FHA 203k Rehabilitation Loan


What are the steps I need to know?

This describes a typical step-by-step application/mortgage origination process for a transaction involving the purchase and rehabilitation of a property. It explains the role of HUD, the mortgage lender, the contractor, the borrower, consultant, the plan reviewer, appraiser and the inspector.

Homebuyer Locates the Property.

Preliminary Feasibility Analysis: After the property is located, the homebuyer and their real estate professional should make a marketability analysis prior to signing the sales contract. The following should be determined:

1) The extent of the rehabilitation work required;

2) Rough cost estimate of the work

3) The expected market value of the property after completion of the work. Note: The borrower does not want to spend money for appraisals and repair specifications (plans), then discover that the value of the property will be less than the purchase price (or existing indebtedness), plus the cost of improvements.

Sales Contract is Executed: A provision should be included in the sales contract    that the buyer has applied for Section 203(k) financing, and that the contract is contingent upon loan approval and buyer's acceptance of additional required improvements as determined by HUD or the lender.

Get contractor bids: For your client’s sake get, from at least two contractors, bids for anything that needs to rehabilitated.

Contact the consultant:  Consultant looks at bids and decides which work needs to be done and a reasonable estimate of the costs associated.  The consultant may call for more work to be done than was included with the bids.  If so, new revised bids will be required.  The consultant decides on the percentage of the contingency.  The property may be required to have a contingency estimate.  For properties older than 30 years, 10% is the minimum, but may not exceed 20%.  If the total cost of rehabilitation is less than $7,500 the contingency requirement may be waived.

Submit: Start the loan process, turn the bids and the consultant’s report in to Mortgage Master.

Appraisal Executed: Based on the bids and consultant’s report.

Loan Processed:  The loan is processed through closing and sold to the lender.

Escrow Account Initialized: Setup after closing with the rehabilitation funds.

Rehabilitation Escrow Account: When the loan is closed, the proceeds designated for the rehabilitation or improvement, including the contingency reserve, are to be placed in an interest bearing escrow account insured by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA). This account is not an escrow for the paying of real estate taxes, insurance premiums, delinquent notes, ground rents or assessments, and is not to be treated as such. The net income earned by the Rehabilitation Escrow Account must be paid to the mortgagor. The method of such payment is subject to agreement between mortgagor and mortgagee. The lender (or its agent) will release escrowed funds upon completion of the proposed rehabilitation in accordance with the Work Write-Up and the Draw Request (Form HUD-9746,A).

Rehabilitation Construction Begins: At loan closing, the mortgage proceeds will be disbursed to pay off the seller of the existing property and the Rehabilitation Escrow Account will be established. Construction may begin. The homeowner has up to six (6) months to complete the work depending on the extent of work to be completed. (Lenders may require less than six months.)

Draw requests are submitted to the lender:  Must use appropriate form.

Releases from Rehabilitation Escrow Account: As construction progresses, funds are released after the work is inspected by a HUD-approved inspector. A maximum of four draw inspections plus a final inspection are allowed. The inspector reviews the Draw Request (form HUD-9746-A) that is prepared by the borrower and contractor. If the cost of rehabilitation exceeds $10,000, additional draw inspections are authorized provided the lender and borrower agree in writing and the number of draw inspections is shown on form HUD-92700, 203(k) Maximum Mortgage Worksheet.  During rehabilitation the lender may not release funds from the Rehabilitation Escrow Account until the lender has received a Compliance Inspection Report and the Draw Request, certifying that the work has been completed in compliance with the accepted architectural exhibits.

Property is inspected for completion of proposed work:  Performed by HUD-approved consultants/inspectors or HUD-accepted staff of the DE lender. The consultant is to use the architectural exhibits in order to make a determination of compliance or non-compliance. When the inspection is scheduled with a payment, the inspector is to indicate whether or not the work has been completed. Also, the inspector is to use the Draw Request form (Form HUD-9746-A). The first draw must not be scheduled until the lender has determined that the applicable building permits have been issued.

New Draw requests:  Process cycles through until work completed.

Completion of Work/Final Inspection: When all work is complete according to the approved architectural exhibits and change orders, the borrower provides a letter indicating that all work is satisfactorily complete and ready for final inspection. If the HUD-approved inspector agrees, the final draw may be released, minus the required 10 percent holdback. If there is unused contingency funds or mortgage payment reserves in the Account, the lender may apply the funds to prepay the mortgage principal.

Contingency fund is released:  Excess goes back to lender and applied to principal balance.  There are options for getting the balance back to borrower as well.  10% holdback released to payable parties.  Interest is paid to lender.

Holdback: A ten (10) percent holdback is required on each release from the Rehabilitation Escrow Account. The total of all holdbacks may be released only after a final inspection of the rehabilitation and issuance of the Final Release Notice. The lender (or its agent) may retain the holdback for a maximum of 35 calendar days, or the time period required by law to file a lien, whichever is longer, to ensure that no liens are placed on the property.

Streamlined FHA 203(k)

After the loan is purchased by Bank of America 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 an instruction letter that explains how the final disbursement works and provides Bank of America contact information. For borrowers doing the work 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. For borrowers working with a contractor, a W-9 must be provided to set up the contractor in our 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.  The balance is disbursed upon completion of all work. If the cost of the renovation is over $15,000, an inspection by the original appraiser is required. As with the rest of the rehabilitation process, Bank of America coordinates the inspection directly with the borrower.

Streamlined FHA 203(k) has two disbursements; one shortly after Bank of America

purchases the loan and the second and final disbursement once all work has been

completed.

Frequently Asked Questions

Is there a time period on the rehabilitation construction period?
Yes, the Rehabilitation Loan Agreement contains three provisions concerning the timeliness of the work. The work must begin within 30 days of execution of the Agreement. The work must not cease prior to completion for more than 30 consecutive days. The work is to be completed within the time period shown in the Agreement (not to exceed six months); the lender should not allow a time period longer than that required to complete the work.

What happens if the borrower fails to perform under the terms of the Agreement?
The lender may refuse to make further releases from the Rehabilitation Escrow Account. The funds remaining in the account can be applied to reduce the mortgage principal. Also, the lender has the option to call the mortgage loan due and payable.

How many draw releases can be scheduled during the rehabilitation period?
As many as five releases (four plus a final) can be scheduled. The number of releases is normally dictated by the cash-flow requirements of the contractor. An inspection is always required with a scheduled release; however, inspections may be scheduled more often than releases if necessary to ensure compliance with the architectural exhibits, HUD’s Minimum Property Standards and all local codes and ordinances. If the cost of rehabilitation exceeds $10,000, then additional draw inspections may be authorized under certain circumstances.

Can the architectural exhibits, including the cost estimate, be modified after the mortgage loan is closed?
Yes. The changes must be approved by HUD or a DE lender prior to beginning the work. If the change affects the health, safety or necessity of the dwelling, the contingency reserve can be used to pay for the change. However, if the health, safety or necessity of the dwelling is not affected and an increase in cost occurs, the borrower must apply monies into the contingency reserve fund to pay for the change. Should the change result in a reduced cost of rehabilitation, the difference will be placed in the contingency reserve fund; if unused, it will be applied as a mortgage prepayment after completion of construction.

What happens if the cost of the rehabilitation increases during the rehabilitation period?
Can the 203(k) mortgage amount be increased to cover the additional expenses? No. This emphasizes the importance of carefully selecting a contractor who will accurately estimate the cost of the improvements and satisfactorily complete the rehabilitation at or below the estimate.  How long will it take after the sales contract is signed to go to closing?  If the cost estimates are completed within two weeks of signing the sales contract, the loan should close within 60 to 90 days, assuming there are no title problems and, of course, your borrower is qualified.

Is a contractor required to do the work?
No. However, if the borrower wants to do any work or be the general contractor, they must be qualified to do the work, and do it in a timely and workmanlike manner. It is very important that the work be done in a time frame that will assure the completion of the work that will be agreed upon in the Rehabilitation Loan Agreement (signed at closing). A borrower doing their own work can only be paid for the cost of the materials. Monies saved can be allocated to cost overruns or additional improvements.

If the borrower does the work, how is the cost for work estimated?
The cost estimate must be the same as if a contractor is doing the work, in case the borrower cannot (for some reason) complete the work.

Can cost savings on the rehabilitation be given back to the borrower?
It is an option to have the funds given back to the borrower, but in most cases the remaining balance is applied to the existing mortgage.  For example the savings can be transferred to cost overruns in other work items or can be used to make additional improvements to the property If the cost savings are not used, the money may be applied to the mortgage principal, but the mortgage payments will remain the same, because the loan has already closed. To use the cost savings, it will be necessary for a Change Order to be completed and approved by the lender.

Can any rehabilitation money be paid upfront to offset the startup costs for the contractor?
No. However, an exception can be allowed for kitchen and bath cabinetry, or floor covering, where a contract is established with the supplier and an order is placed with the manufacturer for delivery at a later date.

Is the borrower required to enter into a contractual agreement with the general contractor who will do the work on the property?
No. However, it is strongly suggested that the lender protect their interests to assure no liens are placed on the property.

Can an Energy Efficient Mortgage (EEM) be allowed using the 203(k) program?
Yes. A borrower can finance into the mortgage 100 percent of the cost of eligible energy efficient improvements, subject to certain dollar limitations, without an appraisal of the energy improvements and without further credit qualification of the borrower.