Home Buyers 203k Loan Survival Guide

2010-07-30T10:00:00.000-07:00

203k Loans provide a wonderful opportunity for home buyers to be able to select a less expensive property that needs renovation, and then be able to afford to customize every design/rehab element. There is no need to be intimidated by this process if you are working with a qualified and creative contractor.

Here is your Checklist & Survival Guide for Using a 203k Loan to Renovate, and How to Select the Right Contractor for the Job…

Verify the Contractor can do the paperwork
One of the most important aspects of successfully working with a contractor during a 203k loan will be to quickly assess their ability, format and response time for putting together a custom estimate that matches what the HUD inspector and 203k loan will require. These loans require extensive detail and line itemization of every proposed expense. They must have labor estimated by hour for each task and outlined separately from materials. Materials must be detailed for each project item as well. Most contractors are used to simply providing a few line items on a single sheet that states one all-inclusive amount to renovate each room or project element. For a 203k estimate, the contractor will need to be familiar enough with HUD guidelines to have custom-created (on their own) an estimate form that is broken down into the exact 35-category outline that matches the US Department of Housing Inspector’s Draw request form categories. (HUD does not provide estimate forms for download off the government website.) These categories are very time consuming to construct an estimate by, because instead of being by-room, the items are all separated. (Windows, masonry, drywall, cabinets, caulking, doors, etc.) This is critical not only to obtain loan approval, but also because percentage of completion inspections will be done and payment made by these categories. Frustrated contractors have been known to get angry enough to halt work when payments are delayed and that can leave you with an unfinished house.

Assure the Contractor Uses a Custom HUD-formatted Estimate
203k loans need to have contractor estimates formatted into the 35-category outline to match HUD draw request format, in addition to providing line item detail as outlined above. Wrong formatting can delay loan approval, closing, interval payments and project work completion.

Before you even send a prospective contractor out to view the house you would like to buy, ask them if they have ever done a 203k loan before, and if so, ask them to send you a sample of a past client’s estimate so you can review the formatting.

Send the Prospective Contractor the Full Application Packet
At the same time, get a copy of the blank contractor’s 203k agreement/application packet from your mortgage person. Email it to the contractor and tell him to review it to assure he meets all the criteria and is prepared to provide all of the references, completed application, copies of insurance for himself and any of his subcontractors. (These final packet submissions can be up to 36 pages long per contractor.) If you are working with a truly professional contractor they will have a preliminary packet already created and available that includes resume, references up-to-date licensing and insurance. Click here to see ours.

The Right Insurance Can Save You… (and your house)
It is very important to understand that in order to fully protect yourself, you should work with a contractor that has BOTH liability and workers compensation insurance. If a contractor has an accident while working on your property and they only have liability insurance, sign a liability waiver, or have only a workers comp insurance EXEMPTION certificate, then the homeowner IS personally liable, unprotected and can be sued. ONLY workers comp full insurance will protect the homeowner. The contractor who can handle all the paperwork for a 203k loan and carries workers comp insurance is going to be a bit more expensive. But you will truly get what you pay for and you must ask yourself if you are willing to risk loosing your new home in a legal dispute or having months of delays in completing the work. Here is an quick Fact Sheet about insurance to assist you in understanding the legalities about insurance.

The 24-Hour Contractor Interview Test
Set up a clear expectation with the contractor as you interview them by phone, that you will need to receive a sample copy of their estimate format via email, and copies of their certificates/proof for BOTH Liability and Workers Compensation insurance. Set up the next contact directive that they will need to call you back within 24 hours to schedule the estimate walk-thru at the property. Hint: this is a test. Contractors usually panic when they see the huge 203k application packet they must fill out, and are less than honest about knowing how to format the estimate itself. They also tell you they have insurance, then can’t produce proof when you call them on it. Let them know you don’t need customized certificates from the insurance company made out in your name yet, just a blanket proof of insurance certificate. If they are not organized to easily produce these things within your 24-hour timeline, then they will NEVER survive the 203k paperwork circus. When they don’t call you back, you will already know that you can’t trust them to handle the huge admin required.

Plan ahead and expect it may take time to find a contractor who passes the Admin test.

How Long Estimate Creation Should Take
You will also need to plan ahead and expect that a good contractor will need to be given at least 5-7 business days to complete all of the paperwork and compose the detailed estimate AFTER the walk-thru with you. This is not a process that can be done in 1-3 days. A general contractor must not only conduct their own strenuous financial breakdown to meet your loan guidelines, they also must wrangle subcontractor estimates on your behalf for licensed specialists such as electricians, HVAC, plumbing, roofers, etc. A good general contractor will tie it all together for you, and handle less professional industry subs. That is what you are looking for.

How Profit Must Be Handled in the Estimate Process
Keep in mind that contractors working with you on a 203k loan have huge admin responsibilities, estimating time, coordinating requirements AND you are expecting that they will have to pay out of their own pocket, up front on your behalf, to complete the purchasing and bulk if not all the work weeks or months prior to getting paid. That can add up to tens of thousands of dollars for some jobs. This service is not free, and contractors need to cover this overhead plus make a bit of a profit to justify the job. Another element in 203k contractor estimates that must be handled differently (and your contractor should know this), is how profit and overhead costs are required to be built-in. Contractors can not build these estimates in blocks of work broken down by room or project the way that is standard in the industry. Every item must be broken down by labor per hour and detailed material costs, and there is no separate line item allowed for profit and overhead. This means that every tiny element must have contractor profit and overhead costs built into it, while still staying in alignment with reasonable, visible, item pricing. This is a complicated mental exercise that can further frustrate a contractor, and attributes to why you must give your selected contractor plenty of time to create the actual estimate.

Rushing Can Cost You - Use an Inspection Report
Keep in mind that you do not want to rush and get a Ball-Park estimate to get to closing faster. A 203k estimate becomes a legal contract and if additional rehab items are needed that were not planned for in the original estimate, then the homeowner must pay cash out-of-pocket to the contractor for these. Some FHA loan guidelines also require very specific rehab elements be included in the project or the loan will not be issued. The best way to control your project and know what needs to be on the contractor estimate in the quickest amount of time is to first obtain a formal homeowners inspection of the property complete with photos and extensive report. Provide this inspection report to the contractor BEFORE they do the in-person estimate walk thru with you, and use it yourself to coordinate and make decisions about what will and will not be included in the renovation.

The Pitfalls of Using Multiple Contractors
It is NOT recommended that you use multiple contractors on the same 203k project who are not coordinated under one general contractor. Yes, you can do it…but you will then have to take on the role of coordinator, deal with multiple payments, etc. Each contractor must complete the full 203k loan application packet with their estimate, and this doubles or triples your chances for delays at closing. This can also cause permit and inspection delays, and nightmares with multiple inspectors failing inspection points based on the mess one contractor makes that interferes with another.

The Rules about Doing Work Yourself
If you are trying to save money and plan to do some of the work yourself, be aware that 203k loans restrict this for most elements unless you, yourself are licensed to work in the field as a contractor of some kind. Also, a good contractor will not let you work on a project as long as they are on site, even if it is your own house, due to permitting and insurance liability issues. For example, a homeowner in Florida was not allowed to participate in painting their renovated bathrooms. The loan and closing were delayed while the homeowner argued about this and lost. The contractor was required to handle all bath renovations including painting due to potential mold and mildew issues.

Assure Lead Testing is Done with the Estimate
Verify the age of the property you are considering buying. If the property was built in 1979 or earlier, new EPA regulations require that you use a contractor that is EPA certified as a lead-renovator to conduct a lead test. If your proposed contractor doesn’t know this, you should reconsider using them. A lead test must be conducted or huge fines can be levied. (Not to mention that your family could get sick!) Also, if lead is found in your house, it will cost thousands of dollars to remove it and renovation of the property must be conducted completely differently. You must assure that your original 203k contractor estimate includes this financially.

Check for Open Permits and Illegal Additions
In addition to lead-testing, it is also important that you ask if your contractor has called the county/city and assured that the records on file match the current structure of the house AND that there are no open permits that did not complete inspection. Homeowners are notorious for adding illegal additions, bathrooms, enclosing garages, adding patios and more. If any structural changes were added without proper permitting and final approved inspections it can completely change the costs involved in renovating your property, and you must know this before you close or sign off on the contractor’s estimate. Some county inspectors will require that entire additions be torn down if proper inspections and permitting were not originally done. This is because there are stages to renovation that get covered by concrete, drywall, etc. and can no longer be properly inspected once finished. Other times, unknown water tables or other issues may have made the addition of a bathroom completely illegal or unsafe.

Assure the Contractor is willing to work without Payment for 3-6 months
Getting the contractor paid is ultimately the responsibility of the homeowner, and due to the fact that 203k loan payments can take 3-6 months to receive from the bank, it is important that you discuss with the contractor in your initial interview this fact. Ask them point-blank if they are prepared to begin and finish renovation on your property then endure the possibility of having to wait for up to 3-6 months to get paid. This will not always be the case, but even in a good scenario there will be delayed payments and bank issues beyond your control.

Payment Scenarios and Homeowner Responsibility
Different payment scenarios exist under different lenders and types of 203k loans. Ask your mortgage banker for a written outline of the payment policies for the loan so you will know in advance. Hint: angry contractors may tell you delayed payment is no problem but later can halt work on your job, put a lien on your house, and hold items like kitchen appliances and bath vanities hostage if they don’t like how long it takes to get paid. Some loans provide a 40% rehab loan draw payment issued at closing. Other loans force you to wait until a larger bank organization buys out your mortgage to even begin to get paperwork or a draw payment for your contractor. We have seen this promised on a 4-6 week timeline and still not seen paperwork for 3+months.

The 3-Party Check Nightmare
Remember, again, it is ultimately the responsibility of the homeowner to get the contractor paid. You are asking a lot from the contractor up front and need to be just as organized and dedicated yourself to getting them paid. All rehab draw payments and checks will come directly to the homeowner and be made out to ALL mortgage holders AND the contractor. This means that ALL MORTGAGE HOLDERS AND CONTRACTOR must go to the bank to cash the check TOGETHER. If you have a co-signer on your mortgage loan and they live out of state, they will have to fly in to go to the bank with you. If you are thinking we are exagerating about this, or that you will magically find a way around it, we can tell you that WE had to get on a plane from Florida to New York to get the last check cashed and it was 6-months late! Bank of America's 203k mortgage disbursement department absolutely refuses to remove any of the three parties names from the check, and the local banks don't want to do "signature guarantees" on either end for parties not present at THEIR bank. Unfortunately as contractors, we have actually reached a point where we decline to work with any new clients who will have this multiple-mortgage holders/out-of-town/3-party check situation pending because Bank of America (the primary 203k lender in the USA) refuses to give us a check we can cash. If you currently find yourself engaged in battle about this or wish to investigate further, remember that your original mortgage broker is out of the picture and can't help once you have closed on the purchase of the property. The direct telephone number you need to call to get assistance is the Bank of America 203k Disbursement Department at: 1-800-293-8155. FYI - be wary of any sales pitch by a mortgage broker that simply assures you that this will not be an issue. These folks never have to deal with this after they close on your house. Demand they provide you in advance with a phone number DIRECTLY to the 203k Department of any bank that might be financing your loan.

Working with a HUD Consultant - Pick a Firm not an Independent
Some 203k loans (usually for amounts $15,000 or less) are completely the responsibility of the homeowner to call and schedule inspections, fax in draw request paperwork, etc. More expensive 203k loans will be assigned a HUD coordinator/inspector. Be aware that these consultants are paid a few hundred dollars to review contractor work, perform on-site inspections and submit paperwork. Usually selected by your mortgage person prior to closing from an area list, it is important that you obtain their contact information in advance and be ready to coordinate between them and the contractor to see that things run smoothly. Some consultants are fantastic; others have little or no training, don’t prepare proper paperwork for draw requests and will walk off your job site and leave you with no support if they don’t get their $250 on time from the bank. Insist on seeing the list your mortgage person is using to select your consultant from and try to pick one that works for a large firm rather than an independent consultant. At the very least, make sure you provide your selected contractor with the HUD Consultant contact information.

Always Require Permits
Permitting is a critical element required by 203k loans. Assure that you or your contractor obtains city or county permits before starting your work on any element that will require one. Copies of final inspections and all permits will be required prior to getting any loan pay-out for rehab. Not having obtained a permit in advance could be a violation of your loan agreement.
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We hope that this information assists you in understanding the 203k process and finding an excellent contractor to turn your property purchase into your dream home. There are many less expensive properties on the market today thanks to foreclosures and the real estate crisis that can be perfect for using a 203k loan to renovate. This means buyers have more selection, and do not have to stress about coming up with cash after closing.

If you are looking for a qualified 203k Contractor in the Central Florida area, we hope you will consider us to assist you with your project. We are additionally the official contractor for Homemakers Real Estate, and here are some additional links to learn more about us:

203k Facts & Resources thru Sherwood Construction

View Samples of our Rehab Work

View Before and After Photos from a Few of Our Projects

Please feel free to email us if you have any questions, or if we can be of assistance to you.