Understanding Renovation Loans

FHA’s 203(k) program offers rich opportunities for mortgage originators

By Andrew Leff , Vice president, national builder and renovation sales manager Bank of America

This past January, Harvard University’s Joint Center for Housing Studies released a report titled “The U.S. Housing Stock: Ready for Remodel,” which foresaw an increased demand in the remodeling industry over the next 10 years. This certainly is welcome news for general contractors, but it also may be welcome news to mortgage brokers and originators, especially those who work with certain types of renovation loans.

There’s good news in the near-term, as well. The National Association of Homebuilders, the National Association of the Remodeling Industry and Harvard’s Joint Center all have projected steady remodeling growth in 2013. There’s a general consensus among these three organizations that this growth will be driven by several factors:

•• Satisfaction of pent-up demand, as homeowners who had put off making repairs and updates decide to move forward with remodeling

 •• Continuing need among buyers and owners for renovation of previously foreclosed properties

 •• Desire among seniors and baby boomers to “age in place” and remodel their existing homes to accommodate their changing needs

Of course, when it comes to the mortgage and housing industries, the big question for everyone involved is: How will these consumers pay for remodeling and renovation expenses? Some homebuyers and homeowners will follow the tradition of paying for remodeling with cash or home-equity loans, but for many homeowners, these traditional methods may not make the most sense financially, especially now that 203(k) renovation loans from the Federal Housing Administration (FHA) are gaining in popularity.

 A 203(k) primer

 Over the past several years, homebuyers, real estate agents and lenders have embraced the 203(k) program, especially as a financing vehicle for buying and repairing bank-owned homes and short-sale properties.  The program’s low down payment requirement and ability to finance the purchase and cost of repairs all in one loan are just two reasons that these loans appeal to many homebuyers.  At the same time, mortgage brokers and originators should be aware that 203(k) loans can be used for refinance transactions, too. In fact, homeowners can refinance and make upgrades and repairs with a 203(k) loan, even if they own their home free and clear.  Mortgage professionals who are eager to make this loan type a larger part of their portfolios should know that there are two types of 203(k) loans, both of which represent opportunities to grow business.

 •• Standard 203(k): These loans typically are used for homes that need substantial renovation — including structural repairs— or need repairs that cost $35,000 or more. The minimum allowable amount for repairs with this loan is $5,000.

 •• Streamline 203(k): These loans typically are used for more minor repairs and improvements. Although there is no minimum cost, the maximum amount for repairs and other costs cannot exceed $35,000.

 Originator roles

 In the past, some mortgage brokers and originators have shied away from the 203(k) program, but today, there probably are more mortgage professionals than ever before who have been trained as renovation-lending specialists. These mortgage professionals are helping homebuyers, homeowners, real estate agents and general contractors navigate the renovation-lending process.

 •• Facilitating the FHA-required contractor package: Renovation-lending specialists work with homebuyers and homeowners, helping them learn about choosing contractors for their remodeling projects. Once a contractor is chosen, these specialists also play a big role in helping borrowers understand the documents that make up the contractor package — a compilation of paperwork that the FHA requires lenders to have on file for use in underwriting a 203(k) loan and managing fund dispersal in actual construction.

 •• Fostering teamwork among borrowers, contractors and 203(k) consultants: Renovation-lending specialists also help to facilitate teamwork and understanding among those involved in a 203(k)- financed remodeling project, particularly among borrowers, contractors, and if applicable, a 203(k) consultant.  As this team works together to determine the scope of the renovations and the estimated cost of repairs, a renovation-lending specialist serves as a helpful resource and coordinator for certificates and inspections required as the loan is being underwritten and processed. Once a 203(k) loan closes, the lender typically opens an escrow account and deposits funds to be used for the renovation, repairs, and certain fees and contingencies.  Next, the construction phase begins.  The role of the originator doesn’t necessarily end here, however, so it can be helpful to know about the 203(k) program in its entirety.

 The draw process

 Thanks to an efficient, managed draw process, the 203(k) program essentially assures contractors they will receive funds in a timely manner for work that’s completed satisfactorily. Here’s an overview of the managed draw process for both types of 203(k) loans.

 •• Streamline 203(k) construction draws:  Typically, up to 50 percent of the contracted amount can be released to a contractor as an initial draw or release for materials. The remaining contract amount is paid as a final release when the work is complete and a final inspection is done.

 •• Standard 203(k) construction draws: Typically, up to five draw requests can be made in the construction phase. In this phase, contractors and homeowners work with the 203(k) consultant, who conducts inspections and submits paperwork to the lender approving each draw.  A reassuring, standardized draw process can be a big relief for busy contractors and homeowners alike, as can assistance  with paperwork and working as a team with inspectors and others.  Mortgage brokers, originators and lenders increasingly are reaching out with educational resources for contractors eager to learn more about growing their businesses by taking on 203(k)-financed projects. Likewise, as favorable market conditions continue to present themselves, an increasing number of homeowners and homebuyers are becoming interested in the 203(k) program— and with that, an increasing amount of originators’ business is coming from the program, as well.

Andrew Leff, Sales manager for Bank of America Home Loans, overseeing preferred lending relationships with homebuilders and managing the Federal Housing Administration (FHA) 203(k) renovation loans. Previously, he handled new-construction loan originations in Atlanta, before moving to New York in 2007 to launch Chase Mortgage’s construction condominium sales division. Leff first joined Bank of America in 2009 and was promoted to his current position in 2011.