How to Purchase a Foreclosed Property – The 203K Loan

Often times, when purchasing a foreclosed property, a buyer is unable to obtain traditional financing because a property is being sold in “as is” condition and is not considered ready to occupy by traditional lenders.  There is little or no negotiation room to get the seller, who is a bank, to make the improvements necessary to deem it habitable.  In addition, lenders generally follow guidelines that do not allow them to offer loans to buyers who are purchasing homes that are not habitable.
One route to take is to obtain a 203(k) loan, which is offered by certain FHA approved lenders and is administered by the FHA, which is a department of HUD (Housing and Urban Development).  A 203K loan is basically a home improvement loan.  The borrower finances the homes purchase price and the amount needed to complete the repairs and improvements.

There is both a “streamlined” and regular version of this loan. The streamlined version has less cost and hassle and is only available to owner occupants and investors are not allowed. The FHA 203(k) streamline loan is available to borrowers of all income levels, to homeowners who plan to occupy the house, and for homes with one to four units.  There are three types of loans currently available, 15 or 30 year fixed or one-year arms.

According to the FHA website, there are three uses of the 203(k) loan:

  • “To purchase a dwelling and the land on which the dwelling is located and rehabilitate it.
  •  To purchase a dwelling on another site, move it onto a new foundation on the mortgaged property and rehabilitate it
  •  To refinance existing indebtedness and rehabilitate a dwelling”

My post will focus on using the 203(k) loan to buy an uninhabitable property that is being sold in “as is” condition.

When shopping for a foreclosed property, the first thing to consider when choosing a lender is: Are they able to offer you this type of loan?   If not, and your property needs improvement prior to occupancy, you should find another lender.  Lenders who are able to provide the 203(k) loan can be found on the HUD website

The following property types are eligible:

  • Condos
  • Town Homes
  • Single Family Homes
  • Mixed Use (Storefront)

To obtain a 203(k) loan there is a minimum $5,000 requirement of eligible home improvement projects on the existing structure of the property. Minor or cosmetic repairs may be included after meeting the first $5,000 worth of repairs.

Of course, if you are buying a condo, you will also be subject to minimum down payment and credit score requirements, which you can read more about here. In addition, only 25 percent of the total number of units in the development can be undergoing rehabilitation at any one time.

Another factor important to be aware of is that an approved HUD Consultant must oversee the repairs.  The process begins with a feasibility study, overseen by an approved consultant. Through this process, the FHA determines whether the improvements would be justified upon completion.  If the estimate of the property’s value after the repairs required in the feasibility study does not equal or exceed the loan amount, then no loan will be granted.

Prior to the start of any work, the consultant will provide a work write-up, which is an item-by-item breakdown of each item to be repaired and the estimated cost. Once agreed upon, the lender will order an appraisal based on the write-up. The appraisal will give an “after-improvements” value. After this step is complete, contractor bids can be solicited. Acceptable bids cannot exceed the cost given in the write-up.

After this step is complete, the loan goes through the normal underwriting and closing process and an initial payment for the purchase of the property is made. The lender holds the remaining funds until the work is completed. As the rehab progresses, requests can be made to pay contractors for work done to that point. The consultant will perform an inspection, and upon approval the lender will release the requested funds. This continues until the completion of the project. If money is left over, it can be used for additional improvements, or reducing the loan’s principal balance, but it cannot go back to the borrower.

Besides the hassle of completing the repairs, the other drawback of these loans is that they tend to come with an interest rate of up to 1% higher rates than the traditional FHA loan.  To get around this, borrowers can refinance the home after the repairs are complete.

Additional information on the 203(k) loan can be found on the FHA Website.

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