The FHA fixer-upper loan, technically called an FHA 203(k) mortgage, is for those who want to purchase property which is in need of repair. The borrower purchases the property with the understanding that it must be renovated or repaired by the purchaser (with funds from the loan) as part of the loan agreement.
Borrowers apply for this type of home loan in a different manner than for new purchase loans where the property must be in acceptable condition–the loans known as FHA 203(b) mortgages. For the fixer-upper or 203(k) loan, the borrower applies for a loan and agrees to make a down payment for at least 3.5% of the purchase price and repair costs of the property.
According to FHA loan rules, the buyer finds the right home and gets ready to execute a sales contract. But unlike a typical new purchase home buy, the purchaser orders a “feasibility analysis” from a real estate professional. When the buyer is ready to commit, the sales contract needs to include language regarding the fact that the buyer wants a 203(k) loan and that the contract is “contingent on loan approval based on additional required repairs by the FHA or the lender” according to FHA rules.
In addition, the borrower must submit to the lender a “detailed cost estimate” for each repair or improvement included in the project.
FHA rules add, “If the borrower passes the lender’s credit-worthiness test, the loan closes for an amount that will cover the purchase or refinance cost of the property, the remodeling costs and the allowable closing costs. The amount of the loan will also include a contingency reserve of 10% to 20% of the total remodeling costs and is used to cover any extra work not included in the original proposal.”
When the deal is closed, the seller is paid, and the remaining portion of the loan is placed into escrow to fund the repair/upgrade portion of the rehab project. Borrowers must begin making mortgage payments once the loan is closed, but FHA rules state that up to six mortgage payments can be added into the cost of the property repairs “if the property is not going to be occupied during construction”.