Financing that Facilitates the “Fixer Upper”

Peter Van Brady

Peter Van Brady

Founder of SoCal VA Homes

Author: Avoiding Mistakes & Crushing Your Deals Using Your VA Loan

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February 19, 2020 (last updated August 8, 2022)

You have a VA benefit and want to use it to create an ideal home, one way or another. There are many flavors of the VA loan, and your job (or a lender’s job) is to find a match between your eligibility and the right mortgage. Although VA loans are usually easier than other loans to qualify for, sometimes you can’t get everything you want with a VA loan. Home owner hopefuls often get creative and seek out other loans they have heard about, usually having mixed results.

In the spirit of exploring loan options, here our purpose is to compare and contrast another government loan, the FHA 203K Construction Loan, with alternatives. The FHA 203K has been around “forever,” and has both its advantages and disadvantages. The FHA 203K is a housing rehabilitation loan, sponsored by the Federal Housing Administration, a division of HUD – The Department of U.S. Housing and Urban Development. This FHA loan program was created so lenders would have a product for buyers who want to purchase and repair a fixer- upper as a path to home ownership.

Advantages of this mortgage include somewhat easy eligibility criteria. Another perk of this loan is that it covers both the property costs and home repair costs, as well as a 10-20% contingency for expenses beyond initial rehab estimates. And it is 100% guaranteed or insured by the federal government.

But there are disadvantages as well. The biggest one being that you are required to live on the property during the construction. Don’t make the mistake of being too easygoing with that idea, thinking that you’ll sacrifice anything to be in your own home. Living in a house that is being built/re-furnished is a nightmare, especially if you’ve just bought it! Being in a house that has even a small remodel (such as a bathroom or the kitchen) is horrible, so few can imagine living in a house where the entire place is being rebuilt. That can strain your nerves, your pocketbook, and your relationships. Not the best of new beginnings. Unfortunately finances and home remodels are the top reasons for divorce, so we proceed with caution!

Still, the key to success is for you to do your homework and learn about the various loans that are available to you.  To that end, compare and contrast the FHA 203k with a product that is very popular among active military and Veterans, the VA loan, especially in regard to mortgage insurance.  A snapshot of the math makes things clear.  Let’s say that you are buying a house for the price of $100,000.  Your final VA loan amount will be $100,000 + $2,150 = $102,150.  The VA funding fee for the first time users of their entitlement is 2.15% of the “base” loan amount.  There is no monthly mortgage insurance premium, as is the case with a FHA loan.  In contrast, the FHA monthly mortgage insurance premium has risen and fallen based on the “financial health” of the program.  The monthly premium has been as low as 0.50% and as high as 1.35%.  At 1.35%, the premium for a $100,000 loan adds another $112.50/month.  That’s like increasing your interest rate from 5.00% to 6.35%!

The FHA loan has a higher “insurance premium” because the mortgage is 100% insured by the government, and the lender passes that risk of default and subsequent foreclosure expense onto the borrower. The VA Guaranty provides protection for only the first 25% of the loan balance to the lender.  That difference can be huge to the lenders.  And unlike the VA loan (where the underwriting requirements don’t require any surplus in your bank account, the FHA loan typically requires a couple months of reserves (2x your total loan payment) to protect against a catastrophe such as losing your job.  Additionally, the FHA loan requires at least a 3.5% down payment.  Three and one half percent!  Most VA buyers don’t have 3.50% to put down.  Thus the FHA loan is so expensive that most VA buyers don’t want it or can’t afford it.  And, really, most buyers don’t want to rehab a home themselves anyway.   You may find that the FHA 203K works for you…but not everybody will.  Perhaps a comparison chart will highlight the differences: