The Contingency Reserve is something that needs to be addressed because it's an extremely important part of the FHA 203k loan. The Contingency Reserve is there for cost overruns- it is a component that is put in place to protect the home buyer or home refinancer in case of additional costs or expenses that may arise as a result of the rehab.
The Contingency Reserve can be anywhere from 10-20% of the rehabilitation costs. This rehabilitation number is set aside in case we open up the walls and there are broken pipes, missing, etc- one never knows what can happen when walls are opened up so there must be a reserve account- just in case!
You buy a vacant property for $200,000 and add on $20,000 of rehab. They open the walls up because it’s a 1930s house with plaster walls and it ends up there's a problem with the electrical or a problem with the plumbing- and the costs exceed the initial estimate of the contractor.
Nobody could have known this and we all obviously want to make sure the customer is taken care of and that the property gets up to FHA minimum property standards. So, with this being said, it's a great reason the Contingency Reserve is there. It’s there to protect against all these types of things.
If we were to get through a project and the contingency reserve was never touched because the contractor hit the estimate "right on the head," then you have a 10-20% contingency reserve there in place, which can be used for changes, as long as there is still money left in the reserve. In this case, you could do additional projects that you initially had thought were not possible, or, as a final option, you can allow the contingency to be put back against your principal...yet another thing that can be done with the contingency! It's something there to protect you, and,"if you don't use it, it's not like you lose it!"
Putting The Contingency Back...Any Slack In Payments?
Now, if we do put it back towards the principal balance of your mortgage, it will not lower your payment, however. It will take down your overall balance, so that's important to remember, because people sometimes think, "well I’m lowering my balance...shouldn’t that lower my payment?" Your payment is set, the only thing that will change your payment moving forward is the potential for your taxes and insurance to change. Otherwise, your principal is going to remain the same.
Other Uses For Unused Contingency
Most of my customers, typically, if they have not used up all of their contingency will add certain things on- maybe there’s an extra bathroom that they now can get done- or ,maybe there's some extra carpeting or some extra hardwood floor that they hadn’t initially hoped to do, but now can. I’ve had customers add on a deck, etc. So, there's additional things you can do with that contingency reserve that hasn’t been used. A majority of the time we see 10% as the contingency, except for vacant homes, where we do 15% as the norm.