The perils of the FHA 203k loan program

I have recently been hearing many people rave about the incredible program put out by the government, commonly called the FHA 203k loan. It essentially allows for repair money to be wrapped up into a new buyer’s mortgage. Here is an excerpt describing the loan from HUD’s website;

“…When a homebuyer wants to purchase a house in need of repair or modernization, the homebuyer usually has to obtain financing first to purchase the dwelling; additional financing to do the rehabilitation construction; and a permanent mortgage when the work is completed to pay off the interim loans with a permanent mortgage. Often the interim financing (the acquisition and construction loans) involves relatively high interest rates and short amortization periods. The Section 203(k) program was designed to address this situation. The borrower can get just one mortgage loan, at a long-term fixed (or adjustable) rate, to finance both the acquisition and the rehabilitation of the property. To provide funds for the rehabilitation, the mortgage amount is based on the projected value of the property with the work completed, taking into account the cost of the work. To minimize the risk to the mortgage lender, the mortgage loan (the maximum allowable amount) is eligible for endorsement by HUD as soon as the mortgage proceeds are disbursed and a rehabilitation escrow account is established. At this point the lender has a fully-insured mortgage loan.”

http://www.hud.gov/offices/hsg/sfh/203k/203kabou.cfm

My most recent client, who just closed on a home in Plaza Midwood, pursued this loan and we were both shocked at how bad this program was. To start with the contractors that are chosen to do the work are withheld 10% of their invoice until all work on the house is complete, with the rational that there is a reserve for the homeowner. The 203k consultant must come and inspect each time a new section or project is complete (with the homeowner having to pay them each time). Perhaps the most outrageous aspect of this program is what we experienced in regards to the consultants estimate. He quoted the repairs (what my client would be forced to borrow) at just a few hundred dollars over the amount for which he would be paid the highest amount possible. Even after we got the seller to make some of the repairs, the consultant would not remove those specific quotes from the estimate. We quickly decided to change loans to a standard FHA loan, with my client planning to borrow about half of the quoted repair costs privately, since that is all it would really take to make the needed repairs, but we still had to pay the consultant for his outrageous estimate. I would strongly suggest that anyone looking to buy a home, stay away from the 203k program.

Why I started selling homes...

In perhaps one of the most unusual housing markets of all time and on the eve of achieving my MBA, I launched my career into high risk, often unstable Real Estate brokerage. Some might look from the outside in and wonder why I would chose such a risky path, and one which did not even remotely require my Masters of Business, which took me the past 6 years to achieve. For me, however, the decision was clear and natural. I have always been around real estate transactions as that is what my parents have always done, and often times as a child, my family would take trips through neighborhoods just to look at homes and search for real estate deals.

Owning a contracting business in undergrad allowed me to see the rehab side of things, how homes are built, what can go wrong, and how to fix almost every aspect of a house. In graduate school I learned the in depth processes of real estate valuation and investment analysis. Upon graduating, I was working as a Realtor in the new homes sector for about 6 months and personally owned 2 investment homes of my own, so I will repeat once again. The decision to enter general brokerage in the often times risky industry of Real Estate was actually very natural and clear.

I am confident this is the path God has directed me too, especially given the recent success that I have been seeing. At this point, I love the work and I love helping people make what often times is the biggest decision of their lives.

Should I buy a home or should I rent?

One of the truest statements I hear people say is "I'm sick of throwing money away by renting." Renting certainly has its place in certain circumstances, such as those with very damaged credit or singles only interested in one bedroom apartments or even studio apartments. For the majority of people, however, home ownership has some incredible advantages over renting.

Owning real estate offers three powerful and distinct advantages over renting (specifically in regards to mortgages vs. monthly rent). The first being that a portion of each monthly payment is principle, whereby homeowners are essentially putting money in savings by increasing their equity and decreasing their debt in their property. The second advantage of a mortgage is that all of the interest portion of the payment each month is tax deductible, unlike monthly rent which provides no tax advantage. The third and sometimes most powerful advantage of owning properties is the appreciation factor. Studies have proven (one study in particular looks at a 400 year time span in Europe) that over time, real estate increases in value an average of 4% per year, whereas inflation has historically increased at an average of less than 3% per year. If you owned a $200,000 house, you would essentially be building $2,000 per year in real dollar wealth.

To really understand this, lets look at a beginning mortgage payment of $1,000 per month vs. a rent payment of $1,000 per month. Lets say that for a given month of the mortgage the principle portion of the payment is $100 and the interest is $900, that is like $100 each month is going directly into savings. The $900 portion of the payment can be deducted from your income taxes, so if you were in a 25% tax bracket, you would be saving $225 per month off your income taxes. For appreciation, if we use the $200,000 house example, our wealth will be increasing at $2,000 per year (with inflation factored in), that would be $166.70 per month. If you add all these up, you would basically be putting $491.70 in your pocket each time you made a $1,000 mortgage payment. You would be putting $0 in your pocket each time you made your $1,000 rent payment.