“The lending industry needs to figure out ways to provide financing for the maintenance and upgrade of existing homes, rather than always harping on building new ones. This will be tough if lenders continue to use the traditional equity position to determine loan amounts, since equity is not where it used to be.” --Darius Baker, D&J Kitchens & Baths, Sacramento, Calif.

“203(k) loans are an opportunity that has increased dramatically because of foreclosures and short sales. I see all pros and no cons in the loans for contractors.” --Lew Corcoran, Northeast Community Mortgage, Brewster, Mass.

“The program is great for remodelers to make new connections for business. Remodelers can coordinator with real estate agents and help someone achieve their dream of homeownership” -- or home improvement. --Peter Schommer, New Spaces Home Remodeling, Minneapolis

What’s the Story?

Home values stopped rising, home equity evaporated, the stock market tanked, and suddenly it took more than a call to the bank (or a whipping-out of the credit card) for most homeowners to easily find the money to remodel their homes, buy big-screen TVs, trade up their cars, etc. U.S. households extracted $203 trillion of equity from their homes between 2003 and the third quarter of 2008, according to the McKinsey Global Institute. First American CoreLogic reports that by June 30, 2009, nearly 15.2 million U.S. mortgages, or 32.2% of all mortgaged properties, were in negative equity or “underwater” (owing more on their mortgage than the home is worth). In Nevada, 66% of mortgages are underwater. Arizona (51%), Florida (49%), and Michigan (48%) follow.

In a number that changes daily, there were nearly 2 million U.S. homes in foreclosure as of Sept. 24, 2009.

My Core Clientele Isn’t Underwater. They Don’t Live in Foreclosure Neighborhoods. What Does This Have to Do with My Business?

Even if they’ve owned their homes for years and have good incomes, many homeowners are unable to take out home equity loans because the housing glut and foreclosures are bringing down overall home values.

One reason for this domino effect is the Home Valuation Code of Conduct (HVCC), which took effect May 1. Designed to curb abuses that arose during the housing bubble, when appraisers often erred on the upside, under pressure from the real estate community and home sellers, the HVCC stipulates that mortgage agencies may purchase only mortgages supported by “independent” appraisals. Builders and others say that the code “is overcorrecting from boom-time sins, turning home price inflation into deflation.” (See this article from BIG BUILDER magazine.)

On a street-by-street/neighborhood-by-neighborhood basis, the HVCC is playing out like this, says Allison Stewart of Florida Pines Realty, St. Cloud, Fla. "Before, appraisers could exclude foreclosures and bank-owned properties and say they weren’t really reflective of the market. Now they have to factor in these properties, and that is impacting overall house prices to a much greater degree.”

And so, besides having less home equity to tap into, homeowners are facing much tighter lending requirements overall. If they want or need to remodel, Stewart speculates, “they’re rethinking what types of renovations they should seriously consider to enhance the value of their homes.”

So How Does the 203(k) Factor Into All This?

A moderately good-news antidote to it all is the Federal Housing Administration’s 203(k) loan program, which rolls remodeling costs into mortgages and refinances. The loans require only a 3.5% down payment on the gross loan amounts, compared to the 10% to 20% typically required for conventional renovation loans and, increasingly, for new-home loans. Established by Congress in 1978, the 203(k) traditionally was used to revitalize blighted urban areas, and to encourage working-class professionals to invest in and improve abandoned properties.

“But now the 203(k) is expanded to everyone, to people in all areas,” says Jennifer Adams, a renovation specialist with a major mortgage lender. While still little known, the program’s popularity has shot up dramatically (see chart, above).

“I’ve done more FHA loans (including 203(k)) than in my whole 20-plus years” of experience, says Dawn Cameron, another mortgage consultant. “As long as the interest rates stay low, it’s affordable for almost anyone, and the government is really trying to create programs to add incentives.”

Those incentives are necessary. Little understood and somewhat stigmatized by its FHA association, the 203(k) “is very underutilized by now only lenders and borrowers, but also contractors and realtors,” says Richard Day, another renovation mortgage consultant.

Unofficially, most remodelers seem to have little familiarity with the program here, based on the results of this survey and anecdotal reporting: http://answers.polldaddy.com/poll/1980655/.

So Why the Interest in the Program Now, and How Bad Are Those Homes, Anyway?

A major motivator for the 203(k)'s growth is that banks want to offload all those homes they’ve repossessed, typically in “as-is” condition. “And most of them are in dire need of repair,” Stewart says. Besides sheer neglect, in some cases, she has seen “horrific” vandalism, either by angered owners or thieves ripping out copper wiring, fixtures, anything that might have some resale value. But Stewart has also seen cream-puff homes that could be 203(k) candidates. And she and others point out that the American Recovery and Reinvestment Act raised the maximum loan amount to as much as $729,750 for high-cost areas. This means that remodeling clients, depending on where they live, may be able to borrow several hundred thousand dollars to buy and remodel a home, or to refinance their existing mortgage and remodel their home.

“The home doesn’t have to be trashed to be eligible for a 203(k)," says mortgage consultant Corcoran. “It can be in great shape. I come across homes day in and day out that would be perfect candidates,” as long as the owner or buyer wants to improve it and is willing to work by the program’s rules.

“Anyone can do it,” Adams says. “I wish I had done it when I bought my second home.”

What Are the Program’s Rules?

Click here to download a good overview of the 203(k). Some of its key provisions include:

  • There are two types of 203(k) loans: the Standard (k) loan is for borrowers who want to do extensive structural work and/or when repair costs exceed $35,000. The Streamlined (k) loan is for a maximum amount of $35,000, and there is no minimum. Homeowners must get approved.
  • Properties must be one- to four-family dwellings that have been completed for at least one year.
  • Typical uses of 203(k) loans include additions, replacement of key systems, and other types of extensive and/or structural work for the Standard (k), and smaller repairs, new flooring, and minor remodeling projects for the Streamlined (k).
  • Borrowers must meet the underwriting qualifications for the 203(b) FHA mortgage insurance program. Profit-motivated investors are ineligible for the loans, but some nonprofits are eligible.
  • Lenders must be FHA-approved to offer 203(k) loans. Hard numbers are difficult to pin down, but it is believed that there are only a few hundred such lenders in the U.S. To find one who can work in your area, contact the mortgage lenders listed at the end of this article.
  • Before loan closing, the borrowers or an approved consultant must write up an in-depth construction plan and cost assessment. An FHA-approved appraiser must determine the property’s estimated value after the work is completed. The work must be completed within six months and be inspected upon completion before the final 10% payment is made.
  • Payment: The loan amount is placed in escrow and an agreement stipulates a draw schedule. “A downside for remodelers is that there are no up-front funds,” says mortgage renovation specialist Adams. “The upsides for remodelers include you know you’re going to get paid. The money automatically goes into escrow, and the money is absolutely there for you.”

Another upside for remodelers: You just may get some good, smallish jobs that sustain your business through this down economy, and you’ll probably also make more connections in the referral market -- notably among real estate agents and mortgage companies that work with home buyers and owners. That’s the thinking of New Spaces Home Remodeling, in Minneapolis. “We know the foreclosure trend isn’t going to last forever,” says Peter Schommer, who handles sales for the company. The 203(k) is “a way for us to create relationships within the real estate industry. And those agents tend to be the gatekeepers” for many home buyers and homeowners seeking advice.

You know, for future reference …

Hmmm, Any Other Downsides for Remodelers?

You’ll have to get certified by the lending institution. “It’s not a huge issue,” Schommer says. “You just how to show certain licensure requirements and fill out some pages. This is the lenders’ way of insuring that properly licensed companies or individuals are performing the work.”

Also, if you’re looking for high-dollar whole-house remodeling projects, the 203(k) probably isn’t for you. “Remodelers have to change their mindset and stop thinking big jobs, multimillion-dollar homes,” Stewart says. You may need to adjust your pricing strategies a bit, too. “Take a look and say how many foreclosures are in my area, and how do I price myself to become more competitive. Don’t let pride get in the way of doing business!” But as far as having to jump through extensive government hoops, most of that work falls on the shoulders of the real estate community. “This is a tricky loan for realtors,” Schommer says. “It takes a log of legwork for them to coordinate with a plumber, electrician, window installer, painting, flooring installer, etc.,” and many agents, in fact, shy away from steering clients to the loans because of all this work.

And that’s another place where you come in. “A good remodeler can help take this load off the back of the real estate agent by helping to coordinate all the elements needed, in one motion,” Schommer says. --Leah Thayer, senior editor, REMODELING.

Remodelers: Want to learn more? Visit http://www.fhainfo.com/fha203k.htm. Other good sources of information are Jennifer Adams (612.730.1252),  Lew Corcoran (www.lewcorcoran.com; [email protected]; 508.258.8039), Dawn Cameron (631.382.2248), Richard Day (804.855.4421; www.fixandfinance.com).