Fixing up a home, whether to make structural repairs, remove toxic substances such as mold, or to remodel it can be expensive. Many people are aware of the ability to use FHA financing to purchase a home that needs to be fixed up with the 203K program, but what often goes overlooked is the ability to use this program for refinancing as well. This program works just like any other refinance, with the exception that you are given funds to make repairs on your home that are held in an escrow account. The entire amount of the outstanding balance on your loan along with the cost of the repairs is bundled into the mortgage, allowing you to make monthly payments on the balance, requiring little to no money out of your pocket.
The Difference from a Home Equity Loan
Many people wonder why they cannot just take out a home equity loan to perform the repairs or remodeling on their home. A home equity loan might be feasible for those that have substantial equity in their home, but if they don’t have the equity, they cannot get the loan. This has become a problem for many homeowners because of the drop in value that most areas have experienced since the housing crisis. Fighting back to get the value is not an easy process and can take many more years than a homeowners cares to wait. The home equity loan, when available, takes the equity out of the home and provides you with the cash to do the repairs. You oversee all of the repairs and work and do not have to meet with anyone’s approval. The money that is left is to be used however you see fit; no one governs what you do with it. You are left with two mortgage payments: a first and second mortgage to pay for the remainder of the term.
The 203K Difference
The 203K refinance works in a different manner. It uses the future value of the home based on the repairs and remodeling you plan on doing with the funds. An appraiser will help the lender determine the appraised value and then the underwriter will maximize your loan at 110% of the projected future value of the home. What sets this loan apart from a home equity or cash out loan is that any issues with the home that make it not meet proper code are able to be financed into the loan. With a home equity or cash out refinance, those issues with the home would have to be fixed with your own money before the refinance would be able to be approved.
Another glaring difference in the 203K loan is that the funds are not yours once the loan closes. The portion of the new mortgage that will be used to pay off your existing first lien will disburse as normal, but the remaining funds, which are left to make the repairs on your home, are placed in an escrow fund. You will never see these funds – they are disbursed directly to the contractors doing the work. An original deposit will be provided to the contractors and the remaining funds will be given out on a draw period which is pre-determined before the loan closes. The final funds are not released until the repairs have met with HUD approval.
The 203K refinance is just as easy to obtain as the standard FHA loan. The requirements are not as strict as a conventional loan, especially if you were trying to take out a home equity loan and tap further into your equity. The 203K loan has flexible credit, loan-to-value, and debt ratio guidelines making it possible for many people to obtain the financing necessary to either make their home livable or make cosmetic changes that they desire.
Justin McHood is America's Mortgage Commentator and has been providing expert mortgage analysis for over 10 years.