If you are interested in buying or refinancing a home to renovate with an FHA mortgage, the FHA 203(k) loan is a great place to start exploring your options.
The FHA 203(k) rehab loan comes in two varieties-one for larger and more ambitious projects, and a smaller “limited” 203(k) that offers smaller loans for simpler repairs/renovations.
The 203(k) loan involves hiring contractors and having work done according to both FHA home loan minimum standards, but also requires that the home be brought into compliance with applicable building codes.
Lender standards, state law, and FHA home loan rules will affect how this transaction is conducted.
One FHA requirement is the FHA rehab loan contingency reserve, which you can think of as a “rainy day fund” in case there are unexpected costs or longer-than-expected labor issues.
The FHA Loan Handbook, HUD 4000.1, has instructions for the lender on how this reserve is to be kept and used.
HUD 4000.1 starts off the section on 203(k) contingency reserves with a definition:
“Contingency Reserve refers to funds that are set aside to cover unforeseen project costs…the minimum and maximum Contingency Reserve is established as a percentage of the Financeable Repair and Improvement Costs.”
HUD 4000.1 has a list of situations where a contingency reserve is required. These requirements will vary depending on the age of the property, the nature of the rehab loan (standard or “limited”) and circumstances that may affect the work, such as evidence of termite damage.
For structures 30 years old or less, a certain percentage may be required at the lender’s discretion and for termites when the evidence warrants it. For homes older than 30 years, a percentage may be required if utilities are not operable at the time the Work Write-Up for the project happens.
There is also a required percentage for homes older than 30 years rather than a percentage required at the lender’s discretion.
The borrower is permitted to provide funds for the contingency reserve if so desired, according to FHA loan rules.
As always, lender standards and other rules may apply above and beyond these FHA home loan standards. Have a conversation with a loan officer if you aren’t sure how these rules might affect your transaction, or those of the lender.