Just so you know, we are not wealthy people. I mean, we manage well enough, but we still live pretty much paycheck to paycheck. It’s not the type of situation that is prime for purchasing a dream-house or even a fixer upper . . . at least that’s what we thought.
Michael and I each owned small houses and we were planning on purchasing a house together soon, but we knew that we’d have to save up for a little while before we could make that happen. Even though we weren’t officially looking, I check out online real estate listings all the time just because I’m a geek about houses. One morning, I started clicking through images of a completely run-down house in one of the nicer areas of town. It was an absolute mess, but had such beautiful old bones. It was a 100-year-old Queen Anne with gorgeous double front doors and a turret. We decided to go look at it just for fun, never thinking we could afford it even in it’s current state.
It was the middle of August and hot when we did our first walk through. The house had been sitting empty for three years so you can just imagine the smell. It was bad. Even so, we quickly realized the potential of this house. It needed a lot of work, but the foundation was good, it was in a great area and it was packed to the rafters with charm (as you can see in our pre-renovation house tour). This kind of house didn’t come around every day. We knew we had to act.
We really didn’t know how we were going to get this house. We definitely didn’t have a 20% downpayment ready for a traditional loan. Nevertheless, we scheduled a meeting with a local bank to discuss our financing options. Well, it turned out we were in luck. The bank wouldn’t finance the house on a traditional mortgage because it was such a mess, but they gave us another option.
Our loan officer told us about a 203k loan. The 203k loan is a specific FHA loan that allows you to finance the initial cost of your home plus any improvements. It also only requires a 3.5% down payment. It is government backed which means that you have to jump through a lot more hoops, but you can finance your home with less out-of-pocket costs.
A 203k is not for everyone though. You can only apply for this type of loan once, and only if you have not used an FHA loan before. It also can take longer to close so you want to make sure the seller knows that you may need more time than a traditional loan. All improvements need to be done by a licensed contractor and they must meet code and correct any issues that are found on a HUD inspection.You also have to make sure that your house will appraise for more than the amount you are financing once the work has been done.
How do you apply for a 203K?
The most important step when applying for a 203k is to find a good, local bank that has experience dealing with these types of loans. Local is key because you will be working with this bank through the financing process and after you have closed. You will have to take money out to pay for the work, and the mortgage specialist is in charge of getting that money to you. There are all sorts of horror stories online of people going with large, non-local banks and not being able to access their money. Just make sure you can trust the people you end up working with.
After you have been pre-approved for this loan, you can start making offers on a home. This process works pretty much the same as usual except that you may have to allot more time for closing because of the 203k process. Once the sellers have accepted your offer, then the scramble begins.
What happens after your offer is accepted?
You need to schedule a HUD inspector to do a 203k inspection. He or she will give you a run-down of all of the improvements that must be done to bring the house up to code per HUD’s requirements. You have to do these repairs as part of the 203k financing and they must be done by a licensed contractor. You can also finance more work, but that is optional.
After you know what work needs to be done, you can start meeting with licensed general contractors. They will need to give you a 203k bid that entails an itemized list of all the work that will be done with the estimated cost. You must have an accepted bid before you can move forward with the loan process.
Your next step is to consult an appraiser. The house must appraise for more than the cost of the home plus repairs and a 15% contingency (this is extra cash in case unexpected problems arise during reno). So if you purchase the house for $100,000 and the general contractor’s bid is $50,000, your contingency would be $7,500, and your home would have to appraise for $157,500 in order to use the 203k financing. The appraiser will do an assessment of the house before you close on the house, but he or she will take into account the value that the proposed work will add. This is how the appraiser will determine if the house will ultimately be worth your final financing cost.
After the appraisal comes back, the mortgage broker and your realtor should take care of the rest. That doesn’t mean you are done though. Your mortgage broker will probably still need you to fill out a lot of paperwork. Just make sure that you have good communication with your broker so that you can return signed documents to them as quickly as possible.
The actual closing day is a whirlwind of paperwork. You will need to bring a cashier’s check made out to the title company for your down payment amount. You will also need to make sure that your insurance information is factored into your loan before you close. You will probably then spend about an hour signing page after page of documents. It can be intimidating but it’s just a part of the process. Don’t be afraid to ask questions though as you are going through the paperwork.
You closed on the house, now what?
After all the pages are signed, you are the proud owner of a new house. Yay! Your next step is to get in touch with your contractor as soon as possible to coordinate the work on the house.
It’s important to get the work done within a certain time period and to order the work in a way that makes sense. For instance, you don’t want to turn the water on until you have heating in the house. A general contractor will be able to lay out your schedule in the best way possible. He or she will also have to work with your mortgage broker and the HUD inspector to make sure that the bank will release the money for the work.
Some of the first work that was done to our new home, tearing off of the old roof and adding new architectural shingles in charcoal.
Even though your loan is covering renovation costs, the bank does not just give you the money for the repairs to your house. Instead they release it in chunks called draws. You may have one to three draws over the course of the work on your house. Each draw requires a HUD inspector to go back through the house and sign off that the work was completed and that it met his or her standards. You, as the owner, will also need to sign off on the work. You don’t have to sign off on the work unless you are satisfied.
Even after a draw is made, it only pays for 90% of the work that has been completed to that point. The remaining 10% is paid when all of the work is done. Because of this, it’s important to make sure that your general contractor and any subcontractors understand that they won’t get their pay up front and won’t receive the full amount until all work is done. Stay in close contact with your general contractor and your mortgage broker to make sure you receive and sign the draw checks quickly so that everyone can get paid.
If you run across repairs that were not originally budgeted as part of your bid, you can use your contingency fund to cover the costs. You will have to sign forms to request an additional draw to cover the extra work. Contingency-funded projects will also get a check that is separate from the larger draw checks. If you don’t end up using your contingency fund, it will roll back into your mortgage, lowering your principle but (sadly) not your monthly payments.
Should you apply for a 203k?
The 203k process is not for everyone. It takes a long time and you need to navigate paperwork, scheduling and personalities. All I can really say is how it worked for us, and it turned out to be a great solution for our home buying needs.
We are fixer-uppers at heart but our house needed work that we just couldn’t do. I wasn’t about to go scaling 30 feet up in the air to put on a new roof. With a 203k, we were able to finance the work that brought our home up to a safe and livable standard, but we left everything else for us to tackle later. Believe me, there is still a ton of work to do.
If you are still interested in pursuing a 203k, check out your local HUD website to learn more and make sure to check out our tips below to make the process run more smoothly.
203K Tips and tricks
- Always go with a local, reputable bank that has experience providing 203k mortgages.
- Ask your mortgage specialist if he or she can give you a schedule of deadlines with dates. This will help you to stay on track and close on time.
- You can also finance six months of house payments into your 203k mortgage, making it easier to afford to stay somewhere else while your new house is being repaired.
- A licensed contractor only has to do the projects that will bring the house up to code and satisfy the HUD inspection and appraiser. That may leave quite a bit of rehab work you can do yourself, if you are so inclined.
- If you’re not a handy person, you can finance more than the minimum HUD items. You can add aesthetic changes to your house. You can even purchase appliances.
- If you don’t use your contingency fund, it will roll back into your mortgage, reducing your premium. You may be able to refinance shortly after and reduce your monthly payment.
- Let your insurer know you will be making improvements to your house as part of a 203k. Many insurers offer new roof or home improvement discounts.