FHA Home Renovation Loans Can Kill You

smiling woman with dog; she's probalby never even heard of FHA's 203k loans

Full disclosure: FHA home renovation loans can cause big headaches if not handled properly. Home Loan Mine funds itself through the affiliate links on the site. Most of the links on this site are affiliate links. If you register or purchase anything through these links, I get a small commission. Nothing to write home about, but together enough to keep the lights on at Home Loan Mine and, maybe, a bit more.

A Bit About FHA Home Renovation Loans

The program is known as 203K and has comes in two, streamline and standard.

Neither can be used to add or replace / repair luxury items.  Luxury items are defined as unnecessary (so, pools) not by quality (granite, quartz are fine).

Both can be used to get a purchase or refinance mortgage and funds for remodeling; the mortgage funds and the remodeling funds together cannot exceed FHA’s county limits. You can check the FHA mortgage limits here.

FHA Home Renovation Loans
See what happens when you do not run into problems with your FHA home renovation loans?

Streamline: any remodeling that is not structural in nature and requires between $5,000 and $35,000. Repair money are given two ways:

  1. In one lump sum once all the work is done and the lender verified it was done and done as per agreement.
  2. If borrowers request it, half of the repair / remodeling funds can be disbursed at closing.

Standard: anything is allowed as long as the foundation remains in place.  Funds are disbursed in increments, based on work that was completed, except that half the funds for materials can be obtained before any work is done was performed (or, better said, as long as the draw for materials is the first draw).

The Two Main Problems People Run Into With FHA Home Renovation Loan

Problem 1: People don’t pay attention to when remodeling funds are disbursed.

People get all excited about the way their home is going to look when all the work is done and forget to think about how the contractor gets paid.  That leads them with an unhappy contractor on their hands.

Usually, it goes something like this:

Bob wants to buy a house for $200,000 that needs $20,000 in remodeling as per Bob’s cousin who’s good with his hands, done an amazing job on his own house a couple of years ago.

Bob’s using most of his money for the down payment and closing costs.  He gives his cousin $5,000, the last of his money, so the cousin can start.

HUD Remodel Loan
HUD Remodel Loan

Materials cost $10,000, so Bob’s last money $5,000) buys half of them and the cousin starts working, for free, for a few days; then he wants to be paid.  He’s right to want to do so: he’s finished the bathrooms and the hardwood floors.

Bob does not have money to pay him.  Bob contacts his loan officer and asks how to get money, surely the lender can see that the floors and bathrooms are done.

The lender could but will not: such are the rules.

Bob’s headaches could have been avoided three ways:

  1. Bob could have hired a contractor who could wait to get paid when the work was done.
  2. Bob could have requested half the remodeling money upfront (his cousin would still have had to wait for some money till the project was done, but a much more manageable amount).  (A good loan originator would have made sure the request was put in when Bob applied for the loan. But not all of them are good.
  3. Bob could have bought a cheaper house so he could have been left with more money after the closing.
  4. Bob could have started a smaller project.
  5. Bob could have started a smaller project on a cheaper house.

Problem 2: People forget that the lender will pay only for the remodeling in the bid they agreed on.

Let’s not malign Bob this time; let’s talk about Angela.

Angela is buying a $180,000 house and gets $53,000 money for renovation work. She draws half of the funds for materials (let’s say that’s $20000/2=10,000).  She is smart about the contractor she chooses, it’s a company owned by a friend but it can work with 4 draws, as Angela’s loan is set up.

The agreement called for the contractor to remove all cabinetry, counter top, sink and faucet, and all appliances and install new ones and replace the floor too. 

FHA Loan With Renovation Results?
FHA Loan With Renovation Results?

The agreement was quite specific about materials and brands but, once she got started, Angela cannot keep herself from wanting marble floors not ceramic and ‘the cheapest of granite counter top.’ 

And while she was upgrading the floor and counter top, it seems silly not to upgrade the appliances and the cabinets.

Unlike Bob, Angela has more money. She can pay for some of these things herself… but it’s not pleasant.  However, she’s counting on the contingency funds to cover her extras.

But contingency funds can only be used when things in the agreement end up running higher than expected not for things that were not in the agreement.

What could Angela have done?

  1. Decide early enough on granite and marble and the more expensive things that she could have put them in the agreement (assuming she would have qualified for the  higher loan amount).
  2. Stick to the agreement.
  3. Ask someone (the lender or her loan officer) what happens if she varies from the remodeling agreement.

I’ve come across people who decided the basement was not tall enough and dig down a foot or two (it’s not cheap), who built an extra bathroom, who finished the basement, etc., without having such work in the agreement the lender saw.  And, of course, the lender refused to pay.

Handled properly, FHA home renovation loans are a great thing. So, think things through before you get the loan and stick to the plan. (Yes, if there’s enough equity in the house, you can add repairs as you go along. But changes add headaches.)