the kitchen is outdated, BUT it needs another bedroom/bathroom, BUT I want a finished basement, etc.  Contrary to what so many people believe about the FHA 203k loan, it is not just for repairs! This little-known program will solve any of these “buts” and more!  With the exception of two ineligible repair costs, major landscaping and the installation of outdoor luxury items (pool, tennis courts), your buyer can include whatever their little heart desires into their loan.  A few ideas to get your juices flowing: carpet, paint, new appliances, new kitchen, new bathrooms, new hardwood flooring, finish the basement, build an addition, build a garage, convert to handicap accessible, install security system, etc.

Avoid Inspection and Appraisal Issues

A buyer could be under contract on a property with every possible thing wrong with it: furnace, water heater, HVAC, roof, sewer, structural, plumbing, electrical, grading, siding, decks, windows, asbestos, lead-based paint, etc., and this property would fly through the appraisal and underwriting without any issues.  When utilizing the FHA 203k loan, the lender is protected from the risk because this is a government-insured loan.

What about all the properties listed as “cash only” due to the property condition?  These properties are screaming for help from FHA 203k loans (educate the listing agent).   

How Much Money Is Needed?

Gosh, I might just become your favorite person in 2012.  Let me show you how the numbers work.   You have a client buying a home at $150,000.  They decide to remodel the kitchen and bathrooms. and install hardwood floors throughout, totaling $30,000 (total amount of bids), and increasing their monthly payments by roughly $150/month (roughly $25/month for every $5,000 increase in loan amount).

  Purchase Price: $150,000   Total Bids: $30,000   Contingency (15% of bids): $4,500 (this is for anything unforeseen)  +Fees: $500 (inspections, title work, loan fees) TOTAL PROJECT COST = $185,000 Client Down Payment = 3.5% * Total Project Cost = $6,475

What if your client does not have the 3.5% minimum down payment requirement?  They can receive the full amount as a gift from a family member or in the form of any city/county/state/federal down payment assistance.  The borrower is not required to pay for any cost other than the typical costs associated with the home process (inspection and appraisal).  Any money not used is removed from their loan amount once the project is completed.

Two Types of FHA 203k Loans

It’s important to understand that there are two types of FHA 203k loans – the Full FHA 203k loan and the Streamline FHA 203k Loan.

The Full 203k is for larger projects requiring more than $35,000 in costs or for projects that require structural repairs.  A HUD consultant is required on the Full FHA 203k loan programs.

The Streamline 203k is the new kid on the block brought about in December of 2005 for less extensive repairs and improvements, therefore eliminating the required HUD consultant.  The maximum costs that can be included in the loan are $35,000, none of which can be structural costs.

How Do These Appraise?

When teaching live classes to realtors on the FHA 203k loan, the very first concern that is raised is what about the appraisal!??  Well, again you’re going to love this.  When buying a home with an FHA 203k loan, only one appraisal is required, providing the “after improvements have been made” value.   Additionally, there is a fudge factor with FHA 203k loans.  The maximum mortgage amount is based on the lesser of 1) the as-is value + the cost of rehab work, or 2) 110 percent of the after-improved value of the property.

The majority of our FHA 203k clients are establishing instant equity where organic appreciation is hard to come by.  Pretty exciting stuff, since they were able to use government-insured money at an incredibly low interest rate.

What Properties Are Eligible?

There is no such thing as an FHA 203k approved property.  Any single-family home, townhome or even multi-unit (up to four units) property can be financed with FHA 203k financing, so long as the buyer is buying the property as their primary residence.   Condos are also eligible but must be in an FHA-approved complex and be one of no more than four units in the building. 

10 Steps to the FHA 203k Loan Process

  1. You educate the client on the ability to use FHA 203k loan program and refer them to an experienced FHA 203k lender
  2. Borrower gets preapproved – if they are preapproved for $250,000 this must include the purchase price + costs they are rolling in
  3. Shop for houses
  4. Negotiate the contract – offering as-is value and selecting FHA financing
  5. Inspections/gathering bids
  6. Finalize bids
  7. Appraisal
  8. Final underwriting sign off
  9. Closing (depending on the bank this will be 30-60 days after going under contract)
  10. Work begins and must be completed in 6 months (with an FHA 203k Streamline) to 12 months (Full FHA 203k loan).

Applying for the FHA 203k Loan

Remember, this is an FHA loan, so the guidelines are just as lenient as any other FHA program.  There are no income limits, you do not have to be a first-time home buyer, credit scores down to a 620 (possibly lower/varies by lender), ability to use alternative credit, debt-to-income ratios up to 50%, cosigners allowed, down payment of 3.5%, gift money/down payment assistance allowed for down payment and seller concessions up to 6%.   I know you’re concerned that the interest rates are much higher.  Of course this varies per lender, but over the past 12 months the rates have been anywhere from the same as a regular FHA (FHA 203b) loan to about .25% higher. 

Hired Help

There is no such thing as an FHA-approved contractor/handyman.  The borrowers can select whomever they would like to perform the work, so long as they are experienced and insured. 

Problems to Avoid The most important problem to avoid is choosing an experienced FHA 203k Lender. This program wasn’t needed until now, so many lenders have chosen not to provide the FHA 203k loan, whether because they don't know how, don’t want to invest in learning how or don't want to do the extra paperwork. Either way, working with a lender who isn't experienced with FHA 203k loans is something you should avoid at all costs – the process is complex enough as it is. The formula to success is 1) selecting the right team of lenders and contractors, 2) setting realistic dates and deadlines, and 3) setting proper expectations with the home buyer.

5 Ninja Marketing Strategies

  1. How to Buy and Fix Up a Property for $100 – a buyer can layer the FHA 203k loan with the HUD $100 down program.  The only requirement is that the buyer is using an FHA loan to buy a HUD property as their primary residence.  This is not limited to first-time home buyers.
  2. Contractors Wanted – guess who may love this program more than you and I?  All of the contractors/handymen that are out of work.  Host a lunch at your office and educate every roof installer, electrician, plumber, general contractor, handyman, etc. you know.  They will turn into your marketing department.
  3. Remember Kiddie Condos – the rental market has been and will be amazing around college campuses.  Educate the baby boomers on the possibility of co-signing for their children on a property, using the FHA 203k loan to fix it up. Not only are they able to do so with little investment, they have the opportunity to establish equity and create a monthly cash flow by renting out to other students.  This is a phenomenal vehicle to help their children pay down their student loans.
  4. Generating more Sellers – sellers are faced with the most common question – move or improve?  In your listing presentation make sure to educate your prospective sellers on the ability to either list now and market their not-so-perfect home with an FHA 203k loan, or use the FHA 203k loan to refinance and fix up their home.  This will give you a much better product to sell one or two years down the road.
  5. Social Proof on Steroids – When working with your next FHA 203k home buyer make sure to gather the goods.  Before and after pictures are worth some serious cash.  Seriously!  You post the before and after pictures to your Facebook page, tagging your clients, and all their friends show up wanting to know how they too can buy a house and fix it up. 

Stop working against the market!  You now have a loan program that will help you show fewer properties, avoid common issues, generate more buyers and sellers and, bottom line, make you look like a rock star to your clients.  This will catch on, so get out there before your competition figures it out. 

If you would like more information on this program, join our weekly webinar.

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