Contingency reserve is likely a term that you hear get thrown around during the 203K process. Why is this term so important? You can think of it as your savings account for emergencies. As we all know, home renovations do not always go as planned. Rather than having to scramble, cut corners, or take out another loan, the contingency reserve is created for these types of situations in order to keep your project moving along.
How much is the Reserve?
The amount that is set aside typically depends on the lender but can be between 10 and 20 percent of the amount of the work being done. This allows for issues, such as a flood when plumbing work is done; the discovery of mold when walls are torn down; or a project just not going as planned. You can talk to your lender about the amount being set aside, but rest assured, whatever money is not used can either be put towards other renovations or paid directly to the principal of the loan to pay the balance down right away.
Why do you Need It?
If you were to experience any of the above examples and were in the midst of the 203K process, you could find yourself in a bind. The 203K renovations need to be completed within 6 months. If time becomes a problem, the lender has the right not to release the funds to the contractors, which could cause problems for you down the road. In addition, if the terms of the mortgage are not met, the lender also has the right to make the loan due and payable right then, which would put anyone in a bind. The contingency reserve helps to make sure that there are extra funds available in order to sidestep any problems that come up. For example, if a new professional needs to be brought it to remove the mold or extra material needs to be purchased for the plumbing problem; the money in the reserve will be used to pay for it. This takes away the risk of you having to come up with the cash in a short amount of time or risk the integrity of your loan, not to mention your home!
Once the contracted work is completed and all fees are covered, if there is still money in the contingency reserve, you can use it to make cosmetic changes to the home. Many homeowners use this to their advantage. Maybe there were changes they wanted to make yet did not have room in the budget when it came to taking the proper loan amount. The contingency reserve now makes those changes possible. The extra work that is completed can be done by the same contractors and the money will be disbursed by the lender, just like the rest of the work. You can make the extra work something as small as changing the colors in the house, changing out the carpeting or getting new appliances. You can also make it something large, such as adding on another bathroom or adding a new deck – the choice is yours.
The bottom line is that you are not going to lose your contingency reserve. If you don’t use it, the money gets put back towards the principal. This does not get you off the hook for your regular payments, but it does help to lower the amount of the principal balance which helps you in the long run as you will not have as large of a balance to pay off in the end.
Types of Homes to Look At
So what types of homes should you look at if you are interested in purchasing a rundown home that will need some TLC to make it livable? With the status of the economy over the past few years, starting with foreclosures could be a great place to look. Oftentimes people that are going through the foreclosure process are upset, frustrated, and even angry at the bank for forcing them to leave their home. These homeowners will do whatever they can to damage the house, leaving it barebones for the person that purchases it. This gives you a blank slate to not only fix the damage that they have caused but also to make the home look how you wish it to look in the end.
The bottom line is that 203K financing makes it much easier to get into a home. The loan itself is not hard to qualify for and is great for first-time homebuyers that may or may not have the best credit. Your credit score will not have the impact it would on conventional financing. Instead, you will be provided with easier to qualify for guidelines that make higher debt-to-income ratios, less than perfect credit, and higher loan-to-value ratios perfectly acceptable. Because this form of financing is backed by the FHA, you will need to pay mortgage insurance premiums, but that is often a small price to pay when you are able to get into the home you desire, especially when you are able to make the changes you want right away without needing a large amount of money to be paid out of pocket!