Contingency Reserve Requirements on Renonvation Mortgages

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I’m staying with the “renovation” theme from my last several posts. This week I want to address a common question I get regarding one of the requirements on the Fannie Mae HomeStyle Renovation Mortgage, Fannie Mae HomePath Renovation Mortgage, and the FHA 203k Mortgage… “Why do these programs require a 10% contingency reserve?

The first thing I should do is define a contingency reserve. Fannie Mae and HUD (FHA loans) require a 10% contingency reserve on these renovation mortgages for unforeseen costs associated with the project.

The last thing anyone wants is to get into a renovation project on a tight budget with no additional assets and an unexpected problem occurs. Some potential issues that arise during a renovation cannot really be accounted for until the process is underway. That is why the 10% contingency requirement exists.

The contingency reserve is not an option. Since this is the case, a better question becomes “what happens to the 10% contingency reserve if it isn’t used?

As anyone who has gone through a renovation project on a home knows, most of the times costs end up going over budget, so it probably won’t be a problem. 🙂 In the event there are funds remaining, usually one of the following occurs with these three programs (203k, HomeStyle, HomePath):

  • additional work on the home – in some cases, the contingency reserve could be used to fund additional work on the home. If this isn’t allowed, then the other option is a…
  • principal reduction – the remaining funds are used to pay down the loan balance. Depending on the renovation program (and lender originating the loan), the borrower could request a recast of the mortgage. In other words, re-amortize the mortgage to lower the monthly payment
  • receive the contingency reserve as cash back – this is typically not an option for the borrower

Contingency reserves can be annoying, but they are definitely needed. As previously stated, the last thing anyone wants is to get near the end of the project and run out of money. What happens then? That is a scenario you never want to face!

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