FHA 203k Interest Rates
When financing either a FHA 203k renovation purchase or refinance transaction borrowers must keep in mind that the interest rate on the FHA 203k renovation loan is typically a .5% higher than the standard FHA 203b loan. If a borrower obtains an initial loan approval based on a standard FHA loan program and subsequently decides to pursue a renovation loan the added borrowing cost of the FHA 203k loan may impact the preliminary loan approval.
The primary reason for this variance of rates is attributable to the point of which the mortgage loan is salable into the secondary market. For the non-renovation FHA 203b loan the mortgage can be sold to another investor or pooled with other FHA loans and sold into the secondary market shortly after settlement. On the other hand the FHA 203k renovation loan isn't salable until all renovation work is completed and the lender overseeing the renovation process completes a final inspection. Since the renovation loan process can take up to six months to complete, combined with the lender requesting a final inspection to ensure that the work is in fact finished, the result is a loan that isn't often salable for upwards to seven months after settlement.
During the time period from settlement to when a loan is sold a lender is exposed to risk caused by fluctuations in the value of the loan based on the variance between the current market interest rate and the interest rate the loan was locked at. For instance if a loan is originated at a 5.00% and sold into the secondary market after a period in which interest rates have increased to 5.50% that loan is less valuable to an investor than another loan being delivered at 5.50. When this occurs lenders loss by having to sell the loan at less than the value of the mortgage amount to compensate the buyer for less interest earned over the life of the loan than a comparable mortgage loan with the higher interest rate.
It is because of this concern that a FHA 203k loan carries an interest rate premium over the standard FHA 203b loan. Since the lender holding a the FHA 203k loan during the renovation process won't know the value of the loan for upwards to seven months, when the renovation project is complete, the lender will purchase what is known as a "interest rate hedge" on the loan. The hedge is essentially an insurance policy that allows the lender to sell the loan at a certain price in the future regardless of prevailing market interest rates. Whenever a lender guaranties an interest through a rate lock they simultaneously purchase the hedge to offset the risk that interest rates will move higher prior to the loan being sold. The greater the length of time that the hedge is for, the more expensive the cost of the hedge.
Assuming a FHA 203k loan requires an additional seven months or 210 days before the loan can be resold and the cost of the hedge is 1 basis point per day the total cost of the hedge is over 200 basis points or what is more commonly known as two points on a loan. In order to absorb this 200 basis point additional cost into the loan the interest rate is typically priced .50% higher than the non-renovation FHA loan. Or if a FHA 203k borrower wants to receive the same rate as what is currently available on the standard FHA 203b loan the borrower can do so by paying 2 points or 2% of the loan amount as a fee to the lender.
For home buyers looking to purchase property needing renovations and homeowners looking to make repairs to their existing property the added cost of the loan needs to be evaluated within the context of available financing options. Currently there are limited options for mortgage loans that contain a renovation budget. Also houses requiring a renovation budget are selling at substantial discounts to similar homes that are in move-in condition. So while the cost of the loan may be a little higher than a non-renovation loan, the savings achieved through obtaining more house for less, usually overcomes the interest rate cost variance.
To learn more about your financing options through the FHA 203k Renovation Loan Program complete a contact form or call (866) 305-7808 to speak to your Nationwide FHA 203k Renovation Loan Experts.