Friday, February 1, 2008

Foreclosed-upon home, even ones....

... needing repair, can be a promising option for owner-occupant buyers.

Investors have been in the market for rehabilitating properties for years now. New buyers have entered the rehab market of late, however, and they are not in it merely for fun or profit. These buyers are looking at foreclosed-upon homes, even ones that need fixing up, to move into themselves.

With an ever-increasing number of foreclosed-upon homes entering the market -- about 750,000 in 2007, -- you may be interested in purchasing a foreclosed home in need of work, if you are going to live there.

Many buyers are afraid of further price declines if they buy a home at today's market value. In some cases, buyers simply can't afford a market-value home -- but they can afford the price of a foreclosed-upon home and the repair costs.

You must be familiar with options for the combination of construction and mortgage financing that you may need and how the process will work.

Financing options (borrow up to $25,000 without banks, tap here)

Owner-occupied buyers are not treated the same way as investor buyers. These buyers often are not inclined to pay the types of rates and fees a hard-money lender would offer.

Therefore, you are left with three options:

1. Private construction loans with a single or double close: Many banks have their own construction-loan products, and they typically offer a choice between a single or double close.
Single-close loans start at a higher "construction rate," and then, once the work is certified as completed, the rate drops for the life of the loan. With a double-close loan, borrowers close on a construction loan and then return to close a second end-loan for the home once work is complete.
2. Federal Housing Administration (FHA): FHA has two options for you. The standard FHA-backed loan, with a small repair escrow attached, will work for properties where needed repairs are limited to a few-thousand dollars and the appraisal supports the increased home value. To complete the funding, you will need to get three competitive contractor bids for completing the work and escrowing the funds.

If repairs exceed $5,000, however, then you will be eligible for the FHA 203(k). The 203(k) program has one significant additional requirement: the FHA-approved 203(k) consultant. Clients must pay for the consultant in advance and work with the consultant throughout the funding process.

Although a consultant creates an extra safeguard for clients, this person can also mean extra paperwork for the broker and additional delays.

3. Government-sponsored-enterprise (GSE) loans: Standard agency loans may be the best option for foreclosure buyers. GSEs offer single-close options with one low rate for the life of the loan. In addition, with the Fannie Mae HomeStyle product, borrowers can receive renovation funding equal to 50 percent of the "as completed" value of the home.

This can work in the borrowers' favor because with foreclosed homes there is typically a large discrepancy between the home's purchase price and its as-completed value. Therefore, a GSE loan may allow the borrowers to get their home with a minimal amount of cash invested upfront and give them a good equity position at the end of construction.

The loan process

When you find a home, you need to decide if it is viable from an economic perspective.
Is the home livable in its current condition? Has the home been damaged by fire? Is there evidence of mold? Is the home condemned?

A property that looks bad in photos will have a hard appraisal review and will need additional inspections -- if the loan even survives the review. If the property is fire-damaged, you'll likely need additional engineering reports. A property with mold might need an estimate for remedy costs and additional environmental certifications. If the property is condemned, the bank will want the condemnation lifted before it will finance.

You should know about the possibility of these additional fees. If the house is condemned, then you probably can't get traditional financing and should look for another home or consider using a hard-money lender.

If the property is a good candidate for bank financing, you need to get a contract with the bank of sufficient length to process the loan. Although construction loans normally take about 45 days, a 60-day contract is usually the best option. It allows for extra time for back and forth between the bank and the contractor, if needed.

Once a contract is in place, you need to get a bid from a bonded and licensed contractor and get a corresponding budget. The contract needs to specify the work to be completed and the phases of the project. The proposed budget must accurately follow this contract. You must prepare a credit package and send this to the bank, in addition to a separate project package containing the contract and budget.

The most common problem at this stage is reconciling the budget to the contract and ensuring that the contract adequately explains the work needed. Contracts and budgets do not need to include minutia such as nails or screws, but they do need to include things such as fixtures and the level of finishing that will be done in every phase.

Problems can also arise if you and the contractor start revising the contract verbally before closing. This happens frequently, and you must strongly guard against this. Everything should be in writing, and the contract the bank gets should reflect all work to be done.
You should never assume anything related to contractors and should always ask for clarifications. Have your attorney review all contracts.

After the final project approval and your credit-file conditions clear, you will receive your cost-to-complete information and can schedule a closing. The closing will reflect the construction money to be escrowed, along with inspection fees and other documents related to construction draws.

As the housing crisis continues and foreclosures mount, owner-occupant buyers will recognize the tremendous equity and safety they can gain from buying homes needing renovation.

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