Non refundable earnest money with 203k financing - YAY or NAY?

Question

Hi BP Friends!

I am trying to go under contract for my first house hacking deal in Chicago using FHA 203k financing. The market is brutal, 15+ MLS offers rejected so far. All the investor friendly multi-unit properties in decent, safe neighborhoods get multiple offers above asking, including cash. Not to mention, many of the best deals on the MLS hardly even cash flow.

I decided to be creative and look at wholesale opportunities then try to convince them to accept my FHA financing. Shockingly someone is open to it but they want $5,000 non refundable earnest money if my financing falls through. This sounds terrible at first glance because of how often FHA deals fall through BUT the property will cashflow $1000+ per month after rehab. What would you do with an upside this big?

Some more details about the property:

• Duplex with illegal basement unit - I can expand each unit into basement and attic to raise rents significantly
• Price: $310k, ARV 580k. Rehab budget: 180k (possibly 153k because of 15% contingency needed for 203k rehab)
• Will rent for up to $5600 per month after rehab. Likely $5300 though.
• Logan square neighborhood: safe, walk able, desirable, close to public transportation, close to restaurants, gyms, etc. It is where I ideally would like to live.
• Needs a LOT of work: full gut. Demo has already been done but house is full of demo related trash. Basement is rat infested. There are holes in some of the floors from rats. Exterior is falling a apart with fake brick turf like veneer and wood underneath. Currently the roof is pointed but would need to be built up and squared off for the expansion into attic. There must be water damage because some windows are missing.
• The lot is small and there is no possibility for garage. It is also very loud due to being right behind the train.

However, there are multiple new construction million dollar homes on the same block. So i know the neighborhood is solid but perhaps this place is a teardown and I am biting off more than I can chew trying to gut it for only $150 - 180k.

I have attached pictures! Any insight you have on determining whether a house is truly a tear down, or experiences with 203k financing falling through would be much appreciated! Thanks in advance.

Account Closed · Answer

@Meera Lakhavani if you're getting a 203K loan, I would always ask for at least 10 days to do an inspection. You won't have all the bids you need within a 5 day period. I would have a SOW ready before getting it under contract too. Make sure you have a lender that specializes in 203K loans.

Lumi Ispas · Answer

@Connor O'Brien , you have a 10% built in reserve for the construction loan to use in case you discover other things to be done. Talk to your lender about it.

@Meera Lakhavani , all 203K consultants are in demand now. I just closed on a 203K and have two under contract. The paperwork takes time. Make sure your contractor has all licenses in place and has done 203K before. I just had to have a contractor take a "lead certification" class yesterday as he was not aware the bank will ask for that certification.

With the right team in place, this is doable. And in negotiations, you can ask to change the amount of earnest money. What's the worse that can happen?

Connor O'Brien · Answer

I just had an appraisal done for 203k. They appraise to the ARV. It was not difficult to get financing even for a house in terrible condition. It takes for ever though (2-3 weeks for the appraisal). Total time to close was almost 3 moths for me.

Lumi Ispas · Answer

@Meera Lakhavani ask your lender how sure he is the loan will close, ask your real estate broker how sure she is of the after repair value and appraised AS-IS value and ask your contractor if the 185K includes all the upgrades, finishes, etc that you have in mind. I will add another 15% to that bid for safety and if everything checks out, add two-three weeks on top of the time frame the lender gives you to close the lone and if you are comfortable taking the risk - go for it.

One more thing- have your attorney add a clause that you can request at least one extension and see if the seller will accept $1000, $2,000 pr $3,000 nonrefundable instead of $5,000.

Good luck to you!

Meera Lakhavani · Answer

@Connor O'Brien thank you so much for the insight! It is great to meet another Chicagoan doing 203k — I just sent you an invite to connect, would love to stay in touch!

That is helpful to know that you didn’t have trouble getting financing but the timeline was extended. Which lender did you use? Did they set your expectations that it would be a 90 day close? My lender (specializes in 203k at Guarenteed Rate) is saying that if we hustle she can close it in 40 days. But as @Lumi Ispas mentioned I will be sure to have an extension opportunity in the contract.

Thank you also for the consultant recommendation! How long did it take him to determine if the rehab was feasible? My understanding is that one of by biggest risks right now is the 203k consultant saying that this gut cannot be done for 150-180k. I have requested a 10 day inspection period to get the consultant to do this evaluation (as my lender recommended) but they countered with 5 days. I am in communication with the consultant my lender recommended to see if this is feasible for him. It might be very unrealistic though as Account Closed mentioned.

I have ample cash to close, so my lender said that the only other things that can kill the deal are rehab costs being too high, ARV appraisal being too low, and rents not being high enough. I of course have validated these numbers and am not worried about anything except the rehab quote from the consultant. Is there anything else you think I should look out for or due diligence I should do?

Thanks in advance!

Meera Lakhavani · Answer

Account Closed yikes! Thank you for your insight that is really helpful.

By SOW you mean what work specifically I need from the contractors?

Noted about lenders — my current one specializes in 203k loans and seems to be very knowledgeable.

Meera Lakhavani · Answer

@Lumi Ispas thanks for the insight! I will be sure to look out for licenses and experience.

Thanks also to @Connor O'Brien and everyone else that provided input.  An update is that the deal is NOT FHA compatible because of the high estimated rehab costs.

I spoke to the 203k consultant on the phone, sent specs of the property and some rehab drawings -- at $55-$70 per square foot for the gut, the rehab will cost about $211k without even touching the exterior. This puts me way above FHA limits for a duplex with a $310k purchase price.

I am very happy that I learned this before putting up consultant fees and earnest money. It looks like the HomeReady loan may work though and they have higher loan limits.

Connor O'Brien · Answer

*my contract had a clause if financing fell through.

it took him approximately 2hours to determine it was feasible. He was hard to schedule though

Connor O'Brien · Answer

I would make sure contractors have plenty of time to get you accurate bids during contingency period. My contact had a financing clause of the financing feel through I got em back.

Connor O'Brien · Answer

My lender is Luis Hernandez from stearns lending. He has a lot of experience and he's cheap but he does not have the same administrative help you will get with guarunteed rate (I think this may have contributed to the extended time to close).

In my experience the hud consultant was looking for a punch list needed to pass FHA... Not the furnishings needed to raise rents or repairs to make the property durable. (My hud estimate was 2-4k... Total rehab costs are 40k)

If I was doing it over I would pay more attention to MY contractors/ their bids and defining scope of work. As some other members mentioned the scope is locked in When you close. So try not to miss anything. (I already found some things I missed)

I'm using Luke with inland construction for the rehab. It's the first time I've used him but he came highly recommended and didn't hold up the financing process at all. (Contractor has to provide a ton of paperwork)

Non refundable earnest money with 203k financing - YAY or NAY?

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