Did you know you could use FHA financing for multi-unit properties? It gives you the opportunity to invest in real estate without paying the higher investment loan rates and fees. The catch, however, is that you must live in one of the units. This makes it ‘owner-occupied,’ allowing you to rent out the other properties while using FHA financing.
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What if you find a multi-unit property that needs renovations, though? You are still in luck. The FHA 203K rehab loan provides you with funds to buy the property and fix it up. It’s all done with one loan, while the funds to fix up the home are kept in an escrow account and disbursed accordingly. You must have a minimum of $5,000 in repairs to be done in order to qualify. You’ll also need a contractor willing to start the project within 30 days of closing in order to get started.
Keep reading to learn the additional requirements necessary for this loan program.
The Property Requirements for the FHA 203K Loan
First, you must make sure the property meets the FHA 203K loan requirements. Most notably, you can only use it on a 1-4 unit property. That means if you find a 5 or 6-unit property, it would not be eligible. However, there’s another catch. You can purchase the higher unit property and knock it down to a 4-unit. As long as the future value of the property is there and the lender agrees, you rehab the property to meet the FHA guidelines using FHA funds.
The property must also be residential and all units must be attached. If you will use the funds to add a unit to the property, it again must be an attached property. Lastly, in addition to the unit being residential, you must live in it as your owner-occupied property. If you own another property, you may not be eligible for the program.
Passing the Appraisal
Your multi-unit property will undergo an appraisal just like it would with any other government-backed loan, such as the VA or USDA loan. The appraiser will make sure the property meets the FHA guidelines, including that it is safe and sanitary. The appraiser will determine the as-is value of the property. This is the base value the lender uses to determine the amount of funding they can provide you.
Next, the appraiser will determine the ‘after repair’ value. In order to determine this, you’ll have to provide the lender and appraiser with estimates of the work you propose. You’ll need official estimates from contractors willing to do the work. The appraiser will determine how the rehab will affect the property’s price and submit that value to the lender.
Determining the Loan Amount
This is where it gets tricky. Your 203K loan takes place in two parts. The first part is the traditional purchase money. Your lender may restrict this amount to the as-is value the appraiser comes up with for the appraisal. If your agreed upon purchase price exceeds the value, the lender may require you to renegotiate the sales contract to meet that amount.
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The second amount is the cost of the impending rehab. This is where the estimates from the contractors come into play. The lender will help you choose the right lender based on the estimates they provide. The value of the repairs will determine how much the lender will provide. Typically, you can borrow up to 110% of the improved value of the home. This allows you to add contingency funds for any unforeseen circumstances and costs.
Distributing the Funds
After you close on the FHA 203K loan, your lender will disburse the purchase funds just like they would with a standard purchase. They pay the seller the agreed upon sales price. The remaining funds sit in an escrow account unless the contract with the contractor allowed an initial disbursement to purchase supplies.
Before you close, the lender will create a contract with your contractor. This includes the schedule the contractor must stick to in order to receive the necessary funds. Upon each phase, an inspector or the loan consultant assigned to your case will inspect the work. If it’s done up to code and the lender’s satisfaction, the lender will disburse the predetermined funds. Once the work is 100% complete, the lender will have a final inspection conducted and disburse the final payment.
If there are funds left that don’t need to be disbursed, usually because of the contingency fund, the lender will pay a part of your principal down with the remaining funds. You cannot receive any cash in hand, no matter how much money remains.
The Types of Changes
You can make a variety of changes to your multi-unit property with the FHA 203K loan in addition to reducing it to 4 units or even adding a unit. Some of the changes include:
- Any major repairs including the removal or rehab of a weight bearing wall
- Adding or removing rooms
- Complete demolishment of the unit as long as the foundation remains standing
- Work that requires blueprints
- Any cosmetic work
- Any major rehabilitation as long as the foundation remains in place
Basically, you can do any type of changes that the lender and/or loan consultant approves. The largest hurdle is making sure the value for the repairs is worth its cost, which you will find out with the appraisal.
If you want to buy and renovate a multi-unit property with an FHA 203K loan it’s fairly straightforward. Make sure you find a lender that is experienced in both multiple unit properties as well as FHA 203K loans, though. Combining the two can make for a complicated situation, but one that is well worth it in the end.
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