Hiring a contractor? Hiring a lender can make more sense for many of your construction needs. When FHA 203K renovation financing is utilized, there are a series of “stop gaps” and guarantees that are not available to a consumer employing a contractor directly.
An important distinction between a consumer hiring and employing a contractor totally independent of the FHA 203K renovation loan and financing the entire project is that in the latter the consumer is protected from the beginning and throughout the process to the completion of the project.
Protections for a homeowner built into the FHA 203K renovation loan
Surprises, or unexpected challenges, are inherent in virtually all construction projects. In fact, anyone who cannot tolerate any sort of deviation from the plan or accept change along the way is probably not a good candidate for ANY kind of remodeling project.
1). Cost and Time Over Runs: In a traditional remodel it is almost a guarantee that everything is going to cost more and take longer than the consumer expected or the contractor promised. Renovating a property with the FHA 203K loan
The initial consultation is performed by a HUD certified FHA consultant. The subsequent report covers the areas that must be addressed for acceptance by the lender AND the desired improvements by the borrower. The contractor and bids are only solicited after the consultant and lender have agreed on the proposed improvements and the industry average costs.
The lender sets the predetermined costs allowable for the project (within reason, there is room for negotiation between the FHA consultant and the contractor) and the specified time frame of completion.
The lender requires a 10% to 20% reserve set aside for the entire project to ensure successful completion of the project. The amount of the reserve is determined by the scope of the project, but this ensure there is sufficient funds to cover any “surprises” throughout construction.
The reserve requirements and agreement between the borrower, contractor and lender also set a rigid maximum on cost over runs that protect all parties involved. A seasoned contractor is going to do the due diligence to protect the bottom line and will not be providing a “guesstimate” of the costs of the project because there is little opportunity to keep adding costs to the project.
The lender, FHA consultant and contractor negotiate the time necessary to do the various phases of the project. The contractor receives funds when timelines and deadlines are met. There is virtually no chance the home owner is going to be at risk of the contractor starting a project and not being timely in its’ completion.
2). Over improvement of the property and/or poor utilization of the allocation of resources.
This is absolutely the biggest mistake consumers make in deciding to renovate or remodel a residential property. When hiring a contractor directly, the consumer’s focus is on the their dreams for the property and the contractor’s focus is on accomplishing the desires of the consumer.
Dollar for dollar appreciation for any remodeling project is very, very rare and should not be expected (at least at the onset) of any construction project; however, there must be some evaluation of cost investment versus real estate appreciation for any project to make sense.
There is nothing quite as disturbing as being in the position of telling a consumer who just spent fifty thousand dollars on a kitchen remodel that there is only ten thousand of improved value in the property.
The FHA 203K renovation loan is structured entirely upon the “Future Value” of the property. The lender orders an initial “As Is” appraisal of the property. Once current market value is evaluated by a licensed appraiser, the consumer meets with the FHA consultant to plan a strategy and prepare a report laying out the exact specifics of the project. The report and plans are given to the appraiser to complete a modified version of the appraisal to determine the “Future Value” of the property as evaluated against comparable sales in the area.
The only monies spent prior to KNOWING the property value will improve sufficiently justify the costs of the renovation project are for the appraisal and FHA consultant fees. (NOTE: HUD has set the FHA consultant fees between $350 and $1,000, dependent upon the scope of the project).
There is simply no better way for a consumer to evaluate whether it makes financial sense to remodel a property than in the consideration of the FHA 203K renovation loan.
3). Contractor Insolvency, Inadequate Insurance, Non-payment of sub-contractors and/or suppliers
Many a consumer has been devastated to learn that their contractor of choice simply disappeared. Or, discovered only after someone was hurt on the project that the contractor did not carry adequate insurance and found themselves involved in litigation because the accident happened on their property.
Even more common (and least understood by consumers) is the contractor who does not pay his/her suppliers and/or sub-contractors and, as a result, the property owner ends up with multiple “mechanics liens” filed against their property for non-payment.
Every contractor working on a FHA 203K renovation loan must to approved by the lender for proper licensing, insurance, credit and reputation. The supervision of adequate permits and assurance that all suppliers and sub-contractors are paid for their services is managed and monitored by the lender and FHA consultant.
If you are considering purchasing a property to remodel, or want to upgrade your current residence considering a FHA 203K renovation loan can be the solution for helping you navigate the trials and tribulations of the construction process.
Working with a seasoned FHA 203K specialist and Lender experienced in managing the construction process is tantamount to success with this mortgage product. The opinions stated in this article are solely that of the author, based upon years of experience in both mortgage finance and remodeling, rehabbing and construction experience.
Understanding the FHA 203K Program
Understanding the FHA 203K Program, Part 2
Understanding the FHA 203K Program, Part 3
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