I met a new real estate investor the other day and he was completely flustered. He had been making offers on different homes for months, but he was continually turned down or outbid on short sales. His real estate agent advised him to start looking at some of the less desirable properties—properties that nobody else wants—and then, he could use an FHA 203(k) loan to fund renovations. Of course, he wanted to know more about this kind of financing and whether or not he’d be in over his head. While 203(k) loans do have their benefits, there are also some definite downsides—and one really big catch.
Are FHA 203(k) Loans Good or Bad?
The 203(k) program enables investors to finance houses that need some work, whether it’s an extensive teardown or just light renovations. The program achieves this by rolling the property’s acquisition cost in with the cost of renovations, forming a single FHA-insured mortgage. From the mortgage monies, the purchase amount is paid to the home seller and any additional funds borrowed are placed into an escrow account that’s used to fund the renovations. While this is a streamlined approach for the investor, it also protects the lender by insuring the property at market value—even before its condition warrants it.
As with any government-backed program, there are a number of requirements that the property must meet in order to qualify for an FHA 203(k) loan. First, currently the house that’s going to be purchased and rehabbed must be at least one year old and the renovation costs must total at least $5,000 and be less than the mortgage limit for the area. These limits vary by county, state, or Metropolitan Statistical Area. Then, after renovation, the house must meet specific structural and energy efficiency standards.
That all doesn’t sound so terrible, right? Well, it’s a bit more involved than you might imagine. Let’s take a look at some of the pros and cons.
- Simple Accounting. All of the costs of buying and rehabbing the property are combined into one loan, so you do not have to keep track of multiple lending types or accounts.
- Low down payment. If your credit is decent, you may qualify for a down payment as low as 3.5%. Even if your credit isn’t stellar, you can expect a mandatory down payment that’s a bit smaller than many other mortgage options.
- Payment options. You can choose between a fixed-rate loan or an adjustable rate mortgage. Of course, if rates are low when you intend to purchase, you’ll want to choose the fixed-rate option so you don’t have to worry about rates rising.
- Tax deductions. Real estate investment properties generally can qualify for a number of tax deductions, including mortgage interest, local taxes, and even the costs of ordinary repairs.
- Accessibility. Not every lender has experience with 203(k) loans, so you may have to hunt around a bit for a lender who knows the ins and outs of how these loans work.
- Time. A 203(k) loan requires a lot of extra paperwork compared to other mortgage types and the length of time to process the loan is a fair bit longer. In fact, some home buyers actually hire an independent professional to prepare their end of the paperwork to ensure that it’s done right the first time.
- Choice. Not all properties will qualify for the loan given the rules and limits on funding. You will need to estimate costs for the entire renovation project. You must also evaluate neighborhood comparables to ensure that the property can deliver a reasonable return on investment.
- Money. You can expect to pay mortgage insurance, which will raise your monthly payments. The closing costs may also be higher, because the bank charges for the extra processing time and oversight needed to ensure that renovations are complete and in line with the set standards.
- Deadlines. You will only have six months to finish the rehab of your house, with the lender performing site inspections at regular intervals. It’s not uncommon to experience unexpected problems and setbacks when buying and renovating distressed homes. Be sure to choose an experienced and insured contractor who can do quality house renovation work on tight timelines.
=> THE CATCH: A 203(k) loan can only be used—and cautiously, at that—by first-time investors. This loan requires that the house is owner-occupied for at least 12 months. Some new investors use their first investment property as their primary residence while they gain the skills and knowledge to truly get their business off the ground.
Finding Qualified Investment Houses
After I told my friend about the ins and outs of 203(k) loans, he decided that he might be willing to work within the confines just to get experience in real estate investing. But a problem remained: he needed to find a house that fit within the guidelines. Lead generation and conversion may be the single biggest obstacle facing new investors. While there are many tips and strategies floating around, the single most effective way to buy a distressed property involves leveraging the nationally known and trusted “We Buy Ugly HousesⓇ” branded marketing tools for investors. Today is the day to get your New Jersey investment business off the ground. Get in touch with HomeVestorsⓇ to learn more!
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