Home203(k) Update: HUD's Phenomenal Rehab Loan
by Stephanie A. Chisholm
Editor's Note: The 203k program has been changed considerably sincethis article was written. Most notably, the investor program was suspendedtemporarily. Contact a 203k lender for updated details on this program.
The Federal Housing Administration (FHA) has recently revised a programwhich can help first-time homebuyers and small real estate investors restoreavailable housing. The 203(k) loan program was initially developed in 1961to encourage the restoration and preservation of the nation's existing housing.Administered by the Department of Housing and Urban Development (HUD) andinsured by the FHA, the program consists of one loan that finances boththe acquisition and rehabilitation of the house with low downpayment requirements.
When a homebuyer decides to purchase a home in need of repair or modernization,the homebuyer must first obtain financing to purchase the dwelling, thensecure additional financing to do the rehab work; and obtain a permanentmortgage when the work is completed to pay off the interim loans. Oftenthe interim financing (the acquisition and construction loans) involvesrelatively high interest rates and relatively short amortization periods.The 203(k) program was designed to address this situation. The mortgageamount is based on the projected value of the property, including work neededto complete the renovations.
In March of 1994, rising interest rates slowed the refinancing boom significantly.As a result, more and more lenders have applied for HUD approval and arebeginning to offer 203(k) loans. Until last year, the program had been difficultto execute, often taking up to six months to reach closing. New federalgovernment changes, including requiring only one appraisal after improvementsand allowing borrowers to hire a HUD-approved consultant to review plansand write estimates have reduced the time to closing.
Mari Adams is an underwriter in HUD's Boston office and has been workingfor HUD more than ten years. Adams comments, "The 203(k) loans aretaking no time at all to close, on average between 30 to 45 days. I wouldsay that Norwest and Capital Mortgage are the biggest lenders in this area,but others are starting to get more into it. We are very excited about theprogram, we have had an overwhelming response and we are very happy thatit is working so well by providing homeownership opportunities to peoplewho may not otherwise qualify. People who don't have a lot of money forthe downpayment can benefit because first-time buyers only have to put down5%. We are also doing an awful lot of applications for investors, who mustput down 15%, but can get the money back if they sell to a first-time buyer."
Edward Bernard has been with HUD since 1965, when it was first organizedas a department by the Federal Government. Bernard, Director of Single FamilyHousing for Massachusetts, talks about the 203(k) Program: "Historically,HUD's FHA program is successful and profitable. In 1995, the programs willbe better and more organized. A process that once took up to two years cannow close in two months, with an actual goal of thirty days. FHA closesone out of every six mortgages in Massachusetts, 33% to first-time homebuyersand 25% to minorities. The bottom line? HUD is becoming more marketing oriented."
Bernard continues, "In Massachusetts, there are 19 employees inthe Boston office who process and underwrite 203(k) loans. We try and makethe program as flexible as possible for local lenders. We hold REALTOR seminarsto encourage broker participation. HUD is also on line, reaching 70% ofbrokers in the state. This year, we hope to close 350-400 new 203(k) cases;last year it was 50. We have met our goal and exceeded it by 200% for thisyear."
How will fluxuating interest rates affect the 203(k) loan? Bernard isoptimistic: "This program is interest proof; as mortgage interest ratesgo up, more and more homebuyers are looking for property to renovate insteadof just buying a new house."
Bernard described the recent development of a HUD consumer informationphone line which can be reached by calling (617) 565-7450, "We rotatestaff, with each person taking 2 half days a month; we all take turns andby doing so we learn about each others programs and find out what the otherdepartments are doing."
New England is a prime site for the 203(k) loans due to the foreclosuresthat have occurred in almost every neighborhood. The property must needa minimum of at least $5,000 in repairs to qualify. Eligible improvementsinclude structural alterations; remodeling aesthetic changes; reconditioningor replacement of plumbing, heating, air conditioning; major landscaping;and improvements for accessibility to the handicapped. More specifically,improvements can even include skylights; built-in microwaves; and new exteriorsiding.
Ken Crandall, Chief Architect of HUD's single-family development states"The program is a good vehicle for affordable housing. We help revitalizeareas of the inner city resulting in better neighborhoods for everyone.The 203(k) loan is revitalizing this nation's existing housing stock"
Robert Paquin heads the Neighborhood Block Grant Program for HUD's Bostonlocation. Mr. Paquin states, "Most people probably don't know thatthe Neighborhood Block Grant Program can also apply to the 203(k) Program.Funds are administrated by the Federal Government annually with most ofthe cities in Massachusetts beginning homeownership programs by July 1.In 1994, total block grant funds for the state exceeded $32 million. 29cities in Massachusetts are involved with each municipality responsiblefor their own marketing. The money for the program just came out in 1992and so far, Congress has not make an effort to take this money back."
"In some cities, money is allocated toward non-profits to rehaba property; however, the applicant's income must not exceed 80% of areamedian income. Boston's median combined household income for a family offour is 47,000, for example. Funds can be given directly to a homebuyerin the form of downpayment assistance or a soft-second in addition to the203(k). The only restriction is the income limit."
How do you apply for a Block Grant? Paquin adds, "People can applydepending on the jurisdiction; each city designs their own program. Youwould not go to a bank to get this loan. The cities need to identify the203(k) lenders; for participating jurisdiction. Now, for example, the cityof Lynn is trying to tie in with 203(k); in fact, cities all over Massachusettscan now pick up properties and oversee the re-hab work. The nicest thingabout the home program is that it provides a way for marginal income familiesto find additional sources for gift money. "
Joseph Smith is a Loan Officer with North American Mortgage in Waltham.North American got started with the 203(k) program in September of 1994.He has personally done between 30 and 40 loans in the past nine months.Smith relates,
"We recently closed a 203(k) loan for an owner occupant who boughta property at a bank foreclosure. He had about $7,000 in downpayment funds,and had to close the loan in three weeks, or else risk losing the downpayment.The appraiser, the inspector and the buyer all met at the same time to makeit happen and meet the deadline. The buyer got $30,000 to fix up the property,a three-family in Salem. The buyer spent $70,000 on the house, and planson basic repairs such as new kitchen, new baths, roof repair and updatingsystems such as electrical and plumbing. He also rolled in a couple of monthsof mortgage payments to help him fix it up; helping his cash flow situation."
Smith gives a profile of the buyer, "This was a young guy, in hismid-twenties, referred to me by another client. He called me, we met thenext day and he was approved in three days."
Smith's experience over the past nine months? "The 203(k) is themost flexible program that has come around in a long time. There's so manyneat things about it; for example, the downpayment can be a gift, you canroll in payments and make payments while fixing up the property. Especiallywhen you are buying a home for the first time, it allows people to do alot with a little amount of money. The other thing is that entire neighborhoodsthroughout the country are being rehabilitated. This is remarkable consideringthe most Fannie Mae and Freddie Mac programs require 30% down and have otherrestrictions. With 203(k), the only restriction is that the buyer or investorcan't own more than 7 property in within a 2 block radius. This is FHA'smost cutting edge program ever."
Anyone is eligible for the 203(k) loan which carries interest rates one-halfpercent higher than conventional 30-year fixed loans. Buyers who plan tobe owner occupants need only make a five percent downpayment with no incomelimits.
Investors are required to put down 15 percent, a savings compared to25 to 30 percent on a conventional rehabilitation loan. Nonprofit groupssuch as community redevelopment corporations are treated as "owneroccupants" and are only required to put down five percent, accordingto HUD. The 203(k) can be used on a "mixed-use" residential property,i. e.; a retail shop with apartments above.
As an example, assume a buyer can purchase a property for $50,000, andthe cost of rehabilitation will be $20,000. A builder/developer would haveto put down a minimum of 15% ($10,500) on the acquisition cost of $70,000($50,000 + $20,000). If the after-rehab appraisal shows the market valueof the property will be $100,000 after the completion of the rehabilitation,then the mortgage for an owner-occupant who will assume the loan will be$95,500. The builder will apply $10,500 to the escrow account and the loanproceeds will provide $25,500 ($95,500 - $70,000). When the loan is assumedby a qualified borrower, the total amount of $36,000 in the escrow commitmentaccount will be released to the builder/developer. A first-time homebuyercould assume this mortgage with no downpayment.
Investors who find a first-time homebuyer within 18 months of rehabilitationcan sell the house with no downpayment. A first-time buyer is defined asanyone who has not owned a house in the past three years. At closing, thebuyer assumes the mortgage and owns a home complete with improvements. Theloan is eligible for endorsement by HUD as soon as the mortgage proceedsare disbursed and a rehabilitation escrow account is established. At thispoint, the lender has a fully-insured loan.