The Investment Property Owner’s Guide to a 203(k) Loan

203k-loan-montgomery-county-rental-propertyIf you are looking to purchase a Montgomery County rental property that needs a little extra TLC, and have noticed that the lenders have become very strict with loan approvals, you are not alone.

And, in light of this tight-fisted approach, investing in a fixer-upper rental property becomes problematic, even for a seasoned property owner.  In addition to a large down payment, exceptional credit, and all of the other hoops you must pass through for a loan approval, you must have enough cash left over to make home improvements in order to make a fixer-upper appealing.

So what is an investor to do when he needs to purchase a home that requires extensive remodeling?

Though there are plenty of creative ways to finance a rental property in the Montgomery County area, if you are looking to purchase a residential rental property that requires renovation, you may benefit from getting a 203(k) loan.

 

What is a 203(k) Loan?

An FHA 203(k) loan allows you to borrow money for a property purchase and home improvements.  In other words, this type of loan finances both the cost of the property and the amount needed to fix it up, all in one mortgage.

Guaranteed by the FHA, this loan is less of a risk to lenders than other types of loans.  With the lower risk level, you are more likely to be approved and with a lower interest rate than a traditional bank loan.  In fact, some 203(k) loan interest rates can be as low as 3.5%.

In addition, using a 203(k) loan will give you quick and efficient access to the much-needed cash you will need to pay for repairs, renovations, and improvements on your less than perfect Montgomery County rental.

 

What Improvements Can You Make?renovating-rental-property-montgomery-county

Since this loan helps investors improve their properties for occupancy, it is important to understand the eligible repairs you can make on your property with the loan money you receive.

Here is an overview of the types of home improvements covered by a 203(k) loan:

  • Roof replacement or repair
  • Replacement, repair, or upgrade of HVAC system
  • Repair or replacement of plumbing
  • Full interior or exterior painting
  • Replacement of old windows
  • Appliance replacement
  • Attic finishing
  • Replacement or repair of deck, patio, or porch
  • Bathroom remodeling
  • Landscaping such as: tree removal, driveway/sidewalk repair, or grading correction

Keep in mind, luxury items that do not become a part of the real property—such as BBQ pits, exterior hot tubs, swimming pools, tennis courts, and satellite dishes—are ineligible for repair under a 203(k) loan.

 

Types of 203(k) Loan Programs

Two loan types fall under an FHA 203(k) loan program.  Which one you need will depend on the cost to purchase the property and the estimated cost to repair your Montgomery County rental.

Standard 203(k) Program

This loan is for properties that need extensive repairs, including major additions and structural changes to the property.  Take a look at the stipulations for the standard loan:

  • Allows for a loan amounting to 110% of the after-improvement value determined by appraisal
  • A thorough property inspection must be conducted by a 203(k) consultant
  • A minimum of $5,000 must be borrowed for repairs
  • All other guidelines are similar to FHA standards

Streamline 203(k) Program

This loan is for properties that require repairs that will cost less than $35,000.  This includes cosmetic improvements that will not affect the structure of the property or do not include an addition.  Furthermore, you will finance your property using a streamline loan, meaning your property will not require an appraisal and the approval process is finished quickly.

 

The Rules of a 203(k) Loan

rules-203k-loan-montgomery-county-rental-property

Since 203(k) loans are a unique kind of loan, there are specific regulations you must follow upon loan approval.

Here are some of the things you can do with a 203(k) loan:

  • Purchase a fixer-upper. 203(k) loans are for those properties that need improvements or remodeling.  Since banks will not typically finance a house that is run-down, a 203(k) loan is a great way to invest in that rental property you know is a diamond in the rough.
  • Do the work yourself. If you can prove you have the ability to do your own remodeling, and can finish within the 6-month timeframe, you can use your 203(k) loan money to do so.  However, you can only use the money on supplies.  Since you are performing the work yourself, you cannot pay yourself as a hired contractor.
  • Expect multiple inspections. An inspector will inspect your property’s progress throughout the 6-month time period.  This is why your contractor must be reliable—he must start working on the home within 30 days and cannot stop work for longer than 30 days.  In addition, there is that ever-looming 6-month timeline.
  • Use the loan money to make the mortgage. You are able to do this even if you cannot yet occupy the property; you can use the loan to pay for up to 6 months of principle, interest, insurance, and taxes.  This is the beauty of having a two-for-one loan.
  • Upgrade your property to be energy efficient. You can get approval for a 203(k) loan to upgrade your rental home to be energy efficient.  An added bonus is that these improvements do not require appraisal.
  • Make mini-renovations. If you invest in a Montgomery County rental that needs a minor renovation such as a new kitchen, bathroom, or room addition, you may quality for the streamlined 203(k) loan mentioned above.  This is assuming the improvements fall within the eligible repair limitations and cost under $35,000.
  • Start over. With a 203(k) loan, you can tear down the entire property and build up again, so long as you keep the foundation in place, and again, make the deadline.

 

Here are some of the things you cannot do with a 203(k) loan:

  • Invest in a new-construction home. The home you are looking to remodel with 203(k) loan money must be at least one year old.
  • Make repairs under the $5,000 minimum. You must spend at least $5,000 of your 203(k) loan on renovations.  This means you cannot replace one or two appliances and pocket the rest for mortgage payments.
  • Break any 203(k) loan rules. You can trust that your 203(k) loan lender will hold you accountable to all of the stipulations such a unique loan has.  He will be involved in every step of your property’s renovations and in the end, you can bet to find yourself in a lot of trouble if you violate any of the loan provisions.

The One Major Downside of a 203(k) Loan

Now that you have a clear idea what a 203(k) loan is all about, there is one major downside to using the 203(k) loan as an investment opportunity that needs to be addressed.

In order to prevent rental property investors from using 203(k) loans to build their portfolios quickly and efficiently, and thus avoiding the hardships many lenders pose as portfolios grow, investors are not allowed to use 203(k) loans to finance their rental properties.

Those looking to utilize a 203(k) loan must occupy the property themselves for a minimum of 12 months, unless you are a qualified non-profit organization.

However, a 203(k) loan can still be an excellent opportunity to buy a property, enjoy it for a while, and then turn it into a rental property after the 12-month minimum residency.

If you are looking to turn your primary residence into an investment property, you should definitely look into the pros and cons in using a 203(k) loan.  Though there are some restrictions in place, this type of loan can be a great way to get quick financing, remodel your property for additional value, and get it into the rental property market looking great.

 

In addition, property owners that need a highly experienced Montgomery County property management company should contact Bay Management Group today.  Bay Management Group can help you keep your remodeled rental home in shape with a 24-hour maintenance staff ready to fix any issue, regular inspections to ensure your improvements are not going to waste, and managers to help you set the highest rent rates possible for your new and improved property.

So get in touch with Bay Management Group now to get started with your rental property business.  You will not regret the peace of mind this exceptional property management company provides its Montgomery County property owners.


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