Important Q & A Regarding FHA 203k and 203k Streamlined Home Renovation Loan

By October 22, 2012
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I came up with a great Q and A list for the FHA 203k Home Renovation Loan. I think this will help many people such as yourself become more educated with the program. I hope to also create more comfort level with borrowers, lenders, realtors and contractors alike.

What is the maximum amount allowed for repairs?

97557439For the standard 203(k) program, there is no maximum. Keep in mind that FHA loan limits apply and the total maximum loan amount, including repairs, cannot exceed the maximum allowed by county within the state. For example in Maricopa County, the FHA 2009 Temporary Loan Limit is $346,250. Contact me if you are looking to sell in other counties within our state.

For Streamlined FHA 203(k), the maximum amount allowed for repairs is $35,000.

The minimum for standard and Streamlined is $5,000.

What if the borrower can not occupy the home during all or a portion of the repair process?

For standard FHA 203(k) loans, up to six months mortgage payments (PITI) can be included in the cost of rehabilitation and deposited in the rehabilitation escrow account when the property is not occupied during construction. This option is not permitted on the Streamlined FHA 203(k) as it does not allow the borrower to be displaced from the property for more than 30 days during construction.

What is the role of a cost consultant?

A good cost consultant will play a significant role in assisting to a smooth transaction. They know exactly what FHA requirements are to complete the rehab work. Since they work closely with the buyer, the contractor, the appraiser and me (your favorite banker), your job is to stay focused on finding more buyers.

Cost consultants can be found on HUD’s website.

Is an FHA 203(k) delivered like a regular FHA loan?

FHA 203(k) loans is delivered to the lender using the same process you use to deliver any other FHA loan. Since the loan is identified as a rehabilitation loan in CLOUT, once the loan has been purchased by the lender, it will route to the Disbursement Group who will work with the borrower and contractor to handle the rehabilitation process, including funds disbursement, inspections, title updates, all paperwork, etc.

How are loan funds disbursed?

The full loan amount should be disbursed at closing. The funds reserved for the rehabilitation will be set up in an interest-bearing repair escrow account and the balance will be used to purchase the property or refinance an existing loan. Here’s an example of how the process works:

$200,000 Total Loan Amount ($175,000 purchase or refinance plus $25,000 rehabilitation cost)*

Amount for purchase or refinance

$175,000

Rehabilitation amount

$25,000

Total loan amount

$200,000

Total amount to be sent by Seller to the closing agent

$200,000

Closing agent disburses funds ($175,000 for purchase or refinance and $25,000 to Seller to deposit into an interest-bearing escrow account

$200,000

Lender purchases loan and premium paid to Seller on

$200,000

Lender wires Seller

$175,000

Seller transfers rehabilitation from escrow account back to warehouse line

$25,000

(This simplified example is for illustrative purposes only and does not include any fees associated with the transaction.)

Is the process for Streamlined FHA 203(k) faster than the standard FHA 203(k)?

From a credit and underwriting perspective, the two programs are no different. What makes the transaction “streamlined” is the type of eligible improvements, the rehabilitation amount is limited to a maximum of $35,000, and there are only two disbursements. In other words, it’s the rehabilitation process that is streamlined.

How long does the borrower have to complete the rehabilitation?

Work must begin within 30 days after loan closing and must be completed within six months.

How do I verify the type of rehabilitation work needed is eligible under the program?

The HUD website has a fairly comprehensive list of eligible improvements. However, no list can cover every possible repair or improvement, if you are unsure if a repair is permitted, contact me and I will find out for you. And since the repairs under the Streamlined program are limited, if the work in question is for the Streamlined program, make sure you specify this when contacting me.

How do the draws work?

One of the benefits of working with me is that we handle the entire rehabilitation process, including draws and inspections. As a result, our preference is to handle the distribution of all rehabilitation funds to the borrower and/or borrower and contractor.

The draw process is different for Streamlined FHA 203(k) versus the standard FHA 203(k) programs:

Streamlined FHA 203(k): After the loan is submitted and set up in our system (a process which takes approximately seven to 10 days), 50% of the rehabilitation funds are disbursed immediately. Included with the disbursement is the Mortgagor Letter of Completion and instructions that explain how the final disbursement works. For borrowers doing the work|For homeowners doing the work|For buyers and homewoners doing the work[/spin] themselves, a self-help agreement must be in the file before the funds are disbursed, and the check is made out directly to the borrower. Self help is HIGHLY discouraged and not many if any lenders are allowing this practice. For owners working with a contractor, a W-9 must be provided to set up the contractor in the system, and a two-party check is made out to the borrower and the contractor and sent to the borrower. If multiple contractors are being used, 50% of the cost of the repairs for each contractor is disbursed up-front. A 50% up front draw is highly recommended as sometimes the lender can take some time to disburse the funds in a timely fashion.

The balance is disbursed upon completion of all work. If the cost of the renovation is $15,000 or more, an inspection by the original appraiser is required. As with the rest of the rehabilitation process, TLC coordinates the inspection directly with the borrower.

Streamlined FHA 203(k) has two disbursements; one shortly after the lender purchases the loan and the second and final disbursement once all work has been completed.

FHA 203(k): After the home loan is purchased by the lender and set up in their system (a process which takes approximately seven to 10 days), a welcome letter and draw request guide is sent to the borrower explaining the process. As with the Streamlined FHA 203(k), a W-9 is required for all contractors and the contractor must be set up in the system. Disbursements are made as each phase of the project is completed based on the draw paperwork provided by the cost consultant. The only exception is for the cost of flooring, roofing, cabinets, and windows where 50% of the cost of these items can be disbursed upfront as part of a normal draw. Inspections are required prior to each disbursement.

A maximum of five draws are allowed on the standard FHA 203(k) program that are disbursed according to the draw paperwork. Keep in mind that a 10% reserve is held back on each draw. The holdback funds are disbursed upon completion of all work along with the final disbursement.

For both programs, a title update is completed before each draw and after all the work has been completed. The title must be clear before the final funds are disbursed.

Is there a fee for handling the draws?

Yes, the lender deducts the Supplemental Origination Fee from wire proceeds for the management of the rehabilitation process. This fee is calculated as 1.5% of the portion of the mortgage allocated to rehabilitation, or $350, whichever is greater. For example, if the total rehab work is $25,000 then the SOF is $375.

Why is there a 10% holdback on the standard FHA 203k program?

The 10% holdback is used to protect the borrower by helping to ensure all of the work is completed. The holdback affects all parties and all draws. Upon successful completion of all work, the holdback is paid to the respective parties. There is no holdback on a Streamlined FHA 203(k) since only 50% of the funds are disbursed before the work is completed, and as a result the balance serves as the holdback.

How does the contractor get paid?

For standard FHA 203(k), the contractor is paid as work is completed based on the draw schedule, with the exception of the holdback amount. For Streamlined FHA 203(k), the contractor is paid 50% upfront and 50% once the entire project is completed. Keep in mind that all work must be complete before the final funds are disbursed. As a result, a contractor who completes his work in the early stages of the project will need to wait until the entire project has been completed to receive the full payment, or be paid directly by the borrower who can then be reimbursed when the final funds are disbursed.

Who orders work inspections and who completes them?

After closing, lender handles all inspections, disbursements, borrower and contractor questions, title updates, and anything else associated with the rehabilitation process, freeing My agents to selling more homes.

What happens if the borrower cannot or will not complete the repairs?

If the repairs are not completed, any remaining funds must be applied as a principal reduction. The Seller is not penalized for work not being completed as long as they aided in attempting to get the work done.

What if weather or other natural disasters delay the completion of the improvements?

We understand that issues can arise during construction, especially delays caused by natural disasters. At the lender’s discretion, they will work with the borrower to ensure the planned improvements are completed.

Who is the rehabilitation check made out to?

Checks are made payable to the borrower and the contractor for all draw disbursements that include a conditional lien waiver. An unconditional lien waiver is paid only to the borrower.

What is a contingency reserve?

A contingency reserve is a cushion of funds up to 20% of the labor and materials cost. The percentage depends on the cost of the project, but must be a minimum of 10% and no more than 20% of the total rehabilitation cost. If utilities are not turned on for inspection, a minimum 15% reserve is required.

This reserve can be used to cover the cost of health, safety, or unplanned issues that arise during construction. If not used, the amount is applied to the principal balance of the loan, or with standard FHA 203(k) can be used to make additional eligible improvements (approval required).

Where do I find the forms listed on the FHA 203(k) checklist?

Most forms should be available from your lender. Also, Forms are also located on the HUD website. In the search screen on the home page, input: 4240.4, which is the FHA 203(k) program, and click on “search.” From the results page, click on the HUD Clips, Rehabilitation Home Mortgage Insurance (4240.4). You’ll be presented with a number of different options, including guidelines and forms.

What if a borrower needs additional funds?

It’s crucial that the work estimates be accurate to ensure there are enough funds to complete the work specified. The contingency reserve provides an “emergency supply” of funds for unforeseen expenses that may arise during a project, but it is not meant as a cushion for poor estimating. Any funds remaining after the project has been completed can be used for additional improvements or upgrades or applied to the principal. Any costs that exceed the total amount of repairs and contingency must be paid by the borrower.

Which items can the borrower get an up-front deposit for?

Borrowers can obtain 50% of the cost of flooring, roofing, cabinets, and windows upfront to use towards a deposit on these items. The deposits for these items should be included as part of one of the normally scheduled draws.

What happens when the work has been completed on a Streamlined FHA 203(k)?

According to the instructions provided to the borrower, once all work has been completed the Mortgagor Letter of Completion should be signed, dated and faxed to Countrywide:

  • If the total rehabilitation cost on line B.14 of the 203(k) and Streamlined (k) Maximum Mortgage Worksheet is $15,000 or higher, the borrower will contact the lender to order an inspection.
  • If the total rehabilitation cost on line B.14 of the 203(k) and Streamlined (k) Maximum Mortgage Worksheet is under $15,000, the borrower will submit receipts and invoices totaling repair budget, as well as any needed W-9s from the contractors. No inspection is necessary.

When the executed Letter of Completion and the inspection report (if required) is received, lender will order a title update. If the title is clear, the second half of rehabilitation funds will be disbursed.

How many title updates and inspections are required?

A single title update is completed at the end of the rehabilitation, for both the standard and Streamlined FHA 203(k) programs, regardless of the loan amount.

The total number of inspections required varies by program. For Streamlined, as indicated previously, only one inspection is required and only if the total rehabilitation cost of the 203(k) and Streamlined (k) Maximum Mortgage Worksheet is $15,000 or higher.

For the standard FHA 203(k) program, an inspection is required prior to every draw. A maximum number of five draws are permitted, if five draws are scheduled, five inspections are required.

The title update fee is $50. The inspection fee varies by HUD office, contact your local HUD office for details.

On the 203(k) and Streamlined (k) Maximum Mortgage Worksheet has fields for both the title update and inspection fees. These fees can be included in the total rehabilitation costs.

Where can I get additional information on these programs including allowable improvements, fees, etc?

The U.S. Department of Housing and Urban Development is a great resource for information of FHA 203(k) and all other FHA loans.