Embrace the Right Tool for the Job
By Kevin Cloyd
This year, the real estate market will feel the effects of two major influences: a long, harsh winter and the still-lingering shadow of the housing crisis. These factors are particularly noteworthy when looking at the state of distressed properties and the rehabilitation and remodeling industry.
As more and more homebuyers and investors purchase distressed properties, rehabilitation loans can prove to be an important part of originators’ portfolios. If you’re tinkering with the idea of embracing the distressed-properties niche, pay particular attention to the Section 203(k) mortgage program from the Federal Housing Administration (FHA). This program offers three different loan types, each of which offers a different array of tools for borrowers who are ready to revitalize their homes.
Although many foreclosure and distressed-property statistics have been trending down in recent years, these homes still comprise a significant portion of the market. This past first quarter, distressed and short sales combined for 16.4 percent of all housing sales, according to RealtyTrac. This represents an increase from the 14.5 percent seen in fourth-quarter 2013.
As confidence in the housing market begins to climb, more potential buyers are looking at these properties as opportunities for homeownership. Distressed properties, however, are often projects in themselves, and many need serious repairs or updating.
Mortgage originators working with homebuyers who are willing to tackle renovations should be aware of the opportunities offered by the FHA for the rehabilitation and repair of single-family homes. Its primary vehicle to help homebuyers and homeowners is the Section 203(k) program, which allows for the purchase or refinancing of a home in addition to financing eligible repairs and improvements.
Of course, these types of projects are not exclusive to distressed properties; many homebuyers may be looking to simply improve upon an already high-quality home. Either way, the 203(k) program can help.
Taking on a fixer-upper
Many potential homebuyers may be leery of tackling significant home improvements or the work that’s necessary to bring a distressed property up to their standards. From basic roof repairs to serious updating, these projects often are seen as time-consuming and expensive — two things that many homebuyers want to avoid at all costs.
According to the National Association of Home Builders (NAHB), the Remodeling Market Index declined to 53 this past first quarter, down from 57 in the previous quarter. For perspective, a score above 50 indicates that remodelers on the whole reported an increase in market activity from one quarter to the next.
NAHB attributes this decline to the effects of the harsh winter, however, noting that many remodelers remain optimistic about the industry’s future. According to the National Association of the Remodeling Industry’s Remodeling Business Pulse, the three-month outlook for business hit 6.51 this past first quarter, an all-time high and an increase from the previous quarter’s 6.41. For perspective, a score of 5 means that a given outlook is about the same as it was for the previous year, with any number higher than 5 (on a scale of 1 to 9) being optimistic.
If the industry’s outlook is bright, many homebuyers will look to their mortgage originators to help them finance the repairs that will turn their properties into the homes of their dreams — while also increasing their long-term resale values. In addition, as more homeowners see the strengthening housing market, they may look to finance renovations in preparation for putting their homes on the market.
Mortgage professionals turning to the 203(k) program must know about the different types of loans offered and what improvements qualify for the program. Everything from energy-efficient improvements to structural changes and appliances are included in the wide range of repairs and improvements eligible for this type of financing. Depending on your clients’ needs, the FHA’s 203(k) program has three loan types to consider:
- The “standard” 203(k) mortgage;
- The streamlined 203(k); and
- The PowerSaver Pilot 203(k)
Choosing the appropriate loan will depend on the type of repairs done and the total cost associated with them. All of the programs can be used for either purchase or refinance transactions, as long as the subject property is a residential dwelling on which initial construction has been completed for at least a year, with a maximum of four units.
Learning about each loan type will arm mortgage originators with the knowledge that they need to help their clients find financing to repair or remodel their homes. Let’s take a closer look at each loan type.
The 203(k) standard program is well-suited for projects that need major reconstruction and renovation. The FHA considers this program an important tool for neighborhood revitalization and the expansion of homeownership opportunities. Traditional home-improvement loans often come with high interest rates and short repayment terms. With FHA’s backing, however, 203(k) loans can save borrowers money and time. In addition to creating homeownership opportunities, houses that are considered undesirable can be rehabilitated, creating homes where once there was merely blight.
Given that this loan is typically used for homes requiring extensive repairs, a standard 203(k) is appropriate for major additions and structural changes. Unlike the streamlined 203(k), repairs must exceed a minimum of $5,000, but the maximum repair amount to be financed is not a fixed number. Instead, a standard 203(k) can be in any amount up to the lesser of the following: the value of the property before rehabilitation plus the costs of the rehabilitation; or 110 percent of the after-improvement value as determined by the appraisal. Originators should note that the total value of the home must remain within the FHA’s mortgage limit for the area in which it is located.
Within these parameters, a vast array of work can be done. Under the standard 203(k) guidelines, a home even can be demolished and replaced as long as the existing foundation remains in place. In addition, an existing dwelling on one site can be moved to a new property using these funds, but the loan proceeds are released only after the structure has been affixed to the foundation. A property also can be converted into a one- to four-unit structure, additions and structural changes can be made, or simple yet extensive remodeling can be completed.
Because these loans encompass more work and larger financing amounts, more oversight is understandably necessary. In light of this, the FHA requires homebuyers to work with an approved 203(k) consultant, so originators can be assured that their customers won’t undertake these changes without professional feedback and perspective.
The Streamlined 203(k) program is aptly named, because this loan is used for repairs or improvements that cost less than $35,000. This loan will be most appropriate for homebuyers who are looking to do either modest repair work or cosmetic improvements. It is unlikely that completing structural work, creating an addition or converting a multifamily unit could be financed with a streamlined 203(k) loan.
In short, these loans are best for improvements that do not require plans, consultants, engineers or architects. Any work that requires a schedule longer than six months is also ineligible. The streamlined 203(k) guidelines are designed to make the approval process flexible and easy, so homeowners can prepare their homes for sale or make their new homes move-in ready as soon as possible.
These loans can help with everything from financing the purchase of major household appliances (i.e., refrigerators, washers and dryers, etc.) to installing new carpeting or finishing a basement. There is no longer a minimum repair amount, but the maximum amount that can be financed for repairs is $35,000. It’s important to note that repairs or improvements that cost more than $15,000 require a third-party inspection after completion.
PowerSaver Pilot 203(k)
The PowerSaver Pilot 203(k) program is an expansion of the FHA’s PowerSaver Home Energy Retrofit Loan Pilot Program that began in May 2011. Launched this past August, the 203(k) pilot program gives homeowners and homebuyers access to funds that are similar to those available for streamlined and standard 203(k) loans, but energy-saving improvements are incentivized with low-cost financing.
The PowerSaver 203(k) has lower loan limits than the 203(k) program’s other two types, along with its energy-saving requirements. The maximum loan amount is $25,000, amortized for as long as 20 years. The energy-efficient upgrades must comprise at least $3,500 of the loan’s total amount.
Energy improvements can include a wide range of upgrades, from updating a home’s heating system to installing new windows, but they must be based on the list of approved measures from the FHA and the U.S. Department of Energy. Other improvements can be made in addition to energy-saving measures, and these improvements are generally the same as those that fall within the streamlined 203(k) guidelines.
This pilot program is scheduled to end on May 4, 2015, so originators — and their customers — should take advantage of it while they can.
The FHA’s 203(k) program encompasses a variety of home repair and remodeling options that will be appropriate for a wide range of clients — from current homeowners looking to update their homes and refinance to new homebuyers looking to purchase a distressed property that needs some work. Although many originators and homebuyers are wary of the extra oversight and time it can take to properly execute a home-improvement loan, working with the right lenders and contractors can go a long way toward making the process a smooth one.
Mortgage originators should prepare their clients for the appropriate timelines associated with these undertakings. Smaller jobs, of course, require less oversight and will likely be completed in a relatively smooth fashion. Updating a house in preparation for a sale can be done fairly easily, and clients should focus on improvements that will bring in the most resale value — traditionally, items such as flooring or upgrading the kitchen and bathrooms.
Borrowers who want to take on more significant projects, however, must be prepared for the extra work that go into them, and these borrowers should partner with lenders and contractors experienced in the disbursement of 203(k) funds and the appraisals that are required along the way. With an experienced lender at the helm, issues can be identified before they become major problems that delay the work being done. By partnering with the right lenders and contractors, homeowners and homebuyers can create the house they desire with low-cost financing.