If you’re interested in buying or renovating a home, one of the few loan products remaining is the FHA 203(k) home renovation loan.
Q: My husband and I would like to purchase a neighbor’s home to remodel and live in. It needs extensive work. I estimate we would pay him roughly $250,000 for the home and we’ll need about $150,000 more to remodel the home.
What is the best way to go about doing this? We have about $120,000 in cash. We could try to get a 203(k) loan, with high upfront costs and a higher interest rate. Or, we could purchase the home with a traditional loan and then take out a construction loan to do the remodel.
We would end up paying closing costs more than once, but would it result in lower final interest rate. Do you have any other ideas on how we could handle this?
A: The first thing you should do is start talking to lenders. While either of your choices might work in theory, you might not find lenders in your area willing to do either. You might want to talk to a big box mortgage lender in your area, a local community savings bank, a mortgage broker and a credit union.
Sit down with each of them to go over your options. Without having them pull a copy of your credit report, you want to know from each of these lenders what loan options they have, what the requirements are for each of the loan options, the costs involved and the interest rate options.
You may feel that the 203(k) loan option is right for you on paper, but you may or may not qualify for the loan. If you don’t qualify for the loan, what would your other options be to finance the purchase and renovation of the home?
These days, lenders aren’t that eager to get involved with residential deals, especially if the residential loan given to you can’t be packaged and sold in the secondary mortgage market. Yes, most loans today are still sold off to Fannie Mae, Freddie Mac, or are backed by FHA. To sell off the loan, the mortgage loan must strictly adhere to certain underwriting standards and guidelines.
Of most importance, you and your spouse must meet the requirements of borrowers for the loan. If your credit history and credit score are great, you can then try to figure out what loan options are available to you. You may actually find that some lenders may have other loan products that might assist you.
A 203(k) loan is an FHA loan product that would allow you to purchase the home and also obtain financing for the renovation costs of the home. However, you may not be able to obtain another FHA loan if you currently have one. As with any loan that involves construction financing, the lender has a greater role in the process until the construction is completed. That additional role will add financing costs and other expenses to the loan.
When you purchase a home with traditional financing, the lender’s costs are competitive and when you are closed, you’ve received the funds and move on with paying your monthly mortgage expenses in the future.
When you obtain construction financing, you’re in bed with the lender (so to speak) for some time. First you close on the purchase of the home and have all the costs associated with that purchase with your lender, but you need more funds for the renovation of the home. The lender will not give you all the funds up front. The lender will need a mechanism to make sure that funds given to you are used directly towards improving the home.
You will have escrows, additional inspectors and appraisers and even title company people involved until the home improvements are completed and the lender signs off on the project. So in addition to FHA loan costs being higher than non-FHA loans, you will have all the added construction disbursement and oversight expenses that go along with the 203(k) loan.
For all these reasons, the first thing to do is to find yourself a qualified and competent person who can give you more information regarding how to finance your project. Based on the money you have on hand, the mortgage broker or lender may have other options available to you or even more clever suggestions on how to get this deal done.
You can get more information about 203(k) loans at www.HUD.gov.