203(k) Update: HUD's Phenomenal Rehab Loan

by Stephanie A. Chisholm

Editor's Note: The 203k program has been changed considerably since this article was written. Most notably, the investor program was suspended temporarily. Contact a 203k lender for updated details on this program.

The Federal Housing Administration (FHA) has recently revised a program which can help first-time homebuyers and small real estate investors restore available housing. The 203(k) loan program was initially developed in 1961 to encourage the restoration and preservation of the nation's existing housing. Administered by the Department of Housing and Urban Development (HUD) and insured by the FHA, the program consists of one loan that finances both the 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, then secure additional financing to do the rehab work; and obtain a permanent mortgage when the work is completed to pay off the interim loans. Often the interim financing (the acquisition and construction loans) involves relatively high interest rates and relatively short amortization periods. The 203(k) program was designed to address this situation. The mortgage amount is based on the projected value of the property, including work needed to 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 are beginning to offer 203(k) loans. Until last year, the program had been difficult to execute, often taking up to six months to reach closing. New federal government changes, including requiring only one appraisal after improvements and allowing borrowers to hire a HUD-approved consultant to review plans and write estimates have reduced the time to closing.

Mari Adams is an underwriter in HUD's Boston office and has been working for HUD more than ten years. Adams comments, "The 203(k) loans are taking no time at all to close, on average between 30 to 45 days. I would say 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 the program, we have had an overwhelming response and we are very happy that it is working so well by providing homeownership opportunities to people who may not otherwise qualify. People who don't have a lot of money for the downpayment can benefit because first-time buyers only have to put down 5%. We are also doing an awful lot of applications for investors, who must put 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 organized as a department by the Federal Government. Bernard, Director of Single Family Housing for Massachusetts, talks about the 203(k) Program: "Historically, HUD's FHA program is successful and profitable. In 1995, the programs will be better and more organized. A process that once took up to two years can now close in two months, with an actual goal of thirty days. FHA closes one out of every six mortgages in Massachusetts, 33% to first-time homebuyers and 25% to minorities. The bottom line? HUD is becoming more marketing oriented."

Bernard continues, "In Massachusetts, there are 19 employees in the Boston office who process and underwrite 203(k) loans. We try and make the program as flexible as possible for local lenders. We hold REALTOR seminars to encourage broker participation. HUD is also on line, reaching 70% of brokers 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 this year."

How will fluxuating interest rates affect the 203(k) loan? Bernard is optimistic: "This program is interest proof; as mortgage interest rates go up, more and more homebuyers are looking for property to renovate instead of just buying a new house."

Bernard described the recent development of a HUD consumer information phone line which can be reached by calling (617) 565-7450, "We rotate staff, with each person taking 2 half days a month; we all take turns and by doing so we learn about each others programs and find out what the other departments are doing."

New England is a prime site for the 203(k) loans due to the foreclosures that have occurred in almost every neighborhood. The property must need a minimum of at least $5,000 in repairs to qualify. Eligible improvements include structural alterations; remodeling aesthetic changes; reconditioning or 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 exterior siding.

Ken Crandall, Chief Architect of HUD's single-family development states "The program is a good vehicle for affordable housing. We help revitalize areas 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 Boston location. Mr. Paquin states, "Most people probably don't know that the Neighborhood Block Grant Program can also apply to the 203(k) Program. Funds are administrated by the Federal Government annually with most of the cities in Massachusetts beginning homeownership programs by July 1. In 1994, total block grant funds for the state exceeded $32 million. 29 cities in Massachusetts are involved with each municipality responsible for their own marketing. The money for the program just came out in 1992 and so far, Congress has not make an effort to take this money back."

"In some cities, money is allocated toward non-profits to rehab a property; however, the applicant's income must not exceed 80% of area median income. Boston's median combined household income for a family of four is 47,000, for example. Funds can be given directly to a homebuyer in the form of downpayment assistance or a soft-second in addition to the 203(k). The only restriction is the income limit."

How do you apply for a Block Grant? Paquin adds, "People can apply depending on the jurisdiction; each city designs their own program. You would not go to a bank to get this loan. The cities need to identify the 203(k) lenders; for participating jurisdiction. Now, for example, the city of Lynn is trying to tie in with 203(k); in fact, cities all over Massachusetts can now pick up properties and oversee the re-hab work. The nicest thing about the home program is that it provides a way for marginal income families to 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 bought a 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 make it 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 plans on basic repairs such as new kitchen, new baths, roof repair and updating systems such as electrical and plumbing. He also rolled in a couple of months of 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 his mid-twenties, referred to me by another client. He called me, we met the next day and he was approved in three days."

Smith's experience over the past nine months? "The 203(k) is the most flexible program that has come around in a long time. There's so many neat things about it; for example, the downpayment can be a gift, you can roll in payments and make payments while fixing up the property. Especially when you are buying a home for the first time, it allows people to do a lot with a little amount of money. The other thing is that entire neighborhoods throughout the country are being rehabilitated. This is remarkable considering the most Fannie Mae and Freddie Mac programs require 30% down and have other restrictions. With 203(k), the only restriction is that the buyer or investor can't own more than 7 property in within a 2 block radius. This is FHA's most cutting edge program ever."

Anyone is eligible for the 203(k) loan which carries interest rates one-half percent higher than conventional 30-year fixed loans. Buyers who plan to be owner occupants need only make a five percent downpayment with no income limits.

Investors are required to put down 15 percent, a savings compared to 25 to 30 percent on a conventional rehabilitation loan. Nonprofit groups such as community redevelopment corporations are treated as "owner occupants" and are only required to put down five percent, according to 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, and the cost of rehabilitation will be $20,000. A builder/developer would have to 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 value of 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 loan proceeds will provide $25,500 ($95,500 - $70,000). When the loan is assumed by a qualified borrower, the total amount of $36,000 in the escrow commitment account will be released to the builder/developer. A first-time homebuyer could assume this mortgage with no downpayment.

Investors who find a first-time homebuyer within 18 months of rehabilitation can sell the house with no downpayment. A first-time buyer is defined as anyone who has not owned a house in the past three years. At closing, the buyer assumes the mortgage and owns a home complete with improvements. The loan is eligible for endorsement by HUD as soon as the mortgage proceeds are disbursed and a rehabilitation escrow account is established. At this point, the lender has a fully-insured loan.

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