By Bud Coburn
To be eligible, the property must be a one- to four-family dwelling that has been completed for at least one year. The number of units on the site must be acceptable according to the provisions of local zoning requirements. All newly constructed units must be attached to the existing dwelling. Cooperative units are not eligible. Homes that have been demolished, or will be razed as part of the rehabilitation work, are eligible, provided some of the existing foundation system remains in place. In addition to typical home rehabilitation projects, this program can be used to convert a one-family dwelling to a two-, three-, or four-family dwelling. An existing multi-unit dwelling could be decreased to a one- to four-family unit. An existing house (or modular unit) on another site can be moved onto the mortgaged property. However, release of loan proceeds for the existing structure on the non-mortgaged property is not allowed until the new foundation has been properly inspected, and the dwelling has been properly placed and secured to the new foundation. A 203(k) mortgage may be originated on a mixed-use residential property, provided the property has no greater than 25% (for a one-story building), 33% (for a three-story building), and 49% (for a two-story building) of its floor area used for commercial (storefront) purposes. The commercial use also must not affect the health or safety of the occupants of the residential property, and the rehabilitation funds may be used only for the residential functions of the dwelling and areas used to access the residential part of the property.
HUD also permits Section 203(k) mortgages to be used for individual units in condominium projects that have been approved by the FHA, the Department of Veterans Affairs, or are acceptable to FNMA under the guidelines listed below. The 203(k) Program was not intended to be a project-mortgage insurance program, as large-scale development has considerably more risk than individual single-family mortgage insurance. Therefore, condominium rehabilitation is subject to the following conditions:
- Borrowers can be owner-occupants and qualified non-profits only — no investors.
- Rehabilitation is limited only to the interior of the unit. Mortgage proceeds are not to be used for the rehabilitation of exteriors or other areas which are the responsibility of the condominium association, except for the installation of firewalls in the attic for the unit.
- Only the lesser of five units per condominium association, or 25% of the total number of units, can be undergoing rehabilitation at any one time.
- The maximum mortgage amount cannot exceed 100% of after-improved value.
- After rehabilitation is complete, the individual buildings within the condominium must not contain more than four units.
By law, Section 203(k) can only be used to rehabilitate units in one- to four-unit structures. However, this does not mean that the condominium project, as a whole, can only have four units or that all individual structures must be detached. For example, a project might consist of six buildings each containing four units, for a total of 24 units in the project, and, thus, be eligible for Section 203(k). Likewise, a project could contain a row of more than four attached townhouses and be eligible for Section 203(k) because HUD considers each townhouse as one structure, provided each unit is separated by a 1-1/2-hour firewall (from foundation up to the roof). Similar to a project with a condominium unit with a mortgage insured under Section 234(c) of the National Housing Act, the condominium project must be approved by HUD prior to the closing of any individual mortgages on the condominium units.
How the Program Can Be Used
This program can be used to accomplish rehabilitation and/or improvement of an existing one- to four-unit dwelling in one of three ways:
- to purchase a dwelling and the land on which the dwelling is located and rehabilitate it;
- to purchase a dwelling on another site, move it onto a new foundation on the mortgaged property, and rehabilitate it; or
- to refinance existing indebtedness and rehabilitate such a dwelling.
To purchase a dwelling and the land on which the dwelling is located and rehabilitate it, and to refinance existing indebtedness and rehabilitate such a dwelling, the mortgage must be a first lien on the property and the loan proceeds (other than rehabilitation funds) must be available before the rehabilitation begins. To purchase a dwelling on another site, move it onto a new foundation and rehabilitate it, the mortgage must be a first lien on the property; however, loan proceeds for the moving of the house cannot be made available until the unit is attached to the new foundation.
Mortgage proceeds must be used in part for rehabilitation and/or improvements to a property. There is a minimum $5,000 requirement for the eligible improvements on the existing structure(s) on the property. Rehabilitation or improvements to a detached garage, a new detached garage, or the addition of an attached unit (if allowed by the local zoning ordinances) can also be included in this first $5,000. Properties with separate detached units are acceptable; however, a newly constructed unit must be attached to an existing unit to be eligible under 203(k). Any repair is acceptable in the first $5,000 requirement that may affect the health and safety of the occupants. Minor or cosmetic repairs by themselves cannot be included in the first $5,000, but may be added after the $5,000 threshold is reached. Examples of eligible improvements are listed below (this list is not all-inclusive):
- structural alterations and reconstruction (e.g., repair or replacement of structural damage, chimney repair, additions to the structure, installation of an additional bath(s), skylights, finished attics and/or basements, repair of termite damage and the treatment against termites or other insect infestation, etc.);
- changes for improved functions and modernization (e.g., remodeled bathrooms and kitchens, including permanently installed appliances, such as a built-in range and/or oven, range hood, microwave, dishwasher);
- elimination of health and safety hazards (including the resolution of defective paint surfaces or lead-based paint problems on homes built prior to 1978);
- changes for aesthetic appeal and elimination of obsolescence (e.g., new exterior siding, adding a second story to the home, covered porch, stair railings, attached carport);
- reconditioning or replacement of plumbing (including connecting to public water and/or sewer system), heating, air conditioning and electrical systems. Installation of new plumbing fixtures is acceptable, including interior whirlpool bathtubs;
- installation of a well and/or septic system. The well or septic system must be installed or repaired prior to beginning any other repairs to the property;
- roofing, gutters and downspouts;
- flooring, tiling and carpeting;
- energy-conservation improvements (e.g., new double-pane windows, steel insulated exterior doors, insulation, solar domestic hot water systems, caulking and weatherstripping, etc.);
- major landscape work and site improvement (e.g., patios, decks and terraces that improve the value of the property equal to the dollar amount spent on the improvements, or required to preserve the property from erosion);
- the correction of grading and drainage problems;
- tree removal is acceptable if the tree is a safety hazard to the property;
- repair of existing walks and driveway if it may affect the safety of the property; and
- improvements for accessibility for a disabled person (e.g., remodeling kitchens and baths for wheelchair access, lowering kitchen cabinets, installing wider doors and exterior ramps, etc.).
When basic improvements are involved, the following costs can be included in addition to the minimum $5,000 requirement:
- new, free-standing range, refrigerator, washer and dryer, trash compactor and other appurtenances (used appliances are not eligible);
- interior and exterior painting; and
- the repair of a swimming pool, not to exceed $1,500.
Luxury items and improvements that do not become a permanent part of the real property are not eligible as a cost of rehabilitation. The items listed below (though not limited to this list) are not acceptable under the 203(k) program, including the repair of any of the following: barbecue pit; bathhouse; dumbwaiter; exterior hot tub; sauna, spa and whirlpool bath; outdoor fireplace or hearth; photo mural; installation of a new swimming pool; gazebo; television antenna; satellite dish; tennis court; or tree surgery. Additions or alterations to provide for commercial use are not eligible.
All rehabilitation construction and/or additions financed with Section 203(k) mortgage proceeds must comply with the following:
(1) addition to existing structure: new construction must conform with local codes and HUD;s Minimum Property Standards;(2) rehabilitation of existing structure: to improve the thermal efficiency of the dwelling, the following are required:
- weather-strip all doors and windows to reduce infiltration of air when existing weatherstripping is inadequate or nonexistent;
- caulk and seal all openings, cracks and joints in the building envelope to reduce air infiltration;
- insulate all openings in exterior walls where the cavity has been exposed as a result of the rehabilitation, and insulate ceiling areas where necessary; and
- adequately ventilate attic and crawlspace areas. For additional information and requirements, refer to 24 CFR Part 39.
(3) replacement of systems:
- heating, ventilating, and air-conditioning system supply and return pipes and ducts must be insulated whenever they run through unconditioned spaces; and
- heating systems, burners, and air-conditioning systems must be carefully sized to be no greater than 15% oversized for the critical design, heating or cooling, except to satisfy the manufacturer’s next closest nominal size.
B. smoke detectors: each sleeping area must be provided with a minimum of one:
(1) approved, listed and labeled smoke detector installed adjacent to the sleeping area.
In order to determine the maximum mortgage amount, the 203(k) valuation analysis consists of two separate determinations of value.
A. as-is value: A separate appraisal (Uniform Residential Appraisal Report) may be required to determine the as-is value. However, the lender may determine that an as-is appraisal is not feasible or necessary. In this instance, the lender may use the contract sales price on a purchase transaction, or the existing debt on a refinance transaction, as the as-is value, when this does not exceed a reasonable estimate of value.
Further, on a refinance transaction, when a large amount of existing debt (i.e., first and second mortgages) suggests that the borrower has little or no equity in the property, the lender must obtain a current as-is appraisal on which to base the estimated as-is value. On a refinance, the borrower may have substantial equity in the property to assure that no further down payment is required on the new loan amount. In some cases, the borrower will not have an existing mortgage on the property. In this case, the lender should obtain some comparables from a real estate agent/ broker to estimate an approximate as-is value of the property. Another way of establishing the as-is value is to obtain a copy of the local jurisdiction tax valuation on the property.
B. value after rehabilitation: The expected market value of the property is determined upon completion of the proposed rehabilitation and/or improvements.
For a HUD-owned property, an as-is appraisal is not required, and a DE lender may request the HUD Field Office to release the outstanding HUD Property Disposition Appraisal to the lender to establish the maximum mortgage for the property. The HUD appraisal will be considered acceptable for use by the lender if it is not over one year old prior to bid acceptance from HUD, and the sales contract price plus the cost of rehabilitation does not exceed 110% of the “As Repaired Value” shown on the HUD appraisal. If the HUD appraisal is insufficient, the DE lender may order another appraisal to assure the market value of the property will be adequate to make the purchase of the property feasible. For a HUD-property, down payment for an owner-occupant or non-profit organization is 3% of the accepted bid price of the property, and 100% financing on all other costs.
Home buyers who purchase a property with cash can refinance the property using 203(k) within six months of purchase, the same as if the buyer purchased the property with a 203(k)-insured loan to begin with. Evidence of interim financing is not required. The mortgage calculations will be done the same as a purchase transaction. Cash back will be allowed to the borrower in this situation, less any down payment and closing cost requirement for the 203(k) loan. A copy of the Sales Contract and the HUD-1 Settlement Statement must be submitted to verify the accepted bid price (as-is value) of the property and the closing date.
The improvements must comply with HUD’s Minimum Property Standards and all local codes and ordinances. The home buyer may decide to employ an architect or a consultant to prepare the proposal. The home buyer must provide the lender with the appropriate architectural exhibits that clearly show the scope of work to be accomplished. The following list of exhibits are recommended, but may be modified by the local HUD Field Office as required.
- A “Plot Plan of the Site” is required only if a new addition is being made to the existing structure. Show the location of the structure(s), walks, drives, streets, and other relevant details. Include finished grade elevations at the property corners and building corners. Show the required flood elevation.
- “Proposed Interior Plan of the Dwelling: shows where structural or planning changes are contemplated, including an addition to the dwelling.
- “Work Write-up and Cost Estimate”: Any format may be used for these documents; however, quantity and the cost of each item must be shown. Also include a complete description of the work for each item.
Cost estimates must include labor and materials sufficient to complete the work by a contractor. Home buyers doing their own work cannot eliminate the cost estimate for labor because if they cannot complete the work, there must be sufficient money in the escrow account to get a subcontractor to do the work. The work write-up does not need to reflect the color or specific model numbers of appliances, bathroom fixtures, carpeting, etc., unless they are non-standard units. The consultant who prepares the work write-up and cost estimate (or an architect, or engineering or InterNACHI inspector) needs to inspect the property to assure:
(1) there are no rodents, dry rot, termites or other infestation;(2) there are no defects that will affect the health or safety of the occupants;(3) the adequacy of the existing structural, heating, plumbing, electrical and roofing systems; and(4) the up-grading of thermal protection (where necessary).
Definitions for Use in the 203(k) Program
A. Insurance of Advances: