I was wondering in a 203(k) loan, how is it determined how much money will loaned towards renovations on a property? Is max amount? Is it based off an appraisal?
Thank you for your time
The maximum amount of your loan is based on how much you qualify for based on your income, assets, etc, the appraised value of the home, and the number of units you will have at then end of the renovation. For example, you may qualify for x amount for a single family home but you'll qualify for more if it's going to be converted to two units because then the lender counts the rental income from the second unit. Under a 203k you can borrow up to 110% of the appraised ARV of the home (assuming your income is not the issue).
Once you have your max loan amount, then your max renovation budget will be your loan amount less the acquisition cost of the property. How much you actually choose to spend is up to you.
The part where this gets tricky is that you have to have a renovation budget to order the appraisal. So you'll have to do your research or work with your contractor and realtor on a scope that brings you within market comps without having the cost of the repairs push you way over what you expect the appraised value to be.
I hope this wasn't convoluted. Your lender and the 203k consultant that you're required to hire should also be able to answer any specific questions you have.
Another point to mention is that the amount you qualify for less the cost of acquiring the property isn't necessarily what you can allot for rehab. Based on your HUD consultants appraisal, the rehab may require a 10-20% contingency reserve for any surprises and unknowns about the property. This contingency will eat up some of your total rehab allowance.
One requirement is that the work be done by a licensed contractor, so with the FHA 203K program you can't do the work yourself or you and bunch of your friends.
The HUD consultant i work with wanted to add extra contingency due to the fact that the house we were looking at had a broken incoming water supply line. He wasn't able to see if the water heater or any of the plumbing fixtures worked. The house hasn't been rehabbed in 30-40 years so the condition of the plumbing, electrical, and mechanical behind walls were unknown. Also the house had some foundation issues.
So i would conclude that contingency would be based on how many items on their checklist that they were not able to inspect. More items = higher contingency.
If i decided to purchase this property and started to dig into the walls and found asbestos wrapped ductwork, galvanized plumbing, and knob & tube wiring....i would be upset if i didnt have a contingency that accounted for potential problems.
On the other hand, on a newer house that only needs cosmetic work...the contingency might be relatively low.
If you are serious about utilizing the 203k, i would recommend reaching out to a local lender that is experienced with the 203k process. They can get you pre-qualified to find out what your max budget could be. They can also recommend agents, approved contractors, and HUD consultants that they have worked with to get you started in the right direction.
We're approved with 5 banks as 203k contractors. In our experience, banks require either 10% or 15% contingency. We haven't seen anything greater than that.
We utilize the contingency more on smaller jobs. On projects where the scope is full gut and rebuild, there are few surprises that can come up so the contingency may go untouched. Whereas on a project where clients are keeping a lot of the existing systems and layout, you may run into surprises behind any one wall you open up and the place may need more repairs than expected. For example, someone wants to keep the kitchen and dining room layout but they want a pass thru window in between. We budget for labor and materials. Then once we open the wall, we find there's a duct/pipe/whatever running right thru the space we were going to open. The client may decide to use the contingency to renovate whatever's in the way so he can still have the pass thru.
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