What Is the Process to Follow When Applying for an FHA 203(k) Loan?

Now that we have explored topics ranging from interest rate to guidelines and requirements, we need to take a look at the overall process you will need to follow when applying for a 203(k) loan. Note that much of this process is identical to applying for any other type of FHA loan, but there are several important steps that are unique to 203(k) loans.

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1. Find a Lender: The first step is to find a lender. Remember that the FHA does not make loans – the organization only insures them. So, you’ll need to shop around to find a lender that fits your needs. There is no one-size-fits-all solution here, either. While you may be able to get a great rate through Wells Fargo or another national bank, you may also have lots of luck with small, local lenders and even with credit unions.

It is also worth your time to shop around and get several quotes. Make sure that the lender understands you are interested in a 203(k) loan, though. Whatever you do, though, make sure that you ensure that the lender you submit an application with is approved to work with the FHA, or is working with a direct endorsement lender as their sponsor.

2. Start Your Application: Once you’ve found your lender, you will need to start the loan process. Generally, this means filling out a loan application and providing the lender with all the documentation the require. This usually includes two years of W-2 forms and the associated tax returns, as well as identification for everyone on the loan, paycheck stubs, bank statements, investment performance statements, and more.

Your lender should provide you with a detailed list of information needed, but be prepared to supply additional documents once the loan goes into the underwriting process. With a completed application, you should be given a pre-approval letter and can start the shopping process. Your pre-approval should also come with an FHA case number, which is what is used to identify you during the lending process.

3. Find the Home: Once you have been given the pre-approval letter, you can start looking for homes. Any offer you make should indicate that you will be using a 203(k) loan to finalize the purchase. You also need to make sure you use HUD’s Maximum Mortgage Worksheet to calculate what you can offer. The form can be downloaded here.

4. Find a Consultant: If you are going with a conventional 203(k) loan with over $35,000 in renovations costs, you will need to find a 203(k) consultant who specializes in these loans. He or she will be responsible for helping you find contractors, which is the next step.

5. Find Your Contractors: With the help of your consultant, you should find licensed contractors who can complete the renovation work on your property. Each 203(k) contractor (or the overseeing general contractor) must submit a detailed proposal that will spell out all the work needed, as well as the associated costs and materials.

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6. Lender Approval: Your lender must approve all contractors who will be part of the project. This will require the lender looking over the supplied proposals, but possibly doing additional due diligence, such as verifying that the contractor is licensed to work in the state. Only after the lender approves can you move on to the next step.

7. Appraisal: This is the point when your property will be appraised. Both the value of the home and the cost of the renovations and repairs will be considered. However, remember that there are three potential valuation methods that can be used. The most common will be to take 110% of the home’s value, plus the cost of repairs and closing costs, and multiply that by the 97.75% LTV for FHA loans to get the final figure. You will also receive a list of mandatory repairs and renovations at this time detailing what is needed to comply with HUD/FHA requirements, as the property will need to be reappraised once all the work is done.

8. Underwriting: The underwriting process is one of the lengthiest for many borrowers. During this period, the underwriter does extensive research on you, the borrower. The goal is to reduce risk and help ensure that the lender is able to make a smart decision, but it is also about protecting other people involved in the loan process, such as a family member gifting you cash as a down payment. However, because you are going the FHA route, underwriting will likely take less time than with a conventional loan. Still, you should be prepared for:

  1. Requests for additional financial information

  2. Requests for additional personal information (previous address clarification, etc.)

  3. Requests to resubmit information you previously delivered to the lender/underwriter

9. Clear to Close: The final state is clear to close. Your lender will contact you in person and tell you that you’re ready to close. This is generally the “all clear” that you’re looking for, but there is one more step.

10. Closing: Closing is the final step in the process. It will take several hours in most instances, and will involve you sitting down with the title company’s agent and going over a ream of documents. Your signature will be needed on a wide range of papers, although some of these may have already been signed during the previous steps. Before going to closing, you will need to get your closing costs together. In most instances, you’ll need to get a cashier’s check, but your situation may require wiring the money, instead.

Once you’ve signed all the papers, you should be given the keys to your new home. Now the rest of the work can begin! The seller will be paid once closing is finished, and the remainder of your loan funds will be put into an escrow account set up for this specific purpose. 50% of the escrow funds will be paid to the contractor initially. As your contractor completes the work on your home, the lender will release funds to them. This is usually done one step at a time to ensure that all work is done correctly.

What Should Be Included in a Contractor Bid?

As mentioned, your contractor will need to submit a bid proposal to the lender that includes a wide range of information. Many contractors have no experience with 203(k) loans and the bid submission process. This can result in the lender rejecting the bid because of a lack of information or documentation. As the buyer, you can help streamline the process by ensuring that the contractor’s bid includes the following information:

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  • Name, address, and license number of the contractor

  • The name of the buyer

  • The address of the property being purchased/renovated

  • Costs of any permits involved

  • A statement that work will commence within 30 days of closing and finish within six months of closing

  • An acknowledgment that the contractor will be paid 50% up front, and the remainder as work is completed.

  • A statement that you (the buyer) will not be displaced for more than 30 days from the home.

  • A breakdown of labor and materials as separate line items.

  • A final bid amount that matches what’s listed on the 203(k) Owner/Contractor agreement (see your consultant for this).

  • Your signature (the buyer), the contractor’s signature, and the date.

In addition to these items, chances are good that your lender will also require the contractor to submit:

  • Their current license

  • Proof of insurance

  • Bond

  • Resume with experience highlighted

  • Workers’ compensation insurance proof

  • References

In general, it is best to have just one or two contractors bid at a time. Otherwise, you’ll spend an awful lot of time embroiled in double-checking bid proposals. With that being said, if your general contractor is not licensed for specialties, such as plumbing and electrical work, you will need additional contractors. Plan for this eventuality.