Question on FHA loans for properties that need rehab

[Raphael Abreu]

I've heard David Greene talk about banks not lending on properties that are complete gut jobs. He mentioned that you'd have to go unconventional for the most part to buy a value-ad opportunity. Is this always the case? I'm going to be saving for the down payment of an owner occupant house hack deal & looking to go the FHA route. I want to find something that can use Maybe Some cosmetic work. Do you think it is possible to find lenders that would lend on homes that are in need of cosmetic work?

[Latasha Griffin]

There is an FHA loan product called the FHA 203K. With this loan, you can finance the purchase of the property and the renovation budget up to 110% of the ARV. With this loan, you can purchase SFR, Duplex, Triplex or Quadplex properties that do not meet the HUD minimum standards-in other words, properties that are in disrepair or even inhabitable. The only caveat is that the foundation must be in tact. You can't do a complete new build. The loan requirements are the same as a traditional FHA loan underwriting (owner occ, 3.5% down at 580 credit or better, Mortgage Insurance, etc) except you can use up to 75% of the rent roll to lower your DTI ratio, and you cannot have any existing FHA loans outstanding unless 100 miles away from subject property.

The 203K loan has a lot of upside but is quite cumbersome to navigate. You'll need to work with a lender who is a servicer, not just an originator because once the purchase transaction closes, the reno budget gets transferred into an escrow account and you need your lender to be able to access it so you can quickly begin working on the reno or you will have problems with your contractor out the gate. When most loans close, they are bundled up and sold on the secondary market as CDOs and purchased by a new loan servicer. This could cause you to have to wait 4-6 weeks after closing to access the funds in the escrow account to pay you contractor. You'll also need a contractor who is financially stable enough to pay their workers out of pocket for a few weeks at a time bc you will only be allowed a certain number of draws during the project after certain milestones have been completed and inspected. There is also the extra expense of having a HUD consultant if the reno budget is >$35k or if any structural changes are being made to the property. This has a cap in cost but is an extra expense. However, the HUD consultant is there to protect you and the lender from shady contractors or subpar work. As a new investor, I'd be happy to use this person as it would be a way for me to learn the construction portion of a reno project for future projects.

I'd suggest starting with finding a lender. On the HUD website there are two lists: one for all of the FHA approved lender in your state who are servicers and originators. Use this list to find all the ones who are "Single Family and Multifamily Servicer-Originator" and 203K approved. Here's the link: https://www.hud.gov/program_of...

Then look at the most recent HUD 203K Endorsement list to find all the lenders in your state who have actually closed 203K loans in the past 12 months. Here's the link: https://apps.hud.gov/pub/chums...

Overlay both lists to identify all the 203K approved lenders in your state who are able to service the loan through the entire reno project and have experience with this complicated loan product. Interview them all to ensure you have a knowledgable lender and feel comfortable with them. Ask them all for references to General Contractors who have worked well on 203K loans with other borrowers they've worked with in the past. Call and interview all of them as well. 

Your agent should also be knowledgeable with the nuance this loan product has. You basically, need to assemble a team in advance of even finding a property to be most efficient with this loan product.

There's more I could explain, but these are the high level details that make the most difference in how difficult or easy the experience with this loan product can be. However, if you're detail oriented, and do a little work on the front end, this loan can be a game changer especially in the beginning of your investment journey.

Feel free to reach out to me directly with other questions. I'm currently looking for my first quadplex purchase and will be using an FHA or FHA 203k loan to acquire it.