Several options are available for construction financing. The first option is a new first mortgage intended for rehabilitation finance – the programs are called HomeStyle and 203k, are offered by Fannie Mae and FHA, respectively, and allow up to 97% of the as-completed value of your home in total financing. The benefits to these programs are that you can do one loan instead of two, they are 30-year fixed loans, and potentially provide for all of the rehab funds that you will need.
The second option is a construction line of credit. With a construction line of credit you can keep your existing first mortgage and add a credit line for the improvements. The benefit with a construction line of credit is that it uses the as-completed value of your home. The disadvantage is that it has to be refinanced when the construction is done.
The third option is a home equity line of credit. The benefit to a home equity line of credit is that you can keep your first mortgage as-is. The disadvantage is that the interest rate is variable, and the current amount of equity is all that is available to borrow.
It might be helpful to get the details of your existing mortgage together with the amount of improvements that you want to make and then we can put figures to this.
As-completed value compared to current value
The as-completed value is an estimation that an appraiser will make based upon the improvements intended for your home. When an appraiser does an as-if appraisal based on an as-completed value, he or she will want to see a bid from a contractor detailing the improvements that will be made. The appraised value that is calculated is then based upon the physical attributes of your property with the to-be-completed repairs included compared to other homes in the area that have sold recently. If the as-if value supports the improvements that are going to be made then financing is available for the project as long as other qualifying criteria are met (credit, income, etc). An example of a repair/improvement that drives value is a kitchen remodel. A repair that doesn’t necessarily drive value is painting to change the color of the property. The appraiser is looking for material changes to the property that drive value. The current value of the property is determined without any of the potential improvements being completed.
Fannie Mae Homestyle
This program allows for financing of renovation/repair funds. The loan amount can be up to 97% of the as-completed value. The financed repair costs cannot exceed 75% of the as-completed value. What this means is the loan program can be used to purchase or refinance a home and include funds to complete the purchase or pay off an existing mortgage.
Here are some commonly asked questions on details:
The benefit to Homestyle over the FHA 203k program is that mortgage insurance is not required if the amount of financing doesn’t exceed 80% of the as-completed value. If mortgage insurance is required (loan amount > 80% of value), then it comes with options.
Fannie Mae loan limits apply (currently $453,100 for a single family home in MN), and the application must gain approval through the Fannie Mae automated underwriting system. Contact us for details on what we need to submit the application.
FHA has two programs under the 203k umbrella. The 203k Full allows for major remodels that include structural changes (additions, tearing down walls, etc). The 203k Limited does not allow for structural changes, but includes the ability to finance most other types of repairs/improvements.
FHA 203k Limited allows for up to $35,000 in included financing for repairs. Some of this goes towards construction inspection costs, title updates and potentially permits (unless the contractor obtains them). This amount also needs to cover the contingency reserve, determined by the age of the property, and is generally 10-20% of the repair estimate. We advise keeping the contractor bid below $27,000 if you plan to finance all of it.
FHA 203k Full allows for up to $100,000 in repair costs, again including inspection/title and contingency reserves, but also including the cost for a HUD inspector/project manager.
FHA loan limits apply for these programs, currently $356,500 in MN for a single family home (higher for multi-unit homes) and FHA underwriting applies. Contact us for details on what is needed for approval.
TO REFINANCE OR NOT TO REFINANCE?
That is the question, but how to find the right answer? First things first – have your goals together. Mortgage Lenders are great at putting together loan options, but they are often times basing those options on what you tell them. If you are asking for the lowest rate, they will put those options in front of you, but surprisingly they may not always be the best options. Wait!? What, the lowest rate isn’t always the best option? Of course not – considering that the lowest rates are adjustable, or shorter loan terms with payments that may be out of reach for you. So, let’s look at your goals for the refinance:
Number 1: I WANT TO SAVE MONEY!
Everyone likes to save money – we like to save money! That’s why we’re writing this blog instead of mailing you a letter. Letters cost stamps! Let’s be more specific: do you want to save money now, as in lowering your monthly debt payments, or do you want to save the most over the term of the loan? Are you struggling to make the payments you currently have, or does your end of month surplus cash look like the US Treasury’s?
The best place to start is by looking at your budget. How much are you spending on all of your debt each month? Is that a high or low percentage of your monthly income? Do you have discretionary funds? Do you have a large amount of unsecured debt? How did you get to where you are and what changes need to be made to not get there again (if it’s not where you want to be)? Is your retirement savings on track? Having the answers to these questions before approaching a refinance is a great idea. Even better – meet with your financial planner before talking to your lender to help put these answers, and goals, together. Define what “saving money” looks like for you first.
Number 2: I WANT TO LOWER MY PAYMENTS
Debt isn’t much fun (well, it is for us, but for different reasons than you would think), but what it offers can be great. Mortgage loans are necessary for most people to own a home. We think owning a home is great! Auto loans are generally necessary to finance your transportation. Student loans – education. Credit cards? We’re not much of a fan of these. Using a credit card for convenience and paying off the balance each month? That’s generally a good thing. Credit cards are bridge financing if you carry a balance – the interest is costly and paying the minimum will take forever to pay off the balance. The point is: carrying the right kind of debt is ok, but eliminating the wrong debt is essential to your financial health. Sounds like we are talking about cholesterol here and the analogy works: having a mortgage loan is like HDL- your financial health is better with this kind of debt, but high a high credit card balance is like high LDL and puts your finances on the path of systemic failure. Refinancing offers an opportunity to right the ship, a “statin” for your system. By eliminating the bad debt and restructuring/lowering your monthly debt payments you can bring your finances to a better place. But beware – the last thing you want to happen is to combine all of your debt, lower your payments and then go on a spending spree. It’s important to take full advantage of the opportunity and create a sound financial plan to avoid adding the “LDL” debt again in the future. If your payments are reduced, plan to put some emergency money away and make sure you can pay off that credit card each and every month for good.
Number 3: I NEED TO FIX OR IMPROVE MY HOUSE
Construction loans, credit lines, fix up funds and often times local money is available in addition to your existing mortgage loan. Sometimes it doesn’t make sense to refinance your current mortgage just to get some money to put a new roof on the house. Look at the terms of your current mortgage and what is available from your lender. If the interest is going up on your current loan by more than what you would save on the construction financing portion, then just add the construction loan instead. Generally construction financing rates are higher than first mortgage rates, but if you are borrowing a small amount or your current mortgage has a much lower rate, then adding the secondary financing is a better option. If the construction project is larger, then it might make sense to refinance to a construction loan program like FHA 203k or Homestyle so that you can make the improvements and get a low, fixed rate loan for the project and your current mortgage balance all in one.
Number 4: I WANT TO LOWER MY TOTAL COST
Long term planners – this paragraph is for you. How much does the rate need to decrease for a refinance to make sense? If your other debt is in order, and your home is perfect as-is, then let’s look at break even points and a cost-benefit analysis. The absolute way to compare your current loan to a new loan is how much and how long. Take your current payment times the remaining term to calculate a total cost on your current loan. If the refinance option reduces that total number by an acceptable amount, by the same math (how much times how long), and the payment works, then it generally makes sense to do. Let’s look at an example:
Current principal and interest payment (exclude taxes and home insurance): $1200
Remaining number of payments on your loan: 280
Total cost: $336,000
New 15 year loan principal and interest payment: $1516
New total cost: $272,880
If the higher payment fits into your budget, this certainly makes sense to do if you are looking for long term savings. Even if the refinance costs $3,000, the savings is about $60,000 over the term. This is a common scenario right now for many 30 year loans with rates in the mid-4% range to refinance down to a 15 year term. You should also compare the total cost on your current loan if you simply increased the payment, but generally the refinance will add up to more savings.
The other calculation you need is the break even point. At what point in the future will I recoup all of the costs of doing the refinance? Two ways to calculate the break even offer manipulation of this time frame. One way to calculate break even is on the interest savings. If you save .625% in interest on the loan (reducing the rate by this much) and the refinance costs 2.375% of the loan amount, then it will take 3.8 years to recoup (ignoring time value of money and the decreasing benefit of interest savings over time). If you are a spreadsheet guru you could put this into an amortization table and calculate the exact break even by interest savings, but hey, life isn’t exact anyway. The other way to calculate break even is on a cash flow basis, but this isn’t as effective a calculation. If the monthly payment savings is $300 and the loan costs $6,000, then it will take 20 months to break even. The reason this approach is flawed is that you might be extending the term on your loan for this payment savings, which would potentially cost more in the long run. The simple formula here is: cost divided by benefit. That will yield the break even point. Have your lender help, and if they don’t know how to calculate this for you, then find a different lender!
Number 4: I WANT TO REDUCE MY TAX BILL
Mortgage interest is tax deductible. If you consolidate other debt that doesn’t have tax deductible interest, you could reduce your overall tax liability. Bring in your CPA and let’s have coffee with calculators. It’s great fun, and so is saving money! We think the government has enough to work with anyway, so why give Uncle Sam more than he has contracted for?
Number 5: I STILL DON’T KNOW WHAT TO DO
This likely has been more fun for us to write than for you to read about it. We are only going to complete a refinance for you if it makes financial sense to do so. Sure, completing loans is fun, but we need to make sure it is to your benefit. MN State law requires that the loan have benefit for you, and we’re you’re fiduciary, which means we need to look out for your best interests (no pun intended!). Bring your questions and scenarios to us and we’ll crunch numbers, calculate the savings, project long term costs, ask CPAs for tax analysis, talk with financial planners about retirement and other savings goals, and have you leaving our office more confident in your financial future. Maybe then you can spend more time working on getting that LDL lower instead of worrying about making extra payments on that credit card that seems to be stretching out to infinity.
The Furlong Team is pleased to offer the FHA Streamline 203(k).
A few quick things to know about 203(k):
- Find your contractor early. They need to be licensed and should be organized with their paperwork!
- Repairs should not require large structural changes.
- The timeline for closing is longer than standard mortgage programs.
- The underwriting process has more details and will be a bit more work than a standard loan program, but just have patience and you will be ok!
FHA’s Streamlined 203(k) program permits borrowers to:
- Finance up to an additional $35,000 into their mortgage to improve or upgrade their home before move-in
- Finance funding to pay for property repairs or improvements, such as those identified by a home inspector or FHA appraiser
FHA offers insurance to lenders for two repair programs – the 203(k) Streamline and the standard 203(k).
Eligible repairs include, but are not limited to:
The FHA Streamline Refinance program waives the requirement for an appraisal, allows for the new, lower FHA mortgage insurance rates, and can save homeowners a lot of interest and insurance fees over the life of the loan. Not to mention, your payment will be reduced without needing to add additional time onto your loan term!
FHA has permitted streamline refinances on insured mortgages since the early 1980s. “Streamline refinance” refers only to the amount of documentation and underwriting that the lender must perform, and does not mean that there are no costs involved in the transaction. The basic requirements of a streamline refinance are:
- The mortgage to be refinanced must already be FHA insured.
- The mortgage to be refinanced should be current (not delinquent).
- The refinance results in a lowering of the borrower’s monthly principal and interest payments, or, under certain circumstances, the conversion of an adjustable rate mortgage (ARM) to a fixed-rate mortgage.
- No cash may be taken out on mortgages refinanced using the streamline refinance process.
Lenders may offer streamline refinances in several ways. Some lenders offer “no cost” refinances (actually, no out-of-pocket expenses to the borrower) by charging a higher rate of interest on the new loan than if the borrower financed or paid the closing costs in cash. From this premium, the lender pays any closing costs that are incurred on the transaction. FHA does not allow lenders to include closing costs in the new mortgage amount of a streamline refinance. Investment properties (properties which the borrower does not occupy as his or her principal residence) may only be refinanced without an appraisal.
The FHA Back to Work program allows home buyers to obtain financing if they had a bankruptcy, foreclosure or short sale at least 12 months ago. This timeline is shorter than the standard FHA guidelines of 24 months with extenuating circumstances or 36 months otherwise. The primary requirements for the FHA Back to Work program are that a 20% decrease in income led to the “economic event”, or bankrupcy, foreclosure or short sale. A divorce situation where the household income decreased as a result does not count. The other requirement is to have completed the Back to Work counseling at least 30 days prior to entering into a purchase agreement or submitting a formal loan application.
“As a result of the recent recession many borrowers who experienced unemployment or other severe reductions in income were unable to make their monthly mortgage payments and ultimately were forced to give up their home. Some borrowers were left with no choice but to file for bankruptcy or short sale their home due to the inability to afford the mortgage payment. Because of these recent recession-related periods of financial difficulty, borrowers’ credit has also been negatively affected. FHA recognizes the hardships faced by these borrowers and realizes that their credit histories may not fully reflect their true ability or propensity to repay a mortgage.”
We can work with you to determine your ability to be approved and guide you to the counselors to become eligible for the program.
Do You Qualify?
FHA will consider you for eligibility if you had a financial hardship in the past but can now document the following circumstances about yourself:
- You can document the mortgage or credit problems resulted from a financial hardship
- You have re-established a responsible credit history
- You have completed HUD-approved housing counseling
- You meet FHA loan requirements
This message was released by the U.S. Department of Housing and Urban Development covering the newest update to FHA loans.
Mortgagee Letter 2013-26
Date: August 15, 2013
To: All FHA-Approved Mortgagees
Subject: Back to Work – Extenuating Circumstances
Purpose: The purpose of this Mortgagee Letter (ML) is to:
- Provide minimum underwriting standards and criteria for evaluating
borrowers who have experienced an Economic Event, as defined in
this ML, that resulted in a severe reduction in income due to a job loss
or other circumstances resulting in reduced Household Income;
- Describe the use of housing counseling to qualify under the provisions
of this ML
- Amend HUD Handbook 4155.1, Chapter 4, Section C to add an
Economic Event to the list of examples of extenuating circumstances
and instruct lenders to use the guidance for Back to Work –
Extenuating Circumstances established in this ML as Chapter 6
Section G, to underwrite an applicant with an Economic Event; and,
- Revise HUD Handbook 4155.1, 4.A.7.e, to clarify the process for
requesting a review of information contained in CAIVRS for
borrowers seeking an FHA-insured mortgage in accordance with the
provisions of this ML.
FHA is continuing its commitment to fully evaluate borrowers who have experienced periods of financial difficulty due to extenuating circumstances.
As a result of the recent recession many borrowers who experienced unemployment or other severe reductions in income, were unable to make their monthly mortgage payments, and ultimately lost their homes to a pre-foreclosure sale, deed-in-lieu, or foreclosure. Some borrowers were forced to file for bankruptcy to discharge or restructure their debts. Because of these recent recession-related periods of financial difficulty, borrowers’ credit has been negatively affected. FHA recognizes the hardships faced by these borrowers, and realizes that their credit histories may not fully reflect their true ability or propensity to repay a mortgage.
To that end, FHA is allowing for the consideration of borrowers who have experienced an Economic Event and can document that:
- Certain credit impairments were the result of a Loss of Employment or a significant loss of Household Income beyond the borrower’s control;
- The borrower has demonstrated full recovery from the event; and,
- The borrower has completed housing counseling.
Housing counseling is an important resource for both first-time home buyers and repeat home owners. Housing counseling enables borrowers to better understand their loan options and obligations, and assists borrowers in the creation and assessment of their household budget, accessing reliable information and resources, avoiding scams, and being better prepared for future financial shocks, among other benefits to the borrower.
The guidance in this ML is effective for case numbers assigned on or after August 15, 2013 through September 30, 2016.