In today’s real estate market you may have heard a lot about the FHA 203k rehabilitation mortgage. It is a popular marketing tool. Most importantly, the 203k loan is perfect for the types of homes that are on the market today: homes that require cosmetic or major rehabilitation in order to make them livable.
In my conversations with Realtors, I often hear how 203k loans never close or take too long. I agree that 203k loans take longer and are more difficult to originate than a standard loan product, but not significantly if you educate yourself on the product and work with competent partners throughout the process. Below I have five essentials steps to take prior to signing a purchase agreement and beginning the loan application. Following these five steps will prepare you for a successful FHA 203k loan transaction.
- Your mortgage pre-approval. First, make sure your loan originator is well-versed in the FHA 203k mortgage, can explain the process in detail to you, and has a history of closing FHA 203k loans. It is also important to obtain a quality mortgage pre-approval based on a 203k loan. Read this article for some great tips: Signs of Good Mortgage Pre-Approval.
- Know the costs of the FHA 203k. This loan is not for everyone nor is it for every property. The risk and expertise required to effectively originate the loan make it a more costly option. The complexity and additional players involved can cause it to take longer to close than a standard loan. Keep this in mind, if you are going to take on a property that needs repairs you deserve to earn additional equity for the extra time and money a 203k loan will cost you. Therefore make sure the price you are paying includes this idea. As a side note, remember that with FHA, a borrower can negotiate a seller credit for closing costs and pre-paid items up to 6% of the purchase price.
- Take time to hire a good contractor. This could potential be the most important factor when working with 203k loans that contain a lot of rehab dollars. Start with family and friend referrals of professional licensed contractors that they have used in the recent past. The accountant by day and contractor by night is not the right choice. Interview a few and get references. A good contractor is important to the entire loan process, both in the beginning when proper documentation is required and after closing the loan where performance and being on budget is a necessity. The lender needs several pieces of documentation from the contractor to approve them for the work per HUD guidelines. The best contractor is not always the guy who is the lowest initial price. Time has shown that the lowest priced contractor has the highest number of delays and cost overruns. The cheapest contractor usually translates into the cheapest quality work.
- Establish a wish list. This is the fun part. Whenever you visit a property that looks promising, return a couple times and have fun putting together a wish list of all you would like to do to rehabilitate the property into your dream home. You may not be able to do everything on your wish list, but you can prioritize and use the FHA 203k to complete the renovation that mean the most to you. I recommend going at least once with your contractor to get a good idea on the cost of what is on your list. This will help you knowledgeably negotiate the sales price with the seller to lock in your equity.
- Create your equity through negotiation of the sales price. This is crucial. Be wary of bidding too high. The property does have to appraise out. While most anything goes on the rehabilitation, the after-completed appraised value has to validate the repairs and updates being done. I have seen buyers end up with less equity than cash they put down on the purchase because they did not negotiate the sales price low enough. Again, visit the property a few times and at least once with your contractor so you know where to start and end the negotiations.
The FHA 203k rehabilitation mortgage is an excellent loan program. Use these five essential steps to create your dream home.