To start with, it’s good to know that the FHA (Federal Housing Administration) will insure loan products that allow owners to finance repairs to their property both through initial purchase and also through refinancing. People often think FHA is a lender, but in fact the agency, rather like its counterpart the Small Business Administration, provides mortgage insurance to lenders on the FHA-approved list. This insurance increases the willingness of lenders to make certain otherwise perhaps unattractive loans, like the Rehabilitation Loan, known in the real-estate business as the “fix-up loan.”
The next interesting piece to this puzzle is mixed-use buildings. These are properties with more than one type of use, for instance comprising a residential unit over a commercial unit. Mixed-use properties are always considered commercial buildings and require commercial lending which is more expensive than residential lending in both closing costs and interest rate. The added problem is that lenders don’t like lending on mixed-use properties, so it can be difficult as well as very expensive to borrow.
Interestingly, the FHA will normally not insure loans on mixed-use property except with their 203K Rehabilitation Loan Program, making it a godsend for existing and future owners of mixed-use property. The program is expensive to close (closing costs, up front mortgage interest costs, and a more costly appraisal) and for the first five years you must pay mortgage insurance even if your debt-to-value ratio is less than 80%.
That said, the 203K program will allow mixed-use property owners to get fully amortized 30-year fixed loans with a mortgage interest rate close to residential levels. This is huge! Usually, since a mixed-use property is viewed by lenders as commercial property, the offered loan period is three, five, or seven years with the interest rate several points above prime. (In essence, this means the interest rate will be much higher than the conforming loan a condo buyer would be able to get). There is no security in a loan that is three, five, or seven years and, if it is fully amortized, the borrower is paying off mostly interest and hardly any principal. This is because, in the first five years of an amortized loan’s life, payments are skewed towards the interest portion rather than the principal portion, as seen in this table for how the payments are broken up on a 30-year (360-month) amortized loan of $100,000:
If you own, or are thinking of owning, a mixed-use building, contact me and I can put you in touch with a great mortgage broker who specializes in FHA 203K loan programs.