There are some great bargains right now in foreclosed homes but they often aren't in the best of shape. Fortunately, the FHA's 203(k) program allows you to both buy a house and fix it up with a single mortgage loan.

The FHA 203(k) mortgage is designed for fixer-uppers. You can borrow up to 110 percent of the expected value of the property after renovation to pay for both the purchase and home improvements. You can even do the work yourself, provided you're qualified to do so, although the FHA will likely insist that you hire professionals for more demanding projects.

Many foreclosures need repairs

Foreclosed properties can be in poor condition for a number of reasons. To begin with, if the previous owners couldn't make their mortgage payments, they probably didn't keep up with routine maintenance either. Second, foreclosures often stand vacant for a long time before they are purchased, and may deteriorate during that time. Finally, homeowners facing foreclosure sometimes remove appliances and other items of value, or simply damage the property to spite the bank.

On the plus side, these are some of the reasons why foreclosures sell at a discount in the first place. Quite often, they can be purchased and put back into shape for considerably less than you would spend on a conventional home purchase with only minor upgrades needed.

Streamline option for basic improvements

There are two types of FHA 203(k) loan. If the home only needs modest improvements, like a new roof, new appliances, kitchen remodeling, repairs or upgrades to heating, electrical and plumbing system, floor repairs, basement refinishing and the like, you can apply for a streamlined 203(k), also called a modified 203(k). This will allow you to borrow up to $35,000 with more simplified application requirements than on the standard 203(k).

The standard FHA 203(k) is used for more extensive improvements, those costing more than $35,000 or involving structural work. This might include adding an addition, repairing structural damage, moving a load-bearing wall or any kind of work that involves detailed drawing or architectural exhibits.

Borrow up to 110 percent of improved value

In either event, the maximum you can borrow is either 1) the total of the purchase price and planned improvements, or 2) the estimated improved value of the home plus 10 percent (110 percent of the improved value), whichever is the lower of the two. In any event, you'll need an appraisal done to calculate what the improved value will be.

In addition, you'll need to prepare a work plan showing what you plan to do and the cost of the materials and labor. You can do the work yourself, but must show that you are qualified to do so. In addition, you must include a provision for the cost of the labor, so that you can pay to have the work completed by professionals if you are unable to do so in a timely manner - you're allowed six months for do-it-yourself projects.

Limited to owner-occupants

The FHA 203(k) loan program is limited to owner-occupants - you must live in the home once renovations are complete. However, the loans can be used to purchase and improve multiunit homes of up to four units, provided that you make one your residence. The loans can also be used to divide a single-unit home into multiple units, or turn a multiunit property into a single-family residence.

Not all FHA lenders deal in 203(k) loans, so you may have to do some looking around to find one who knows how to handle them. You can also expect a somewhat longer closing period than on a regular FHA mortgage, usually about 45-60 days.

Buying a foreclosure

When shopping for a foreclosure to buy and rehab with an FHA 203(k) mortgage, your best bet is to focus on what are known as real estate owned (REO) properties. These are bank-owned properties that went unclaimed at the foreclosure auction. The reasons for doing this is that 1) you can't arrange FHA financing for properties bid on at a foreclosure auction and 2) you can inspect and assess a bank-owned property beforehand.

Finally, FHA 203(k) mortgages are not just limited to foreclosures - you can use one to buy a home through a conventional purchase and rehabilitate it as well. But with all the discounted foreclosed properties on the market these days, that's likely where you'll find your best opportunities.

    Published on January 18, 2009