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Borrowers who are doing a home renovation project with an FHA 203K or conventional HomeStyle loan will be working with a contractor. Even if you will be using your own funds to finance a home renovation you will likely be working with a contractor, usually a General Contractor. Unless you have the experience of doing that, the process can be unclear and overwhelming. If you have never worked with a contractor before I thought it might be helpful to provide a basic overview. While not intended to cover every possible situation, below are points to consider:

  • Check the local building department for what type of Building Permits will be required. I recommend doing this even before purchasing property to renovate. The reason why – the cost of the Permits should be part of your overall budget. The cost may be higher than you might expect. I have seen municipalities require extra inspections or work on homes that have been vacant for a long time, for example, or require wired smoke, fire and carbon monoxide detectors rather than battery operated types allowed years ago. I know of a town that required the general contractor to sit and pay for a 4 hour written test prior to issuing the general contractor a license to work in that town. I had a client rehab a home in a town that required the sewer line out to the street be snaked with a camera to verify tree roots have not grown through the sewer line. All this may add more cost to your project that would be helpful to learn in advance. These costs may even play into a decision to purchase a property or not.
  • Learn if an Architect will be required by the local municipality to draw plans for approval of your renovation project. You may want to inquire at the local Building Department when checking on types of Permits needed. If so that cost can be in addition to the base budget. Many   contractors may prefer to work with their own Architect partners. That cost can be added to the overall budget or broken out separately in 203K and HomeStyle rehab loans.
  • Contractors will prepare a Bid On Repairs document which should describe in detail what is to be done and show the cost for labor and materials. Be sure this document accurately reflects exactly what you want done for each task. Tasks can be in categories like Masonry, Plumbing, Electrical, Kitchen, Flooring, etc. Be specific on materials to more accurately reflect costs. The more detail included will help to accurately insure a complete and satisfactory result.
  • In 203K and HomeStyle renovation loans there will be a schedule of contractor payments or what we call “Draws” planned. Usually a maximum of 5 but there can be more if need be. Meaning we do not pre-pay a contractor at all on a Standard 203K or HomeStyle loan. After each phase of work is done the contractor will submit paperwork to be paid for that part of work now completed. If you are using all your own funds for a renovation I recommend a similar arrangement. Never pay a contractor for all or a majority of the cost up front before any work is done. This way the contractor knows payment will be coming only after specific work is done per the contract. Always agree in writing as to terms of payment before moving forward. In 203K and HomeStyle loans the draw payments are two party checks sent to you, the borrower, but made out to both you and the contractor. This way these funds never go direct to a contractor and only reach the contractor if the borrower is satisfied with the work completed. We use an FHA Consultant or outside project consultant to review all work performed prior to approving a draw payment on Standard 203K and HomeStyle rehab loans.
  • Be sure to have a Contingency Reserve based on the planned budget. In both 203K and Homestyle loans at least a 10% reserve is required. In 203K if any one of the utilities are non-functional then required reserve rises to 15%. Possibly even 20% in some cases. A reserve is just that- funds held back in reserve for any contingencies, emergencies or really surprises that arise during construction. This reserve is calculated off the main budget. Let’s say your renovation budget is planned to cost $50,000. Then a minimum 10% reserve will be $5000.00. I often recommend a 15% reserve just to be sure enough extra funds are available. These funds can be your own cash or part of the renovation loan. But the funds are set aside in an escrow account with the rest of the renovation loan funds. The reserve is to be held back or “in reserve” until the construction is at least half way done. This way you know you are covered for any surprises that arise as walls are opened or plumbing is uncovered, etc. Then at the end of the construction the reserve can be used to pay for appliances or other “extras” if desired. Or in 203K or HomeStyle loans we can reduce the ending size of the loan by that portion of the unused reserve. Many contractors will recommend a 10% reserve but I have found a 15% to be more realistic in older properties.
  • Always Holdback or Retain 10% of each payment made to your contractor until the project is fully completed and you are happy with it. When we do Standard 203K or HomeStyle rehab loans we holdback or retain 10% of each draw payment made to the contractor as work progresses. The “retention or holdback” is released to the contractor with the final payment. The reason why is to be sure the work is fully completed per the Bid On Repairs and you are happy with the results. Also to be sure the contractor or any sub-contractors employed by the general contractor have not placed any Mechanics liens on your property for lack of payment.
  • Always be sure to have a Warranty in your contractor agreement. Most contractors will have no problem issuing a warranty for at least 1 year on all their work. If not then it may be best to select another contractor.
  • While I don’t see it often it would be a good idea to write specific Performance Dates into your contractor agreement. In 203K and HomeStyle loans we require the project to begin within 30 days of closing the loan. Completion should be planned for 6 months or earlier. But even more specific it may be helpful to have dates for specific phases of the project to be done. It may even be appropriate to consider a penalty for late completion written into the contractor agreement.
  • Request at least 2 References from your contractor and speak to each. In 203K and HomeStyle rehab loans we require at least 2 references we will check. You should do the same. This part of the process is what we call “contractor validation”. Meaning if the contractor cannot produce references then why consider hiring that contractor ?
  • Secure a copy of your Contractor’s License to work in your town and if required in your state. This is required for both 203K and HomeStyle loans. But you should also be certain you are hiring a fully licensed contractor.
  • Secure a copy of your contractors Insurance for Liability and if the contractor has their own employees, a copy of the Workmens Compensation The insurance will protect you and your property in case of an accident or work done that harms the property or workers.
  • Learn who will be the on-site Supervisor each day. In other words, who will be overseeing the project if the contractor is visiting other projects each day. Always have a contact to speak to with questions or concerns.
  • For large renovation projects where the property will not be inhabited for more than a month or two you may need Builders Risk This is a special policy in case your normal homeowner’s insurance policy is not valid during extended periods of vacancy during construction. It would cover accidents and damage to the property and possibly theft of materials. Ask your insurance agent for details and if your normal homeowners policy is valid during an extensive renovation.
  • Be sure there is a task defined for Daily Cleanup and Disposal of Debris. This should be part of the budget and contractor agreement. Your town may also require a portable restroom on site during construction. Be sure to include these costs in your budget.

I hope this post has been helpful and encouraging to those that may have thought a Renovation project was too complex or beyond their ability to manage. My intent is always to inform, educate, and generate discussion. Please call me or email me directly or visit my website for more information on renovation loans. I welcome your comments and questions!

Join the discussion 7 Comments

  • You mentioned that contractors will prepare a Bid On Repairs document which should describe in detail what is to be done and show the cost for labor and materials. Do most general contractors have licenses in different types of work? My wife has decided that we need a new look for our kitchen and is planning a remodel project. Hiring a contractor to assist us could be very helpful.

    • PerryF says:


      Yes my advice is to find a good quality General Contractor who will have all the sub-contractors for plumbing, electric, carpentry etc. so you do not have to go looking for each one. Many contractors don’t like detailed paperwork as they are otherwise busy during the day. So they will often give you a one page proposal that just states “kitchen remodel for $10,000”. That is not a good proposal as you have no particulars on labor/material costs. In a 203k or HomeStyle we force a detailed accounting of each task ( new cabinets, demo old ones, floor tile X square feet, X linear feet of upper and lower cabinets, etc.). DO demand as much details as possible and if the contractor will not don’t select that one.

  • I agree that you would want to find out if you need to draw up plans before a remodel. I would imagine that you would need to have this type of conversation with your contractor before you actually start a remodel. I would also imagine that drawing up plans would be a really helpful way to ensure that your design gets done right in a renovation.

  • Jenna Hunter says:

    I liked how you the article pointed out that one should learn if an Architect will be required. My son just renovated his house and there was an issue with the ceiling and they had to wait 2 days to continue until on Architect could come by. We will be sure to ask about this when we renovate our attic!

  • I appreciate how in-depth your advice has been. The more information about the finer details of working with general contractors, the better. I had not considered a contingency reserve, but it definitely seems like it would be a great idea to have some kind of safety net. It’s better to be safe than sorry. Great advice!

  • Nick says:

    Is it common in HomeStyle Rehab Loans to have an NTE clause or some other maximum cost value written into the contract? If the contractor goes well over the Bid on Repairs and even over the contingency money, would the borrower be liable for the overage? Thank you for your article. It is very informative.

    • PerryF says:

      With HomeStyle since we are appraising the house at the front end off the written Contractor work proposal, we know what ARV or as renovated value will be. The loan will not be approved to close if the renovation budget exceeds 50% of the ARV or as renovated value. That is a regulation of HomeStyle. So that in itself is a sort of NTE or not to exceed clause. HomeStyle is very tough on this rule with the idea that a home should not be over improved. Unlike a cash renovation situation where the owner or buyer is just paying a Contractor cash without the oversight of the lender. Then an NTE clause would be advisable.