Understanding 203(k) Contingency Reserve Requirements for a 203(k) Transaction
The requirements for a Standard 203(k) transaction always requires a contingency reserve. The contingency reserve is established as a percentage of total project cost plus taxes and included fees. The total cost of repairs plus the contingency reserve shall be the amount used to determine the allowable consulting fees.
The basis for the contingency reserve for structures <30 years old is typically as follows:
• If termite damage is observed: Minimum = 10% to Maximum = 20%. Typically determined by the consultant and will be greater based on the amount of possible wood destroying insect damage.
• Consultants discretion: No Minimum % to Maximum = 20%. Typically 5% if the structure is in good visual condition. In this scenario, the consultant is solely responsible for determining the percentage to be used, however, most consultants should not go below 5% on $100,000 projects or more and no lower than 10% on projects <$100,000.
The basis for the contingency reserve for structures >30 years old is typically as follows:
• Always required: Minimum = 10% to Maximum = 20%. The consultant is required to determine the minimum to be used. 10% is typically always used unless an underlying condition dictates a higher amount.
• When power, gas and water utilities are shut off: Minimum 15% to Maximum = 20%. The consultant will use a higher amount if the property condition dictates. This category is used due to the exclusion of mechanical and equipment during testing. It is assumed that these items could require replacement and therefore should be accounted for in the Work Write-Up.
In all cases the Borrower may use cash funds to satisfy the contingency amount specified by the consultant. When a Borrower chooses to use his own funds to satisfy this amount, the amount of contingency shall be listed below the line, however, the total cost of repairs plus the contingency reserve shall still be the amount used to determine the allowable consulting fees.
Contingency Reserve is not a requirement for a Streamlined 203(k) loan; however, at the Lender's discretion, a Contingency Reserve may be required. Whatever the requirement, the contingency shall not exceed 20%. For Streamlined 203(k) loans, a consultant will not advise or include a contingency.
In all cases, if a Lender requires a contingency reserve which exceeds the consultants recommendation, the higher amount is to be used.
Bald Eagle Inspection Services, LLC is a 203(k) Consultant with over 20 years of experience in the construction industry, especially estimating and management. If you or someone you know is in the need of a 203(k) Work Write-Up, please be sure to visit http://www.baldeagle.biz