Ahhh, the market. The market that is flooded with foreclosures — some that are in decent shape, some that are stripped of anything of value and homes that fall somewhere in between. Here’s the dilemma that many buyers are experiencing … how do I buy that house when the lender won’t finance it due the condition it’s in? There’s a great question. With so many opportunities to get a great deal on a house right now, use first time buyer money and take advantage of a 40-year low in rates, how can anyone “make it happen”?
It’s called the FHA 203K loan. A little background first on where the mortgage market is now. Most buyers are using FHA financing, which stands for the Federal Housing Administration. The main reason is the minimum down payment requirement of 3.5%. Another reason for its popularity is being the closest thing to a “sub-prime” loan. Now, I am not saying it’s like a sub-prime loan in the true meaning of it. It is, however, the most lenient loan on credit score requirements. You need a minimum mid-score of 620. Conventional loans recently came back to the marketplace with a 3% down loan in part due to the PMI (private mortgage insurance) companies are willing to insure them. To do 3%, you must be a first time buyer and in most instances, need scores over 700. My experience these days supports that score being tough to come by.
Since most buyers are using FHA financing, many are unable to get offers accepted on foreclosed properties with any work that needs to be done. Why? A few reasons. First, FHA is a little more strict on safety and structural issues with the homes. When we send an appraiser to the property, they’re supposed to look for those things that could pose a hazard, such as missing cover plates on outlets, or the biggest one, peeling paint ANYWHERE in/on the home if the house was built before 1978. Those homes have a higher chance of the paint being lead-based. If you eat the paint chips, you could get sick — too many, like a little kid might, and you could die. That’s scary and that’s why FHA is very clear on their position. So, if any issues are found, they must be fixed prior to closing on the home Second, many banks won’t accept FHA financing. Due to the amount of work potentially required by an FHA appraiser, they don’t want to have a deal fall through if an FHA appraisal comes in with work orders. In 99% of the cases, the bank won’t fix the issues. Banks are known for selling the home “as is” and really, this makes sense. They never lived there, so they really can’t comment on water damage or storm damage or stolen fixtures. Yes, some people DO take the toilet and sink. Seriously, what are they going to do with that stuff? Nothing, I would assume — it’s just a way to say “I’ll show you bank for taking my house away”.
So, if the bank won’t accept FHA financing and most people are buying this way, how can these foreclosures be sold? The financing that can handle this is called the FHA 203K loan. Under this program, there are two sub-programs, the streamline 203K and the full-blown 203K or “K” as I call it. This is a rehab loan that would allow you to get into a home BEFORE those repairs are completed. The repairs would be addressed in a bid which is added to your loan size. There are only a handful of companies that do these loans, mostly because they are labor-intensive and carry a lot of risk. We’ve been doing this for years and understands the niche that is filled by doing the rehab loans.
As I mentioned, there are two sub-programs. The streamline “K” is a more condensed rehab loan. The maximum addition to your loan size is $35000 including the “K” costs. The main difference with the streamline vs. the full-blown “K” is that you cannot do any structural or foundation work on the streamline. You can paint, carpet, replace the furnace, add A/C, change lighting, add a bathroom, do the roof and even something that isn’t re-habby at all like buying appliances. Most importantl, you can fix those items that are required by the appraiser to bring the home to FHA standards. Another REALLY cool thing about this streamline “K” is that we CAN do a smaller version of this in conjunction with the MN Housing Finance Agency loan (max $15000 including “K” costs) and you could still get $5000 in assistance. We can do the the regular version with both the City Living and Dakota Countyprograms, which are programs that just received a big chunk of money at a low rate. And speaking of rates, if you don’t use a first time program, then the rate on the 203K loans will be about 1/4 – 1/2% higher than a normal FHA loan. Trust me when I say, this is a screaming deal even at a little higher rate.
The second sub-program is the full-blown “K”. The loan amount that can be added to your primary loan is UNLIMITED, assuming two things — 1) you can qualify for the loan and 2) you stay under the FHA loan limits, which in the 11-county metro area are $365,000. In this rehab program, you can do anything — like items mentioned above, doing an addition to the home and get this, even tearing down a home just as long as you re-build on the existing foundation. Yes, seriously. Of course, you’d have to get that home pretty darn cheap to keep a new home build under $365,000.
You may be thinking, ‘this is cool, but how do I qualify for this?’ Are there any special requirements? Nope, not really. You need the 620 score or higher, need to be able to qualify for the higher loan amount and need to do a little extra in terms of paperwork and hiring a contractor. We have a team of awesome contractors that are ready to give a free bid based off what your needs are and what the inspection may bring to your attention. We don’t require you to use our preferred contractor partners, BUT, we highly recommend it. I can tell you stories as to why another time!
Okay, what’s the process? More than likely, you won’t be looking for homes that need the work. But, the appraiser may just require that work has to be done and now the 203K program becomes a necessity. Essentially, you locate the home, make an offer using the 203K (since many bank-owned properties won’t accept regular FHA financing), we have an inspection and potentially have the contractor out there with you to assess the scope of work and provide a written bid. This information goes to processing with your file and an appraisal is ordered using the purchase price PLUS the bid. The home will be valued “as-is” and also given an after-repairs value. Here’s an example of built-in equity. I helped finance a townhome that just required new flooring throughout and then the client decided to get appliances (were none in the home) — home price was $115,000, bid items added up to $13000 — it appraised at $150,000. WOW, that’s awesome. The work, not that extensive at all nor value-enhancing per se, just brought the home to a level playing field with the other townhomes that are in good shape.
There is more to the process, but I see that this post has become quite long. You can wake up now!! To summarize, you DO have a way to do an FHA loan and still purchase a home that needs work or is bank owned. We have the opportunity waiting to help you and I do profess that this is one of those programs I have done quite a bit and with great success. I hope I can help you make the house you’re buying a “dream home”.