HUD’s 203(k) Program, courtesy of HUD.gov
The purchase of a house that needs repair is often a catch-22 situation, because the bank won’t lend the money to buy the house until the repairs are complete, and the repairs can’t be done until the house has been purchased.
HUD’s 203(k) program can help you with this quagmire and allow you to purchase or refinance a property plus include in the loan the cost of making the repairs and improvements. The FHA insured 203(k) loan is provided through approved mortgage lenders nationwide. It is available to persons wanting to occupy the home.
The downpayment requirement for an owner-occupant (or a nonprofit organization or government agency) is approximately 3.5% of the acquisition and repair costs of the property.
The 203(k) loan includes the following steps:
|A potential homebuyer locates a fixer-upper
and executes a sales contract after doing
a feasibility analysis of the property with their
real estate professional. The contract should
state that the buyer is seeking a 203(k) loan
and that the contract is contingent on loan
approval based on additional required repairs by the FHA or the lender.
|The homebuyer then selects an FHA-approved 203(k) lender and arranges for a detailed proposal showing the scope of work to be done, including a detailed cost estimate on each repair or improvement of the project.|
|The appraisal is performed to determine the value of the property after renovation.|
|If the borrower passes the lender’s credit-worthiness test, the loan closes for an amount that will cover the purchase or refinance cost of the property, the remodeling costs and the allowable closing costs. The amount of the loan will also include a contingency reserve of 10% to 20% of the total remodeling costs and is used to cover any extra work not included in the original proposal.|
|At closing, the seller of the property is paid off and the remaining funds are put in an escrow account to pay for the repairs and improvements during the rehabilitation period.|
|The mortgage payments and remodeling begin after the loan closes. The borrower can decide to have up to six mortgage payments (PITI) put into the cost of rehabilitation if the property is not going to be occupied during construction, but it cannot exceed the length of time it is estimated to complete the rehab.|
|Escrowed funds are released to the homeowner during construction through a series of draw requests for work that is completed. To ensure completion of the job, 10% of each draw is held back; this money is paid after the homeowner informs the lender that the work has been completed and after the lender determines there are no additional liens on the property.|
For a list of lenders who are offering the 203(k) Rehabilitation Program, please see the 203(k) Lenders List. The interest rate and discount points on the loan are negotiable between the borrower and the lender.
Does the rehabilitation construction have to comply with HUD’s Minimum Property Standards?Yes. The improvements must comply with HUD’s Minimum Property Standards (24 CFR 200.926d and/or HUD Handbook 4905.1) and all local codes and ordinances.
Is the Section 203(k) program restricted to single-family dwellings?
No. The program can be used for one-to-four unit dwellings. Maximum mortgage limitations are the same as for properties under Section 203(b).
Can Section 203(k) be used to improve a condominium unit?
Yes, however, condominium rehabilitation is subject to the following conditions:
A. Owner/occupant and qualified nonprofit borrowers only;
B. Rehabilitation is limited only to the interior of the unit. Mortgage proceeds are not to be used for the rehabilitation of exteriors or other areas which are the responsibility of the condominium association, except for the installation of firewalls in the attic for the unit;
C. Only the lesser of five units per condominium association, or 25 percent of the total number of units, can be undergoing rehabilitation at any one time;
D. The maximum mortgage amount cannot exceed 100 percent of the after-improved value. After rehabilitation is complete, the individual buildings within the condominium must not contain more than four units. By law, Section 203(k) can only be used to rehabilitate units in one-to-four unit structures. However, this does not mean that the condominium project, as a whole, can only have four units or that all individual structures must be detached. Example: A project might consist of six buildings each containing four units, for a total of 24 units in the project and, thus, be eligible for Section 203(k). Likewise, a project could contain a row of more than four attached townhouses and be eligible for Section 203(k) because HUD considers each townhouse as one structure, provided each unit is separated by a 1 1/2 hour firewall (from foundation up to the roof). Similar to a project with a condominium unit with a mortgage insured under Section 234(c) of the National Housing Act, the condominium project must be approved by HUD prior to the closing of any individual mortgages on the condominium units.
E. The individual buildings within the condominium must not contain more than four units. By law, Section 203(k) can only be used to rehabilitate units in one-to-four unit structures. However, this does not mean that the condominium project, as a whole, can only have four units or that all individual structures must be detached. Example: A project might consist of six buildings each containing four units, for a total of 24 units in the project and, thus, be eligible for Section 203(k). Likewise, a project could contain a row of more than four attached townhouses and be eligible for Section 203(k) because HUD considers each townhouse as one structure, provided each unit is separated by a 1.5 hour firewall.
Can a six (or more) unit building be done using the 203(k) program?
No. However, the building could be renovated and reduced to a four unit building.
Can nonresidential (storefront) property be eligible for a 203(k) insured loan?
Yes. Mixed-use residential property is acceptable provided the property has no greater than 25% (for a one story building); 33% (for a three story building); and 49% (for a two story building) of its floor area used for commercial (storefront) purposes. The rehab funds can only be used for the residential functions of the dwelling and areas used to access the residential part of the property.
Can HUD-owned properties be purchased using the 203(k) loan?
Yes. However, the property must be advertised that it is eligible for financing with a 203(k) loan. If the HUD-owned property is purchased with other funds, a 203(k) loan can be made after the property is in the buyers name. In this case, cash back will be allowed to the borrower for a period of six months from purchasing the HUD-owned property.
Can an investor use the 203(k) program?
No. In October, 1996, the Department placed a moratorium on investor participation in the 203(k) Rehabilitation Mortgage Program.
Can a local government agency or a nonprofit organization use the 203(k) program?
Yes. The same qualification requirements will be used as for an owner-occupant of the property.
What is the definition of a First-Time Homebuyer?
A single person or an individual and his or her spouse who have not owned a home (as a tenant in common or as a joint tenant by the entirety) during the three years immediately preceding the date of application for the 203(k) loan. Any individual who is legally separated or divorced cannot be excluded from consideration, because the three-year waiting period does not apply, provided the individual no longer has an interest in the home.
Is there a limitation on how many properties a person or organization can have in any area of the community?
Yes. A borrower can have not more than seven (7) units within a two block radius of the property they want to purchase. However, if the property is in a local community area that has been designated for redevelopment or revitalization, then this seven unit limitation does not apply.
Can Section 203(k) be used to convert a one family dwelling to a two-, three-, or four-family dwelling (or vice versa)?
Yes, under the Standard (k) program.
Can Section 203(k) be used to move an existing house onto another site?
Yes, under the Standard (k) program, however, release of loan proceeds for the existing structure on the non-mortgaged property is not allowed until the new foundation has been properly inspected and the dwelling has been properly placed and secured to the new foundation. At closing, funds would be released to purchase the site and the rest of the mortgage proceeds would be placed in the Rehabilitation Escrow Account. The borrower would have the site prepared to accept the dwelling. The first release would be based on the improvements made to the site, including the installation of the existing structure on the new foundation.
Can a detached garage or another dwelling be placed on the mortgaged property?
Yes, under the Standard (k) program, however, a new addition must be attached to the existing dwelling, and must comply with HUD’s Minimum Property Standards in 24 CFR 200.926d and all local codes and ordinances.
Can a dwelling be converted to provide access for a disabled person?
Yes. A dwelling can be remodeled to improve the kitchen and bath to accommodate a wheelchair access. Wider doors and handicap ramps can also be included in the cost of rehabilitation.
What is the minimum amount of rehabilitation required for a non-streamlined Section 203(k) mortgage?
There is a minimum $5,000 requirement for the eligible improvements on the existing structure on the property. Minor or cosmetic repairs by themselves are unacceptable; however, they may be added to the minimum requirement. Under the Streamlined 203(k) program, a minimum repair/improvement cost requirement is not applicable.
Is there a time period on the rehabilitation construction period?
Yes, the Rehabilitation Loan Agreement contains three provisions concerning the timeliness of the work. The work must begin within 30 days of execution of the Agreement. The work must not cease prior to completion for more than 30 consecutive days. The work is to be completed within the time period shown in the Agreement (not to exceed six months); the lender should not allow a time period longer than that required to complete the work.
What happens if the borrower fails to perform under the terms of the Agreement?
The lender may refuse to make further releases from the Rehabilitation Escrow Account. The funds remaining in the account can be applied to reduce the mortgage principal. Also, the lender has the option to call the mortgage loan due and payable.
Does HUD always require a contingency reserve to cover unexpected cost increases?
Typically, yes. On properties older than 30 years and over $7,500 in rehabilitation costs, the cost estimate must include a contingency reserve. The reserve must be a minimum of ten (10) percent of the cost of rehabilitation; however, the contingency reserve may not exceed twenty (20) percent where major remodeling is contemplated. If utilities were not turned on for inspection, a minimum fifteen (15) percent is required.
Can the architectural exhibits, including the cost estimate, be modified after the mortgage loan is closed?
Yes. The changes must be approved by HUD or a DE lender prior to beginning the work. If the change affects the health, safety or necessity of the dwelling, the contingency reserve can be used to pay for the change. However, if the health, safety or necessity of the dwelling is not affected and an increase in cost occurs, the borrower must apply monies into the contingency reserve fund to pay for the change. Should the change result in a reduced cost of rehabilitation, the difference will be placed in the contingency reserve fund; if unused, it will be applied as a mortgage prepayment after completion of construction.
What happens if the cost of the rehabilitation increases during the rehabilitation period?
Can the 203(k) mortgage amount be increased to cover the additional expenses? No. This emphasizes the importance of carefully selecting a contractor who will accurately estimate the cost of the improvements and satisfactorily complete the rehabilitation at or below the estimate.
Can a Section 203(k) mortgage be an Adjustable Rate Mortgage?
Yes. An Adjustable Rate Mortgage is available to an owner-occupant only. Investors and non-profits are not eligible for an ARM.
Can mortgage payments (PITI) be included in the mortgage?
Yes, under the Standard (k) program. Up to six months of payments may be included in the mortgage if the property is not able to be habitable due to condition of the property during the rehabilitation period.
Is a contractor required to do the work?
No. However, if the borrower wants to do any work or be the general contractor, they must be qualified to do the work, and do it in a timely and workmanlike manner. It is very important that the work be done in a time frame that will assure the completion of the work that will be agreed upon in the Rehabilitation Loan Agreement (signed at closing). A borrower doing their own work can only be paid for the cost of the materials. Monies saved can be allocated to cost overruns or additional improvements.
Can cost savings on the rehabilitation be given back to the borrower?
No. However, the savings can be transferred to cost overruns in other work items or can be used to make additional improvements to the property If the cost savings are not used, the money must be applied to the mortgage principal, but the mortgage payments will remain the same, because the loan has already closed. To use the cost savings, it will be necessary for a Change Order to be completed and approved by the lender.
Can the borrower do their own work write up and cost estimate?
Yes, but only under the Streamline (k) program.
Is only one appraisal required to establish the “after-rehab” value of the property?
Yes, provided the lender can be assured that the contract sales price is reasonable for purchase transactions or the existing debt on the property is low enough to assure a good equity position of the homeowner.
For HUD-owned – REO Acquisitions, mortgage lenders must order, and the purchaser(s) may be charged for, an as-repaired appraisal on all Section 203(k) transactions. If the M&M contractor’s as-is appraisal is more than six months old mortgagees also have the option of ordering an updated as-is appraisal. However, an as-is appraisal is not mandatory if the underwriter believes the sales price is equal to the as-is value.
Can an Energy Efficient Mortgage (EEM) be allowed using the 203(k) program?
Yes. A borrower can finance into the mortgage 100 percent of the cost of eligible energy efficient improvements, subject to certain dollar limitations, without an appraisal of the energy improvements and without further credit qualification of the borrower.
What is a streamline 203k mortgage?
HUD has developed an FHA insured mortgage, called the Streamline (K) Limited Repair Program that permits homebuyers to finance an additional $35,000 into their mortgage to improve or upgrade their home before move-in. With this product, homebuyers can quickly and easily tap into cash to pay for property repairs or improvements, such as those identified by a home inspector or FHA appraiser.More…
Is there a secondary mortgage market for Section 203(k) mortgage loans?
Yes. The Government National Mortgage Association (GNMA) permits the Section 203(k) mortgage to be placed in both GNMA I and II pools with Section 203(b) mortgages. GNMA accepts the 203(k) mortgage once it has been endorsed by HUD. The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) will also purchase a Section 203(k) first mortgage.
Can Section 203(k) be processed under the Direct Endorsement program?
All unconditionally approved Direct Endorsement (DE) lenders are eligible to process Section 203(k) loans without completing any pre-closing test cases. The Streamlined K Limited Repair Program also does not require submission of pre-closing test cases for DE lenders with unconditional approval.
Does a Direct Endorsement lender who is approved for the 203(k) program need to be approved in another HUD office?
No. However, the lender needs to submit their approval to the other HUD office where they wish to originate 203(k) loans. A preclosing review in the new HUD office will not be necessary.
Can a DE lender sponsor a correspondent lender to originate 203(k) loans?
Yes. The correspondent lender can even use the DE sponsor’s staff appraisers, inspectors and plan reviewer /consultants for processing.