Contingency Reserves for 203(k) Loans
A contingency reserve, which consists of funds set aside at the beginning of the loan process, is required for a 203(k) loan. This can account for up to 20% of the cost of repairs. For instance, a home loan of $100,000 would require a contingency reserve of up to $20,000 put into a separate holding account.
What are Contingency Reserve Funds Used For?
In particular, contingency funds are used for unexpected occurrences, such as mitigating mold not noticed during the inspection, or damage from a burst pipe when the contractor has already finished work. While this money is initially set aside, it can be used to pay the principal of the loan if it is not tapped into during the renovations. It can also be used to make cosmetic repairs around the house once the rest of the work is done.
For instance, suppose $20,000 were set aside as a contingency reserve on a $100,000 mortgage, but only $5,000 of that amount was used to mitigate issues prior to closing. This would leave $15,000 of additional capital that could be deducted from the loan’s principal, or used for additional improvements to the property.