Adding Value by Dennis O'Hagan: FHA rehab loans ideal for distressed homes...

Rolling purchase price, fix-up costs into 1 loan is next best thing to new construction

By Steve Bergsman
Inman News®

Foreclosures and short sales always look so enticing, but these kinds of deals are not for the faint-hearted or those on slim resources.

Buying a residence that is not newly built usually requires immediate rehabilitation and remodeling to be followed by regular maintenance. Taking on a foreclosure or short-sale property only ratchets up the process with more intensive rehabbing and certainly a lot more maintenance.

However, one of the most overlooked FHA programs, the 203(k) loan, can help with all those problems if you want to take on the burden of the foreclosure investment.

I bring all this up because I wanted to discuss the 203(k) loan program, which is an underappreciated FHA opportunity that can combine purchase price and fix-up costs into one mortgage, and, secondly, because there have been increasing discussions about the virtues of buying a new home instead of a cheaper property where the mortgage is busted.

I'll address the latter issue first.

Just like the purchase of a new car instead of used one, many prefer to buy a new home because it comes with all the modern bells and whistles and since everything is brand-new; as a homeowner, one shouldn't have to deal with structural and systematic breakdowns.

Recently, the National Association of Home Builders pulled some data from the 2009 (most recent) American Housing Survey, a joint production of the U.S. Census Bureau and the Department of Housing and Urban Development (HUD), to see how frequently maintenance was required in a new home (four years old or younger) versus an older property.

Its conclusions: 26 percent of all homeowners spend $100 or more a month on various upkeep costs; only 11 percent of owners of newly constructed homes spend this amount. In addition, 73 percent of new homeowners spend less than $25 a month on routine maintenance costs.

The same holds true for energy expenses, NAHB reported. On a median-square-foot basis, homeowners spend 78 cents per square foot per year on electricity. Owners of new homes spend 65 cents per square foot per year. For homes with piped gas, homeowners spend on average 53 cents per square foot per year; owners of new homes spend 38 cents per square foot per year.

"The message is, when you compare the average new-home price to the average existing-home price, new homes are more expensive, but when you consider additional, incremental costs, you are getting additional value," said Robert Dietz, an economist at the NAHB. "Obviously, the new home is going to be in superior condition, which means less expenses in the early years."

Although the numbers from the 2009 American Housing Survey are getting a little ripe, Dietz doesn't foresee a big change when the next survey appears. If anything, he said the gap should be wider because homes are much more energy and maintenance efficient; meanwhile, the cost of energy and maintenance has only increased.

"When you hear someone say, 'Hey, I got a short sale and the price is good,' the economist in me would respond, 'There's no free lunch,'" Dietz said. "It is going to require some effort and dollars to bring that home up to the standard the homeowner wants. In new construction, you get that standard in day one."

Still, buyers of short sales and foreclosed homes seem to know what they are doing, and really, really want to purchase existing residences at what they consider bargain prices. They know there will be some fix-up costs, and if they're smart they'll be aware of one of the better FHA programs, the 203(k) loan.

I checked in with Brian Robison, a principal with Summit Design Build LLC, an Atlanta contractor and renovation specialist company, who works the 203(k) loan market in his area.

"A lot of people don't know about this loan; it's really a tight-lipped kind of thing," he said. "Everyone wants to buy foreclosures, but they don't know about the 203(k) loan programs."

That's unfortunate, because it is a great selling point.

Just a few notes from the FHA 203(k) loan website:

--This is the Department of Housing and Urban Development's primary program for the rehabilitation and repair of single-family properties.

--The program operates through FHA-approved lending institutions, which submit applications to have the property appraised and have the buyer's credit approved.

--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.

The best feature of this loan is that it can be rolled into the mortgage.

Robison explains: "The reason people should use this loan is because it is a way to not have to come upfront with cash. You bring the home's value up and roll it into your mortgage. It really opens up what's available on the market because if someone is looking at homes and saying, 'I can't buy this one because it is going to take $30,000 to redo the kitchen and put in a new carpet, they can get the expense wrapped up into one loan with one closing."

There is even a streamline version of this loan that can go up to $35,000. Otherwise, the FHA loan limits vary by market, which, according to one website, range from $271,050 to $729,750.

The same website offers this note about qualifying: minimum down payment of 3.5 percent; credit score of 640 or higher; no other FHA loans; and you do not have to be a first-time buyer.

In 2011, Robison said his company did about 14 projects using the 203(k) loan. "They weren't very popular last year. The FHA only closed about 4,000 of these loans across the country," he said.

And for this year?

"It's just now catching on," he said. "Through the first couple of months in 2012, I've already done four. If I stay on this track, I'll probably do 20 to 25 this year."

Steve Bergsman is a freelance writer in Arizona and author of several books. His latest book, "Growing Up Levittown: In a Time of Conformity, Controversy and Cultural Crisis," is now available for sale on Amazon.com.