Homeowners who need to repair an older house, or potential homebuyers looking to purchase and renovate a run-down home may want to look into applying for an FHA rehab loan. These loans are designed to make homes in urban and/or low-income areas more attractive and more livable, and are ideal for individuals on a limited budget. Because and FHA rehab loan is meant to facilitate sustainable development, it cannot be used to construct an entirely new home.
What is the FHA Rehab Loan?
The Federal Housing Administration, part of the U.S. Department of Housing and Urban Development, created the 203k rehabilitation loan in 1978 as a way to improve urban development and provide low-income families with the means to renovate older homes in need of repair. The program also allows individuals to roll all purchase and remodeling costs into one loan, saving them time and money. Because loan lenders would typically consider these projects to be a high-risk investment, the government insures these loans, to encourage lenders to get involved with rehabilitation.
The FHA rehab loan program is actually the Department of Housing and Urban Development's main initiative dedicated to rehabilitating poor and disadvantaged urban communities. The FHA realizes that the individuals living in these communities, and those looking to move there, will have lower incomes and lower credit ratings than in more privileged communities, and therefore they have adjusted the FHA rehab loan terms and conditions to be more flexible and negotiable than a typical construction loan.
FHA Rehab Loan Required Applicant Information
Most of the application requirements for an FHA rehab loan are similar to those of any other loan. For instance, borrowers must submit to a credit check and employment verification, and they must meet the minimum requirements for individual lenders (which may vary by lending institution). However, the minimum requirements are often much lower than they are for traditional construction loans. Some lenders may approve FHA rehab loan applications for those with credit scores below 640, depending on the situation of the individual applicants.
Eligible Properties for the FHA Rehab Loan
While the FHA rehab loan comes with flexible terms for individual applicants, the fundamental requirements for eligible properties are fairly strict. The FHA rehab loan, for example, can only be applied to the renovation of existing properties that have been built for at least a year or more. The FHA rehab loan can also only be used to cover the renovation of a maximum of four units-in other words, it can be used to fix up an single family house, a duplex, or a condo or property that contains four individually occupied units. These properties are subject to an appraisal before the loan is approved.
An FHA rehab loan allows borrowers to include the price of both purchase and repair in the overall loan amount. For example, if a family finds an affordable home, but discovers that it also needs a new kitchen, the loan amount would be calculated by adding the cost of the home with the estimated cost of repairs. FHA Rehab Loan applications require that all of these repairs be listed; in the case of the kitchen, this would mean obtaining a detailed price estimate from a certified contractor for everything from counter tops to permits.
The 203k loan program also builds in a contingency plan for the FHA rehab loan in case the cost of repairs exceed the estimate. For example, applicants can also request a 10-20% "contingency reserve" that can be allocated in the event that unexpected expenses arise. The percentage of the purchase price to be included in the loan can also be negotiated, as can the first several months of mortgage payments. This can be especially useful for people who must pay rent or mortgage to live elsewhere during the renovation process.
Rates and Interest
The interest rates on the FHA rehab loan are incredibly low compared to traditional loans. Additionally, borrowers are only required to put down 3.5% as a down payment. This percentage also includes the cost of repairs, so if a family buys a home worth $100,000 that also needs $20,000, the total value of the house-and the loan itself-would be $120,000. Therefore, the family would need to produce a down payment of at least $4,200, which is 3.5% of $120,000.
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