My 203K Loan Process and Lessons Learned

Hello!!  Since my big old farmhouse is finally a few weeks from being officially move-in ready, I thought it would be a good time to outline what the past year has looked like with regard to the acquisition and renovation process.  I went with a Full 203k loan, so I will be focusing on this gem of a mortgage product ; )

What is a 203k Loan?

The “203k loan” is actually backed by an insurance product developed by the Federal Housing Authority (FHA) back in the 60s.  It was authorized in Section 203(k) of the National Housing Act, and the insurance this section provides allows lenders to lend under the conditions outlined in the Code of Federal Regulations (CFR).  We have come to know mortgages backed by this insurance as 203k loans, or rehab loans.

203k loans come in two flavors, if you will.  If the home being mortgaged required repairs of under $35,000, the process is streamlined, and overall the rehabilitation is a pretty painless process.  For more extensive repairs and rehabilitation, a full 203k is required, and this is what I will be outlining for you.  Both loans provide homeowners the opportunity to purchase less desireable homes, or homes in need of some TLC, that are not otherwise not eligible for other rehabilitation options (like Fannie Mae owned properties eligible for HomePath loans).

For more on the technicalities, I would recommend visiting the HUD website at: https://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/sfh/203k/203k–df

1. Getting Started

The first 3 steps tend to happen all at once, but you may find you already have an agent, already have financing, or already have a home picked out.  In any case, proceed as necessary!

Get Pre-Approved

Most websites will advise that you get pre-approval before you start shopping for a home at all.  I would recommend this as well, if for no other reason that to see what you might qualify for.  You might be surprised at how much you could actually qualify for, so this is an important step. Along with your pre-approval, it is also smart to think about what you would be comfortable paying.   In my case, for example, I was comfortable with my $1,900 rent payment, but not happy I was spending it on rent.  While I qualified for much more, I stayed within the parameters I set for myself, and found an amazing property : )

A few things to remember – you do not have to obtain your mortgage through the company that pre-approves you, and typically the pre-approval is contingent upon you finding a home, providing evidence of income, etc.  Don’t waste time trying to find the perfect lender right away, but do start shopping around, talking to lenders about their process, familiarity with 203k and other mortgage products.  More on this later : )

In my case, I knew what I could afford, but was casually browsing when I stumbled upon my future home.  In my experience in real estate, this is typically the case with most homebuyers today.

Pro tip – Don’t bug your realtor to show you multiple properties until you are sure you are ready to fall in love with a home ; ) Some agents will not work with clients who have not at least been pre-approved, and considering the time it takes to set up walk-throughs, schedule with sellers or the bank, this is completely responsible.  Pre-approvals are quick (1 day max.) and really give you an idea of what your limits are.

Find an Agent

A responsible agent will be able to tell you a few things that will be critical to your purchase and investment:

Is the house properly listed?

This is critical because you will essentially subtract the initial investment (how much you pay) and the repairs, from the appraised value.  The FHA process has guidelines that help protect you (more to come on that), but a good agent will also help you negotiate the best deal, much like a lawyer defends your best interests in court.

What could the potential resale value be if it were updated? (Read – What might your equity position look like/Is this worth it?)

Again, an agent who knows the neighborhood and surrounding areas will be able to tell you about school districts, things that affect value, and what kind of rehab you will need to do to bring it up to snuff with comparable properties.  Your contractors and FHA consultant will be able to create your dream home, and make sure its safe, but if you are trying to do a low-budget renovation in an uppity neighborhood, your home may never sell with laminate flooring or anything other than marble countertops.  Similarly, going overboard on renovations may put your home out of the market for potential buyers, and your appraisal will never be as high as the money you put into it.  There is definitely a ceiling in most neighborhoods, and this ceiling tends to be lower in areas where there are a lot of distressed properties.

How is the neighborhood?

You might find a cheap house, but is it really a place you want to call home?  Is it a place you want to raise kids?  Are there sufficient yoga studios and fresh produce markets? (Ok, that was my standard alongside school district ;)) If you are looking to flip, is it a place other people are willing to live?  Again, the neighborhood will contribute to your ceiling, and more importantly if you are living there, will have an impact on your quality of life.

When you are searching for an agent, find someone reliable who you trust.  My Realtor was recommended to me by someone who she represented on several transactions, and the first time we met at the huge scary property, she was as excited about the adventure as I was.  (If you are in the Southern New Jersey area, Gwen Mazzeo is the absolute BEST.  She stuck with me through the WHOLE convoluted process you are about to read, and I honestly do not think it would have ended so smoothly if she wasn’t representing me!)  A FULL 203k is not going to be a simple, 60 day closing in most cases, and hopefully this guide will help, but you NEED someone on your side who won’t give up.

Will the seller accept a 203k loan?

Sometimes this information is available online, but your agent will have more information than you about property details that may not be listed.  The MLS still contains a lot of information only available to agents.  For example, perhaps the seller mentioned foundation issues, or the home is being sold completely “as-is”.  In my case, there was a shared well on the property, and I was able to gather more information about that, the location of the updated septic, etc. by talking to my agent before we even visited.

Find a Property

I put this step last, of the three, even though it is typically first (I’m talking to you there, pro surfer at Realtor.com…..)  I admit that I found my house pretty much first too, but that did mean I had to hurry through the rest of the process (I fell in love at first sight).

You see a leaky ceiling, smelly cabinets, and a weird staircase…I see a future laundry room and extra prep space for DIY bath bombs! Did I mention 203k projects require a little imagination?

Realtor.com is a good place to start, but if you know you want a fixer-upper, and you have an agent and pre-approval, you are in a much better position.  Bonus points if you already have a contractor in your arsenal, and gold stars if they are certified as an 203k consultant).

To bring, or not to bring, a consultant and contractor…

On your first walkthrough, unless you have a full crew ready to work with you, it is not necessary to bring an entourage.  You will have several visits with the home before the loan closes, so my advice is to walkthrough first with your agent, and use your judgement based on what you see.  Take pictures, and if you think it might be feasible, re-visit with your contractor or consultant.  203k consultants typically charge upfront to prepare a feasibility study, and I did not have mine completed until after my first walkthrough, and after I had a structural engineer do an inspection.  I will discuss this further in a bit.

On our first walkthrough, even though my agent had scheduled the appointment with the selling agent (who worked in her office), the current tenants of the property refused entry at first.  My agent had to call the seller’s agent, who contacted the seller, who contacted the tenants (again) to let us in.  The point being, you never really know what you might be walking into on the first (or subsequent) walkthroughs.  Be safe, and ALWAYS head out with an agent to walk a property, even if it looks vacant, or you couldn’t imagine how anyone could possibly be living there.  I’m pretty sure in our case it was a misunderstanding, but safety should always come first.

2. Hire a 203k Consultant

The next step is to find a 203k consultant you can trust.  Along with your agent and bank, the consultant is an important (not to mention required) player dedicated to your protection.  203k consultants are typically current or past contractors with experience in the field, who can make responsible estimates of the work your potential home needs.  The consultant charges a fee, that is set by HUD’s fee schedule (so they can’t rip you off), and the total fee is determined by the cost of repairs.  The initial cost is typically a few hundred dollars (mine was $300).  With this payment, the consultant will conduct a feasibility study.

What is a feasibility study?

The feasibility study is an extensive inspection of the property that estimates the cost of mandatory and desired repairs.  As he or she conducts the study, the consultant will take note of anything HUD will required to be done to bring the house up to code.  Once the feasibility study is turned into to official specification of repairs, these will be marked mandatory, and must be completed to the specifications outlined.  If there is additional work you would like to be done, the consultant will estimate the cost, and tag it as desired.  Once the study is complete, you will have a good idea of what the repairs should cost, and the bank will have security that the house will be brought up to code, thus ensuring resale value.

Make sure that the feasibility study includes everything you want done at the property.  When I walked through, I thought it was too early to think about things like layout, grade of flooring, etc.  You can generalize, but make sure the “big stuff” is included.  It is better to overestimate than under estimate.  After my study was completed, I had to remind my consultant to add in things like the heat service being transferred from oil to gas, and the kitchen being remodeled.  Once everything was accounted for, I had a better idea of the renovation cost and could think about the offer I wanted to make.

3. Make an Offer

Assuming you have your pre-approval ready to go, you can proceed with making an offer on this property.  Typically agents will recommend that you get a specific pre-approval for the offered purchase price of the property.  You never want to disclose your purchasing power to the seller or seller’s agent, since their on the other end of the deal.  Be aggressive but reasonable, considering what you know about the property.

Pro-tip: You may be able to renegotiate based on further inspections, and the appraisals and score of work that you will develop with the help of your 203k consultant.  The offer should be made based on what you know, and while you are technically under contract once the seller accepts, there are certain timelines written into your contract that protect you against unforeseen circumstances.

In my case, the home was listed at $111,000, and had been on the market for about 6 months.  We made an aggressive offer at $85,000, plus $5,000 in closing costs, considering the work that needed to be done (the feasibility study revealed more work than the listing outlined), and after the seller countered, we finally settled on a final price of around $90,000, with $5,000 toward closing.  This offer included that the seller would pay for the installation of a new well on the property before closing, and the contribution to closing costs would reduce my required liquid funds at closing.  The property currently shared a well with the home next door.

When the loan was in underwritting (more on that later), the FHA did not want to risk the seller not holding up his end of the bargain, and required that the well installation be included in my scope of work.  We renegotiated to reduce the cost of the house by $5,000, and I included the cost of the well installation in the scope of work.  I ended up buying the house for around $85,000.

Finding a Lender

The next section will begin discussing how to go about choosing a lender for your 203k renovation.  I went with the lender who offered me my pre-approval, but had I shopped around or understood the process, I may have been able to save a lot of time.  Grab a big  enormous glass of wine, and join me in the next post, where you will learn about how to manage the relationships between your lender, consultant, and contractor…