FHA or FHA 203k (rehab) loan

15 Replies

Hello BP community,

I have been in the market for several months now looking for my first small multi-family property and its been a slow process to say the least. Properties are going fast and furiously here in Chicago and every offer I put down has gone under market within days and have gone to "best and highest." 

How does one starting out in this super competitive market close on his first deal? And btw I plan on using an FHA loan. My question is do I continue to look at retail properties on the MLS and play it safe with a more turn key property that won't require any rehab or try to find an off-market deal that is distressed and utilize an 203k loan to force appreciation and create leverage for my future deal(s)?

What do you think?

@Conrad Legé

I am a fan of the 203k. All you have to do is put a property plan together than makes sense and follow it. Being able to purchase a property for 3.5% down (plus some closing), getting the funds to purchase and repair it, and having usually low rates locked in are great. There is a requirement for most FHA loans that you pay PMI even after you go below the 80% LTV. Ask you lender about it. Also, be prepared for the trip down the qualification paperwork trail it can be tedious at times. Don't over renovate for the area either -- that is a pitfall.

With that said, I currently purchased my personal SFH with a 203k, put 3.5% down and did a light renovation on a 20 year old house. I forced appreciation and am poised to sell at the 2 year mark in a couple of months for $20,000 more than I purchased it. Or I can rent it out with a tight cash flow or with a heavy downpayment for a lease option. This means I put $7200 cash to get $20,000 or more in two years.

In addition, my FHA loan is assumable to a qualified buyer. This means that I can sell it for what is owed and then carry the note for the forced appreciation. In addition, if interest rates continue to rise -- I can actually market the loan as part of the sale for the locked in low rate 4.5% that is currently at 5.4% with two rises expected this year!

@Joe Gamatoria This encouraging to hear, Joe. I hear other investors, experienced investors, say stay away from this kind of loan but I think there is clearly value. There is a lot for me to unpack here that I didn't realize about the loan. Thank you for the response.

Can I ask why you say the cash flow is tight? Were the margins tight to begin with when you ran the numbers?

Just a thought here.  The number may not be to your favor, i haven't run them, but here goes anyway.

A good private money loan might be a good option for the purchase and rehab, then refi into your conventional loan once all done.

the 203k is a great loan idea, but it's a bit of hoop jumping.  you have to get bids, escrow money, pay in draws, may not be able to do work yourself, and it takes a long time to get funded (due to the bidding and valuations it needs).

I close tomorrow on a hard money loan where I'm paying 2 points up front, and 10.75% interest, with interest only payments and a 9 month term.

My "appraisal" only cost me $250, since they only wanted a BPO, and fees were less than a traditional loan at a large bank (they hide a LOT of junk fees in there).  Meaning I paid about a point over a traditional, conventional loan, if that.  They qualified the loan on the deal, not me.  They didn't even ask for or about my credit, only that the numbers on my deal make sense.  They have a 3 month minimum interest I have to pay (if I paid it off in less than 3 months).  I would have closed in a week if not for July 4th giving my attorney a 5 day weekend last week.

If you could use a loan like this to acquire and rehab your place, and get yourself 10 or 20% equity, your take-out (permanent) financing would not have such high PMI costs (or none), and would also avoid some other FHA costs, so it might not cost you much more than the 203k in the end. If you recalculate your 203k loan with PMI as interest, and reverse the rate, the PMI could be costing you 1-2% in rate equivalent, for the length of the loan. They don't remove it anymore, it's permanent. I think they charge a point or 2 in up front PMI also, but I could be wrong about that. I haven't written a loan in almost a decade now.

If you don't have too much work to do, this private financing could allow you to finish the rehab work before you could even get the 203k loan funded to even start the work that way.  The extra rents you collect for getting done sooner might cover the extra costs, if there are any.

Like I said, I don't know your whole scenario, and this type of financing might not be 'cheaper', but it might be 'better' for other reasons.  

Worth thinking about.

@Conrad Legé it depends on how much time, experience and patience you have. Rehabbing a property with no experience can be a challenge. The 203K loan program can be tricky to navigate so just be prepared for a lot of work.

Hi Conrad!

Agreed that 203k can be trickier and more to navigate, but the right lender does make a world of difference on 203k loans.  They don't have to be rocket science....even though most lenders make them difficult.  That said, rehabbing (outside of just the financing side of things) is not for the faint of heart.  I'd definitely do your research and make sure you have the stomach for it....on the 1st one especially.  Buying a multi-unit can be enough work as it is, so you really need to make sure you're ready to take on the challenge of rehabbing.

Regardless of whether you're focusing on rehab projects or as-is, I'd highly recommend connecting with a top agent in this space.  Not a top agent that sells primarily condos and single families, but one that specializes in multi-family.  Like you said, properties are flying off the shelf.....never in my 17 years have I seen such demand on 2-4units, coming from within Chicago, from the coasts, and overseas.  You need an agent that can source property and get you in front of the right ones before the masses show up.  If you need some names, let me know.  All the best!

@Chris Baber Interesting. I had not considered a hard money loan before but I wonder if this could be an option.. My question is If they are not looking at FICO scores would I have to have some sort of prior experience to show in order to qualify for a HML?

@Mike D'Arrigo I understand it would be a big undertaking for my first property, however if all went well I think I  would create more financing options and leverage for my future deals.

I vote for the 203K loan.  Invest some money into marketing to find an off market deal and you will not only find a better deal but you will also learn some great lessons about marketing!

Generally, with hard money, what I've seen is your costs (points &/or rate) go down as your experience goes up.  A couple deals under your belt (in the last 2 years generally) would save about a point up front or 1/2% interest as a very general average.  A couple more deals, more discount.  What I've seen is that if you sound like you know what you're talking about, and are honest about what you're trying to do, many lenders will give you a loan.  It may not be a great loan, but if the numbers of your deal work, and you can have money in your account in 7-10 days with little documentation on your part, it's worth considering.

Good, fast, cheap.  Pick 2

Also, compare the Fannie Mae Homestyle renovation loan against the 203k to see what works best for your situation, cost, and timeline. We went with the FNMA. They have different benefits. 203k is for owner OCC only, it has PMI that costs more up front and if you want to get rid of PMI you may have to pay to refi to drop the PMI. It is assumable, I don't think the FNMA is assumable, but check with your lender. I wasn't concerned with that option. FNMA is investor, owner, w 5% down, or vacation, I believe it's more down for the vacation homes. It has lower up front cost for PMI vs 203k, PMI can be dropped when your equity hits the mark without the cost of refi like the 203k. I believe my lender said at 2 year mark we could drop PMI without refi cost. Prior to two year we would have to pay for refi to drop it, which I was not aware of when we took the loan. I'm not sure if that is a lender rule, or FNMA rule. A good resource to look at is the mortgage reports site. Search Homestyle vs 203k. It should give you a good visual comparison. My advice would be to find a great lender that has experience closing the renovation loans and know all the details. Get recommendations from your lender on contractors that they have worked with and been successful to close the purchase part and the renovation, draw, and lender inspection part to the final closing total. On your first one I would not recommend using contractors that have not been through the process. They will need to carry costs until the draws. Even though our contractor had done a few in the past and had received funds up front for materials and costs from the lender, the lender changed their rules since prior projects and he couldn't pull money up front anymore. The purchase part took 45 days to get the contractor itemized bid list and appraisers out, the contractor part went out longer. It was a total of 3 draws, with three lender inspections prior to paying out contractor each time. The third payout was the final draw released at the final inspection and the adjustment on the loan total. We picked the FNMA Homestyle loan since it had the PMI drop. That was in case we stayed in the house longer than the 2 year no capital gain tax mark, or kept it long term for rental. I didn't want the added cost of refi for the FHA to drop PMI if I wasn't holding long term since the refi vs PMI savings cost might not make sense on a shorter term play if I had to exit sooner than break even on the refi cost vs PMI savings. I was also not wanting to have to refi an FHA into possible increasing interest rates when my equity hit the PMI drop off mark if it took longer than expected with market help. I should be able to drop the PMI this next month for free at the 2 year mark to bring the payment down and we are now sitting on around 6 figures equity. I am happy we did it. I couldn't have closed the home with a regular loan with the shape it was in.

@Brock Mogensen My sentiments exactly Brock!

@Chris Baber Good to know Chris. I will keep that in mind.

@Greg H. That great Greg. I was not aware of this Fannie Mae renovation loan. I am going to ask my lender about this. This might be a good option as I would be able to potentially take advantage of two low-money down programs for my future deal instead of being limited to one if I decide to go FHA, which I've recently learned. Thank you for the insight.

Hello all! I hope that I'm not going off topic, but I am very, very new to the real estate investing community. I'm interested in investing in a small multi-family unit (2 units) not too far from my home. Is it possible for me to apply for an FHA loan for the property to live in one unit and rent out the other? Secondly, I am currently married and living with my husband but I am willing to live in the investment property for the required FHA time frame?

Please advise. Thank you!