By Anita Clinton
In the midst of what is being called “the mortgage breakdown,” opportunities for investors and homebuyers can be found in just about any area or neighborhood. The varied unfortunate mishaps of some have turned out to produce fortunes for others. Some of the properties are in “move in” condition, while others require a little, and some instances, a lot, of TLC. Conventional lenders will not finance properties that are in disrepair. This is where the rehab loans come into play. These loans are used to cover the purchase and rehabilitation (rehab) costs of the property. In most instances, these loans are “temporary” loans, usually with 6-12 month terms. They will also have higher interest rates than conventional loan because of the increased risk factors.
THE REHAB LOAN
Like convention loan products, there are different requirements/guidelines for each lender that offers rehab loans. However, the one constant factor amongst them is the amount financed is based upon the after repair value (ARV) of the property. The ARV is determined by an appraiser who will factor in the amount and type of repairs to be completed and comparable properties within a one mile radius that have sold within a 0-12 month period. In this market, this can prove to be challenging and the lender is aware of this. Therefore most rehab lenders will lend between 50-80% of the ARV. At the conclusion of the rehab, the loan is then refinanced into a conventional mortgage product. For instance, if the ARV is $100,000 and the lender is financing 75% of the ARV, then the maximum loan amount allowed is $75,000 ($100,000 x .75).
OTHER FACTORS
The various factors that are considered when financing rehab loans are determined by each specific lender. However, here are some general factors to consider:
• Qualifying Requirements. Like any other loan, the borrower must have a sufficient credit profile, income and reserves. Most rehab programs require a minimum 620 middle credit score, adequate income to support repayment of the loan, and at least 4-12 month reserves. Reserves are accessible funds (savings accounts, open line of credit, CDs, etc.) that have been seasoned (sitting there) for at least 2 months.
• Down Payment. The down payment requirements for each program can vary anywhere from 0-25% down. In most instances, if there is a down payment requirement, it is based on a percentage of the purchase price. However, there are programs that will calculate the percentage based on the total loan amount.
• Closing Costs. With some programs, closing costs can be finance in the loan providing the total doesn’t exceed the maximum loan amount. In addition, some programs may allow a 2-6% seller’s concession (seller paid closing cost).
• Interest Rate. Because lenders incur a greater risk with rehab loans, the interest rate will be higher than normal. The rate is usually calculated as interest only and could range anywhere from 8-20+%. Keep in mind, this is a temporary loan and the goal is to get in and out as quickly as possible.
• Work Order. The rehab lender will request a copy of the borrower’s contractor bid (s) and a breakdown of the repairs to be completed. Most lenders will provide a “Work Order” form for the borrower and/or contractor to complete. This document will also be used to determine the phases for the project’s completion.
• Appraisal. The rehab lender will most likely request two types of values: the as-is value and the value after rehab. The as-is value will denote the value of the property in its current state. The value after rehab will factor in the repairs and comparable properties in the area. Therefore, the appraiser will ask for a copy of the work order.
• Mortgage Payment Reserves. Some programs will allow the borrower to finance mortgage payments into the loan. Meaning, the borrower does not have make payments during the rehab. If the project is completed in a shorter timeframe than originally expected, the remaining payment reserves will be credited toward the principal balance.
• Draws. The monies for the rehab is held in escrow, usually by the title company until the draws are requested. Draws (or payments) are issued to cover the expenses of each phase. Some lenders will issue the first draw at the closing table, allocating the funds upfront to start the rehab project. While others issue the first draw only after the first phase is completed and inspected by a lender approved inspector. This inspection will be done at the end of each phase to ensure that the project is progressing and being completed up to the lender’s standards as agreed.
• expenses of each phase. Some lenders will issue the first draw at the closing table, allocating the funds upfront to start the rehab project. While others issue the first draw only after the first phase is completed and inspected by a lender approved inspector. This inspection will be done at the end of each phase to ensure that the project is progressing and being completed up to the lender’s standards as agreed.
• Holdbacks. Some lenders require up to a 10% holdback on each draw as a cautionary method. The total holdbacks are usually released after the final inspection is completed.
• Contingency Reserves. Contingency reserves can range from 5-20%, at the lender’s discretion. This is money that is set aside to cover unexpected costs, ie, inaccurate prices, missing items, overdrawn accounts, or any unexpected expenses. Like the holdbacks, this money is usually released after the final inspection is completed.
FHA 203(K) REHAB LOAN
HUD offers the FHA 203(k) program which is the exception to the general rules stated above. The FHA 203(k) program is for buyers who plan to live in the property that is being rehabbed (owner-occupied). It can be used for 1-4 unit properties and some mixed-used properties. Like the standard FHA product, it requires 3-5% down. However, the borrower can use Down Payment Assistance Programs (DPAP) to cover down payment and closing costs. The interest rate will be more favorable that the other rehab loans, but not as low as standard FHA loans. In addition to the contractor bids, the property must be inspected by an FHA approved plan reviewer. He/she will inspect the property before the appraisal is ordered to ensure compliance with the program requirements. Once the project is complete, the loan acts as a standard FHA product. There is no need to refinance.
CONCLUSION
The rehab loan is an excellent product for investors, especially in the current market we are in. However, due to misuse and inadequate planning, which results in defaults, the program requirements are becoming more and more stringent. Successful investors adequately plan out there investment ventures. They precisely run their numbers, plan for the unexpected and devise contingency plans just in case things don’t go as originally planned. Wealth can definitely be created in this season. Be sure to be a responsible investor.
Anita Clinton is a licensed Loan Origination and the founder and creator of OwnSomethingToday.com, which encourages people to invest in real estate, stocks, and/or business to create wealth.
No comments yet.