When getting an FHA 203k loan, a contingency reserve is typically required to cover unexpected expenses.
On properties older than 30 years and over $7,000 in rehabilitation costs, the cost estimate must include a contingency reserve. The reserve must include a contingency reserve of a minimum of 10% of the cost of rehabilitation; however, the contingency reserve may not exceed 20% where major remodeling is contemplated.
If the utilities were not turned on for inspection, a minimum 15% is required. If the scope of work is well defined and uncomplicated, and the rehabilitation cost is less than $7,500, then lender may waive the requirement for a contingency reserve. A notice about the Contingency Reserve must be provided to the borrower prior to, or at the closing of the loan.
The contingency reserve can only be used on those changes that affect the health, safety, or an increase in cost due to a necessity item. If the contingency reserve is insufficient, the borrower must place additional monies into an account for payment upon acceptance of the change.
If a change order (use a Request for Change, Form HUD-92577), results in a decrease in costs, the amount will be added to the contingency reserve. Additional improvements that do not affect the health and safety, or an increase in cost due to a necessity item, must be paid for by the borrower and not paid out of the contingency reserve fund. If the work is complicated, a 10% to 20% contingency reserve may be added to the change order request.
Any unused portion of the Contingency Reserve Fund remaining at the time of issuance of the Final Release Notice must be applied to reduce the mortgage balance. Work items cannot be deleted from the rehabilitation if it will decrease the value of the home, since the loan has already closed.
If the borrower feels that the contingency reserve will not be used and they wish to avoid having the reserve applied to reduce the mortgage balance after issuance of the Final Release Notice, the borrower (or any other person, organization or agency on the borrower’s behalf) may place their own funds into the contingency reserve account.
In this case, if monies are remaining in the account after the Final Release Notice is issued, the monies may be released back to the borrower (or other person, organization or agency who placed the money in the contingency reserve).