Refi storm-ravaged homes with special FHA loans

Yellow oceanfront home damaged by hurricane sandy

It's very difficult to refinance homes that have been badly damaged or fallen into disrepair.

But you can do just that with what's called the FHA 203(k) loan and come up with the money you need for repairs in the process.

Although they're normally used to purchase and restore properties that have deteriorated from neglect, these FHA loans can also be used to refinance and fix homes ravaged by natural disasters like Hurricane Sandy.

The U.S. Department of Housing and Urban Development has pledged to speed federal disaster assistance, including 203(k) loan funds, to affected homeowners in New York and New Jersey.

Some banks that make these loans are even promising to waive application and closing fees for eligible disaster victims.

“The FHA 203(k) loan is a great loan to help fund necessary repairs due to natural disasters,” says Sue Pullen, regional vice president at Fairway Independent Mortgage in Tucson, Ariz.

For example, homeowners who learn that their insurance won’t completely cover the damage can use a 203(k) loan to refinance their existing mortgage and get extra money to make repairs.

If the home needs only minor repairs that can be completed for less than $35,000 and in fewer than six months, the streamlined 203(k) loan is an option, she says.

Examples of minor repairs include a new roof, new flooring, new appliances, new paint, new doors, and new air conditioners and heaters. The streamlined loan will not cover pool repairs or landscaping, nor does it allow homeowners to add square footage or move walls.

“If the home has more extensive damage, then the standard FHA 203(k) renovation loan could work. This loan does allow for structural issues to be repaired as well as more costly repairs,” Pullen says.

Even a condemned or demolished house can qualify for this loan if the home is at least a year old and the foundation is kept in place. (As you can see from these photos from Far Rockaway, N.Y., many homes fall into the demolished category.)

The loan can also be used for deferred maintenance and renovations that disaster victims may want to address while they already have the disruption and hassle of dealing with construction work.

“The program is available all the time, but when a natural disaster arises, it’s an option most people don’t even know exists,” says Jeff Onofrio, director of renovation lending at AnnieMac Home Mortgage in Mount Laurel, N.J. “203(k) loans are available to everyone as long as the home is a primary residence.”

Most surprising is that the FHA will lend you more than the home is currently worth, as long as the repairs will increase its appraised value.

The most you'll be allowed to borrow is 107.525% of what it will be worth after all of the work is done.

Also, because 203(k) loans follow normal FHA underwriting guidelines, you can qualify with a lower credit score and more debt than a conventional loan would allow.

Demand for construction materials and contractors increases during a disaster recovery period, so any construction or renovation projects will likely cost more than they would in calmer times.

The 203(k) loan amount cannot exceed the property’s expected post-renovation value, so the increased costs may limit your scope of work.

You’ll also need to allocate part of your renovation budget to making sure the home will meet the FHA’s standards for energy efficiency, structural soundness and habitability as well as local housing codes and ordinances. If you’re doing structural repairs, you’ll need architectural drawings, too.

“The interest rate can be a little higher than the regular FHA loan, and there are additional fees associated with the renovation loans,” Pullen says. “But these loans are a great way for homeowners and home buyers to fix up properties without using their own funds and/or credit cards to finance the repairs.”

Onofrio says that right now, 203(k) loan interest rates average 3.75%.

A regular FHA loan averages 3.25% in today’s market. The 203(k) loan costs more because of the extra risk associated with construction projects.

Philip Georgiades II, a specialist in government mortgage products for VA Home Loan Centers, also points out that borrowers are required to pay all of the usual FHA mortgage insurance premiums.

These include both an up-front premium, which can be rolled into the loan, and monthly premiums.

“Also, there is the additional cost for financing the repairs when compared to paying for the repairs out of pocket. A $30,000 repair can cost you an additional $60,000 in finance charges if paid over 30 years,” Georgiades adds.

Borrowers also face possible contractor nonperformance and unforeseen expenses, he says.

“The funds for the 203(k) loan are released in stages and only when the prior stage is complete. If the contractor takes the funds and does not do the work, you may have to pay another contractor to finish that particular stage,” he says.

Finally, Georgiades says, obtaining contractor bids can delay the close of escrow for a 203(k) loan, and you may have to pay for temporary housing until your home becomes habitable.

However, 203(k) loans allow homeowners to finance the first six months’ worth of mortgage payments. This provision can ease the sting of paying for temporary housing.