The FHA 203K refinance helps you remodel your home with little money out of pocket. It sounds too good to be true, doesn’t it? With only 2.25% equity, you can change the look of your home. The lender bases the 2.25% on the future value of your property. This isn’t the value of the home before repairs. It’s the value after you make the desired changes to your home. We discuss how this works below.
A Single Close Loan
The FHA 203K loan takes the hard work out of remodeling your home. You don’t need 2 loans with this program. With one closing, you can refinance your 1st mortgage and get cash for your remodeling projects. At the closing, the agent pays off your current mortgage. They then put the remaining funds in an escrow account. The lender or designated 203K loan consultant handles disbursement of the funds. Read on to see how this works.
Determining the Future Value
One of the largest factors of the 203K loan is the future value. The FHA calls it the “after repaired value.” The appraiser determines the value based on the changes you will make. You provide the appraiser with the contract or cost of the proposed changes. He then determines how those changes affect the value of the home. Before he does this, he comes up with an as-is value now. He then values the changes and creates the after repaired value. This is the number the lender requires to determine the size of your loan.
Determining the Loan Amount
Once you know the future value of your home, you can determine the loan amount. Lenders maximize your loan amount with the following information:
- Outstanding principal balance on current loan
- Eligible costs you can include in the loan
- Cost of remodeling
- Future appraised value
Generally, the new loan amount can’t exceed the outstanding principal balance plus the cost of remodeling. However, it can’t exceed 110% of the future appraised value. You can obtain the lower of the 2 amounts. You can’t receive cash in hand. If there are excess funds at the end of the remodeling, the lender pays down your loans’ principal.
How the FHA 203K Refinance Works
The FHA 203K refinance process differs from any other loan program. First, you must find a contractor. The FHA and most lenders don’t allow homeowners to do the work themselves. The only way to do the work yourself is to prove you have the qualifications for the work and the time to complete the work. This doesn’t happen often because homeowners applying for a mortgage usually have a job. That job prevents them from having the time to complete the renovations. The FHA 203K allows up to 6 months for work completion – that’s not a lot of time if you work full-time.
Once you find a contractor, you can negotiate the costs. It’s best if you shop around with different contractors. Get at least 3 bids. This way you have choices. The lender has the final approval on which contractor you choose. They look at not only the costs, but also the experience, and availability of the contractor. The contractor must meet the 6-monthd deadline. It’s best to choose contractors with experience with the 203K process.
Once you have a contractor, the loan process can begin. You must personally qualify for the loan. See how below.
Qualifying for a 203K Refinance
Qualifying for the 203K refinance is much the same as qualifying for the FHA loan. You must meet the following requirements:
- Credit score of 620 or higher, although this varies by lender. Some may require slightly higher credit scores. Others may accept a score as low as 580.
- Debt ratios shouldn’t exceed 31/43. This means no more than 31% of your income should cover your mortgage payment. Also, no more than 43% of your income should cover your total monthly debts.
- You can’t have a history of defaulting on any federal loans.
- The home must meet FHA requirements via the appraisal. With the 203K loan, though, you can include the cost of any issues that don’t pass the FHA appraisal.
- You should have stable employment for at least 2 years. If you have different jobs during that time, they should be within the same industry.
The FHA 203K loan has basic requirements with a lot of flexibility. Some lenders add stricter requirements to avoid the risk of default.
The FHA 203K Refinance Process
Once you secure approval for the FHA 203K refinance, you can close on the loan. Here’s how it works:
- Your 1st mortgage lender is paid off. You no longer have that lien on the home.
- Your new 1st mortgage becomes effective.
- The money left over after paying off your 1st mortgage goes into an escrow account.
- If the lender agreed to pay the contractor upfront, they disburse the money at the closing. They usually disburse no more than 50% of the cost of the work at the closing.
- The contractor begins the work.
- The lender or 203K loan consultant inspects the work.
- On or after a specified disbursement date, the lender disburses funds after inspection of the work.
- After the work is complete, the lender performs a final inspection. The final funds are released only after the lender determines there aren’t any mechanics’ liens on the property. This means all subcontractors were paid.
Usually, you start making mortgage payments right away on the home. For example, if you closed on September 28th, your first mortgage payment would be due November 1st. However, if you can’t live in the home while the work is done, you may wrap up to 6 months of mortgage payments into the loan. This leaves you money to pay for another place to live during the remodeling.
Under no circumstances can you receive cash in hand after the process is complete. If there are excess funds, the lender can pay down the principal of your mortgage. You can also choose to use the funds for further remodeling. You can talk to your lender about your options if that occurs.
Paying Mortgage Insurance
Just like any other FHA loan, the FHA 203K refinance requires mortgage insurance. You pay this fee upfront and with your mortgage payment each month. Initially, you’ll pay 1.75% of the loan amount. You can pay this amount at the closing in cash or wrap it into your loan amount. You’ll also pay annual mortgage insurance. This amount equals 0.85% of the outstanding principal balance each year. The FHA bills your loan servicer for the full amount annually. Your lender, however, divides the amount up between your 12 mortgage payments. The amount decreases slightly each year you decrease your principal balance.
The FHA 203K refinance is a great way to remodel your home with one loan. You don’t have to qualify for 2 separate loans. You also don’t have to worry about making 2 mortgage payments. With one loan that is easy to qualify for, you can make significant changes to your home as long as the value supports the costs.