203K loans are a great product for those that are willing to purchase a home that needs repairs. With the ability to roll all of the remodeling and repair costs into your mortgage, it certainly is a convenient way to get the home you want. These “fixer upper” loans allow you to save money in the end, typically as well because they do not require you to have a separate loan, which means more closing costs, higher interest rates, and two monthly mortgage payments. With all of the benefits of these loans, however, come some common mistakes that make the good loan turn into a nightmare loan. Try to avoid these simple mistakes the next time you consider a 203K loan.
Not Realizing there is not Enough Room for the Repairs
Many people get so caught up in the excitement of having a loan that will allow them to afford renovations on a home that they forget they need the room in the value of the home to be able to do the repairs. This comes down to the selling price of the home. For example, if the home is selling for $250,000 and the value is $250,000, there is not any room for repairs. On the other hand, if the repairs/renovations you are making will add incredible value to the home, you may be able to get away with it. Typically, however, you need to find a home that is selling well below its market value in order to be able to include the repairs/renovations that you need/want to make. Repairs and renovations that you make are not matched dollar for dollar when the value is determined, unfortunately. There are some repairs that you will see very little return on your investment and others that will add tremendous value. The key here is to use professionals that know what they are doing when it comes to figuring out the future value to determine if you have enough room to do what you want to the home.
Assuming that all Repairs are Acceptable
The repairs you plan to make on the home must be approved by the lender or funding will not occur. This is a top mistake that many borrowers make; they think they can make any changes or even change their mind mid-renovation. This is not the case; everything has to be run through the lender and not just verbally – the lender needs to see everything in writing including a line by line budget to see how the money will be spent. In addition, the appraiser needs to see these items to see how the changes will impact the future value of the home. If the home is not going to appraise at the value you think, the renovations might not be approved and the funds will not be disbursed.
Using Inexperienced Contractors
There is not a list of experienced 203K contractors, but you can find out for yourself who is and is not experienced in it. Asking the right questions during the contractor interview will help you determine who is the right person for the job. You might find a contractor that is great for the work you need to be done, but if he does not have the experience with 203K loans, he might not be prepared for what is about to happen. For example, he needs to have adequate capital to get the job going – the lender is only going to disburse a certain percentage of the price of the renovations to the contractor up front. If the contractor is not experienced with 203K loans and does not know this, it could result in him not completing the job due to insufficient funds. In addition, contractors need specific types of insurance in adequate quantities. The loan will not get approved without this insurance, whether liability or workmen’s comp insurance. You need an upfront contractor that will not only be honest with you but be able to prove his insurance so that the process can move forward.
Not Setting Enough Money Aside for Reserves
Things happen during construction – it is just the nature of the beast. If you do not have enough reserves set aside, you could end up having issues with the completion of the construction on your home. If you do not have the cash to come up with to pay for the issues that have arisen, you could find yourself with a serious problem as a condition of the 203K loan is that the renovations are complete and meet with inspection and appraisal. Make sure you are working with an experienced 203K lender that can ensure you that you have enough set aside in escrow in the event that something was to go wrong. Typically, lenders will set aside 10% of the purchase price of the home in the event an emergency arises.
Not Creating a Budget
A realistic budget needs to be created and can be done with a loan consultant. You need someone that will help you realize the actual cost of the renovations you are going to have done and set a budget accordingly. If you don’t set a budget, you could end up hiring an expensive contractor that will not complete all of the work that you specified in the contract with the budget you have set. The loan consultant will be the one that walks you through the entire process and negotiates between the contractor, lender, and yourself to ensure that everyone is on the same page and that the process will be completed as desired.
Try to avoid these common mistakes with your 203K loans in order to have a process that moves along as smoothly as possible. This FHA loan is very effective at helping you renovate a home to make it look the way you desire, but you have to follow the guidelines in order to ensure that the task is completed as you wish.