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Using FHA 203k Loans To Rehab Your Short Sale or Foreclosure

December 6th, 2010 by Randy Whiting

There are a few common ways that I have seen an FHA 203k loan used.  Predominantly the clients I’ve worked with use this type of loan to purchase a property that either needs some general rehabbing throughout or to finish a job that was left incomplete for one reason or the other.  As rehab loans of any other type have virtually disappeared the FHA 203k loan has been on the tip of many buyer’s tongues lately.  The only challenge is that the type of property that would motivate a buyer to seek this type of loan typically ends up in a multi-offer situation; speaking in terms of my local market.  If you had a chance to read my short article on TheChicago77.com entitled, “Short Sale and Foreclosure Multi-Offer Strategy“ or you have had any experience as a buyer or buyer’s agent attempting to purchase distressed properties then you already know that in a multi-offer situation an FHA 203k loan gets the lowest priority of any offer on the table.   For an in-depth explanation of why please visit the article mentioned above.  The long and short of it is that the FHA 203k loan has a huge amount of contingencies, outs, or reasons to fail before close, and that is very unattractive to a bank.  As banks are the ultimate decision makers in many distressed property sales it is their opinion that counts, and they want nothing more than the quickest close possible.

Clearing The Air

I’m sure there will be some of you reading this who have used an FHA 203k loan to buy a distressed property, and I do not mean to say it is impossible.  Local market conditions significantly impact the possibility that this loan will be accepted for the purchase of a distressed property.  For example, with most suburbs of Chicago and a few of the fringe neighborhoods of the city proper the competition is virtually nonexistent.  A bank attempting to sell a property in areas with low demand are often so desperate for any type of offer that on the slight chance that one comes it matters not what type of loan it is; they’ll pounce on it like a starving cat.

Back To Business

The purpose of this article is to illustrate an example that worked out very well for a buyer that I have been working with for quite some time.  As with many savvy investors my client was very particular about what he wanted in a property.  His goal was to find a distressed building, preferably a multi-unit, and convert it into a beautiful modern single family home for himself.   As such it took us quite some time to locate the perfect property.  When we finally did it was a gutted two unit that had little more than the bricks, the studs and a pile of rubble lining the floors.  With an asking price of around 180K it was ripe for the plucking.  When he asked me to put an offer in on the place, protocol demanded a pre-approval or proof of funds and I asked him for such.  A few moments later he forwarded me a pre-approval letter from his lender for an FHA 203k loan.  Knowing what I know about this type of loan and also about the desirability of this type of property to other investors I correctly surmised that a multi-offer situation was at hand.  Given a very small number of days on the market, there was little chance the seller of this property would jump on a 203K loan.  Instead, they would graciously acknowledge our offer and hold out for something more attractive; cash or a conventional loan offer with a low number of contingencies.  Given this, I called a couple lenders who I know that have their fingers on the pulse of the lending market and we came up with a solution.

The Challenge

Our challenge was how to make our offer stand out on top versus the others that were sure to come.  Knowing my client had enough cash to buy this property with some to spare, I asked him why he chose an FHA 203K loan.  He gave me the answer I was expecting, “I want to save my cash for the rehab.”  Knowing what we now know about the low desirability of this type of loan it was only natural that I council him on the unlikeliness that his offer would be considered.  As the ball was in my court to find a superior alternative I shared my discovery with him.

FHA 203K Refinance

Let me cut to the chase.  If you buy a property with cash there is no title seasoning requirements to re-finance the property with a 203K loan.  As such the refinance can happen immediately after purchase.  Combine that with the huge desirability of cash in the eyes of the seller and this significantly increases the likelihood of a win-win situation.

What If I Don’t Have Cash?

Here’s the good news for investors out there who want to take advantage of this scenario but don’t have enough capital to purchase with cash.  The FHA 203k refinance has the same title seasoning requirement (zero days) if you purchase with a conventional mortgage.  In other words, if you buy a property with a conventional loan, right after you close you can turn around and re-finance it with a FHA 203k loan allowing you to obtain extra money to do some rehabbing on the property.  So why not make the initial offer with an FHA 203k loan and why did I not recommend a conventional loan to my client and encourage him to save the cash for the rehab?  To get that answer I suggest you read my article on Multi-Offer Strategy.

Ciao for now!

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