FHA 203k Loan/Conventional Construction-To-Permanent Loan

August 13th, 2010

construction crew

I am occasionally asked about construction/renovation loans or the FHA 203k loan (which is FHA’s version of construction/renovation loan), so I wanted to write an overall analysis/opinion of these loans. They are very complicated, and a lot of sellers will not wait for the time period needed to process a loan like this. I’ll explain below.

Construction Loan

A construction/renovation loan is typically used when you are building a home from scratch, or have a large renovation of an existing home. The initial “acquisition loan” to buy the house and then start the renovations is usually an “Interest Only” loan, based on “Prime Rate”. So you may pay Prime Rate + 1%, for example. A bank will usually restrict your time period on the renovations, for example they may give you 6 months to complete the renovations.

Rate Risk

After the renovation is over you get a “permanent loan”, with a market rate for a traditional loan (like a 30 Year Fixed Rate), with the rate being determined at the time the renovation is complete. Hence, there is some interest rate risk, since you won’t get your “permanent loan” with a final fixed rate, until the renovations are complete. If you found a house now, went to closing in 3 months, and finished your renovation in 6 months, you’d end up with market rates for your permanent loan 9 months from the start of the project. Most banks will not lock-in your rate 6 months away from settlement, let alone 9 months. This could be quite a rate risk, not having a locked-in rate through a half year or more of a large renovation project.


Obviously a benefit with a finished home, not needing renovations, is that you lock-in an interest rate right away, removing a lot of risk. A construction renovation loan is complicated in that the banks want to: -pre-approve, in advance, your plans and specs.
-pre-approve your General Contractor
-they want to see a draw schedule for the planned cash draws over the course of the renovations.
-and a bank will NOT let a homeowner/borrower act as their own General Contractor. So you’d have to get a contractor and architect/draftsmen, all in advance, to even have the loan approved as a renovation loan.

There is usually a 4-6 week lead time to get plans drawn up. And since these loans are so complicated they take longer for a lender to process them, after receipt of the plans and the choice of builder. And that is a hassle and delay many sellers won’t wait for. A seller wants to sell their house and settle on it in 30-45 days, waiting 6 weeks for plans and another 6 weeks for loan approval, is usually not in the cards.

And last is the overall hassle with contractors, which short of childbirth, personal bankruptcy, and getting hit by a car; could be one of the most painful and emotional experiences you will ever deal with. I have done a few renovations, and I don’t think I’ll do another as long as I live. The cost overruns are a certainty, delays are a virtual guarantee, and trying to find a trustworthy and efficient contractor (general contractor or sub-contractor) is like finding a needle in a haystack.

General Contractors

Go to this page on my website: Loan Tracking, and at the bottom right of the game board, click on the “Contractors” button. It’s got some other good data on the contractors. My suggestion would be to try and find a resale home that is done the way you want, or at least close to the way you want. Then maybe it just comes down to a much smaller amount of money that you could fund on your own, or pay as you go, by doing smaller projects on your own. I am aware that most places will never be exactly what you want. But to avoid the hassle of a renovation and a renovation loan; I’d find something close to what I want, that maybe just leaves the buyer painting a few rooms, remodeling a bathroom, and putting in some new appliances.

Paperwork Needed

If the above has not clearly shown the hassle associated with a renovation loan, the below checklist of some of the items needed may help: Here is an overview of much of what a bank may need for a renovation loan:
-plans & specs
-contract between borrower and builder
-title work and recent survey
-provide evidence of Builder’s General Liability Insurance for at least $500,000 (sometimes $1mm or more).
-need proof of Builder’s Risk Insurance equal to at least the loan amount
-copy of builder license
-builder resume
-pre-closing conference call between bank rep., builder and borrower
-draws are based on % of work complete, no draws on stored material
-draws are wired directly to builder, or by joint check to builder and borrower
-once all documentation is received, the bank will order the inspection of the property, and the draw is released based on items completed
-complete a draw request form for each draw

And more, and more, and more….. Unless you have a lot of time, and an enormous amount of patience, I’d stay away from renovating a home that you need to get a renovation loan for. If you have a lot of cash, and can do a renovation using your own cash, that is another story. Although using your own cash does not alleviate the hassle of construction delays and cost overruns, it deletes the major hassle of renovation loans. I think renovating or building your own is a fun, romantic notion, but its probably best left to the pro’s who will sell it to you when its finished.

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Brian Martucci is a loan officer for Capital Bank Home Loans, a division of Capital Bank, N.A. He has been in the mortgage industry since 1986 and has served in a number of roles, including loan processor, loan officer, mortgage broker, branch manager, and vice president. Brian Martucci – NMLS# 185421. His opinions do not necessarily reflect the opinions and beliefs of Capital Bank Home Loans or Capital Bank. Capital Bank, N.A.- NMLS# 401599. Click here for the Capital Bank, N.A. “Privacy Policy”.

2 Responses to “FHA 203k Loan/Conventional Construction-To-Permanent Loan”

  1. chelsea says:

    I understand that you have some experience in these areas, and that being involved in the renovations you have done has been a hassle, but I don’t think trying to scare other people away just because you haven’t had great experiences is right. Building your own place is a romantic notion, and one that everyone should be supported in if that is what they choose to do. Making people aware of the challenges and imposing your personal judgements of the processes are two different things, and I hope this article doesn’t scare anyone away who is legitimately pursuing their dream home. The work is long and tedious, but it is well worth it. To some of us, anyway.

  2. brianm says:

    Thanks for commenting Chelsea. You are right of course, and so am I. By that I mean that everyone is entitled to their opinion, so each opinion is right to that person. This is a blog, and I think everyone understands its opinion based and not fact based. I did not do a study based on thousands of surveys, and this is only my limited opinion. So I am sure people take it with a grain of salt, hope to learn a few things, and move on to make their own decision. You are right that renovating or building a home can be a romantic notion, and can in fact end up with the perfect house for someone that they’d never find without building or renovating it. Again, its only my own opinion after having myself done numerous gut job renovations, and also due to what I do for a career I have had access to information dozens of other construction and renovation projects; that none of them have come in on time or on budget. I want to make sure that people understand that achieving the dream of renovating or building your own house comes at a cost that they need to be aware of. That cost is frequently changing/increasing budgets, and time delays. I don’t think people get deterred from realistic news, they get educated. But I am glad you pointed out that people should be supported in their dreams, that is always the case, and I hope my blog on this topic helps those that choose to move forward on a project like this, have a better understanding of the dream they are about to engage in.

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