FHA 203(k) Loans: What They Are And How They Work

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Key takeaways

  • FHA 203(k) loans provide funding to finance both a home’s purchase and the cost of repairing it. If you qualify, you can obtain one from an FHA-approved lender.
  • This type of loan is reserved for borrowers who intend to live in the home, not house-flippers or investors.
  • There are two types of 203(k) rehab loans: limited, for repairs less than $35,000, and standard, for more expensive projects.

When you buy a home, there are usually a few repairs to pay for. If you plan to take on a fixer-upper, you might be facing the prospect of many projects. If this is the case for you, you might be considering an FHA 203(k) loan.

What is an FHA 203(k) loan?

An FHA 203(k) loan, also known as an FHA 203(k) rehab loan or Section 203(k) loan, combines the financing for a home’s purchase and remodeling or repairs into a single loan. Along with these costs, you can also use a 203(k) loan to finance up to six months’ of mortgage payments while you live elsewhere during renovations.Like other FHA loans, a 203(K) loan is insured by the Federal Housing Administration and offered by FHA-approved mortgage lenders. It also comes with the requirement to pay FHA mortgage insurance.Types of 203(k) rehab loans

There are two types of FHA 203(k) loans: limited 203(k) and the more popular standard 203(k). Here’s an overview:

Key terms

Limited 203(k) loan:
Designed for non-structural projects valued at less than $35,000, with no minimum cost requirement

Standard 203(k) loan:
Designed for more extensive jobs, including major structural work like an addition, with a minimum cost requirement of $5,000

How does an FHA 203(k) loan work?

A 203(k) renovation loan can be a 15- or 30-year fixed-rate or adjustable-rate mortgage (ARM). The amount you can borrow depends on criteria such as your credit rating and income. The total amount borrowed through 203(k) loans must be within FHA loan limits for the area in which the home is located.

Generally, the most you can borrow for the loan is the lowest of the following:

  • The FHA’s maximum loan limit for the county where the property is located
  • The home’s before-renovation value plus improvement costs
  • The home’s after-renovation value

What can an FHA 203(k) loan be used for?

A standard 203(k) loan can cover many major projects, including:

  • Converting a property from one unit to up to four units, or the reverse
  • Foundation repairs
  • Adding or repairing a deck, patio or porch
  • Adding or remodeling a garage
  • Adding or repairing septic or well systems
  • Adding a fence
  • Adding accessibility features for those living with disabilities
  • Installing appliances
  • Landscaping
  • Remediating health and safety hazards, such as lead paint

This type of loan can’t cover improvements such as adding a gazebo, swimming pool or tennis court. It also can’t be used for repairs to co-ops or mixed-use properties, unless that property is primarily residential.

A limited 203(k) loan, in contrast, can cover upgrades like new carpeting or paint.

FHA 203(k) loan requirements

There are many requirements to qualify for an FHA renovation loan, including:

  • Occupation – The main restriction for an FHA 203(k) loan is that the borrower has to be the owner-occupant of the home. Investors are not eligible for this kind of loan, although in certain situations, nonprofit organizations might be allowed to obtain one.
  • Credit score and down payment – You’ll need a minimum credit score of 580 with 3.5 percent down, or a minimum score of 500 with a down payment of 10 percent.
  • Debt-to-income (RTI) ratio – Your debt-to-income (DTI) ratio, which  measures your gross monthly income against your monthly debt payments, can’t exceed 43 percent.
  • Renovation rules – You can only use a limited 203(k) loan for non-structural renovations costing less than $35,000. For a standard 203(k) loan, the work has to involve major construction and cost at least $5,000.
  • Timeline – Generally, the work has to be completed within six months of closing.

How to get an FHA 203(k) loan

Once you’ve identified a home to buy and fix up, you can apply for a 203(k) loan with your lender. If you’re obtaining the standard version of the loan, the lender will assign a 203(k) consultant to your project. The consultant will visit the home to estimate repair costs. If you’re getting the limited 203(k), you’re not required to work with a consultant.

Once your lender signs off on these details and closes the loan, you’ll work with a licensed contractor to handle renovations. Ideally, this contractor should be familiar with 203(k) loans, especially the payment schedule and requirements. If you’re qualified, you might be able to do some or all of the work yourself, but you can’t use the loan proceeds for your labor cost.

The process from there works like a regular construction loan: The lender issues payments to the borrower at various phases of the renovation. As the project progresses, the consultant will inspect the work to authorize more payments. You’ll have six months to complete the renovations. Once the project is finished, you’ll provide a release letter and the consultant will evaluate the work.

FHA 203(k) loan pros and cons

An FHA 203(k) loan offers the opportunity to purchase a home that needs some work without having to obtain two loans. However, there are many rules to qualifying for this type of mortgage.

Pros of an FHA 203(k) loan

  • One loan for both purchase and renovations
  • Lower credit score requirement
  • Low minimum down payment requirement
  • Potentially lower interest rates compared to credit cards or home improvement loans
  • Can finance up to six months of mortgage payments if living elsewhere during renovations

Cons of an FHA 203(k) loan

  • Must plan to live in the home during or after renovation, for at least one year
  • FHA mortgage insurance payments required
  • Rates might be higher compared to buy-and-renovate conventional loans
  • Work must be completed in six months, in most cases

FHA 203(k) loan refinancing

You can use FHA 203(k) loans to purchase a fixer-upper or rehabilitate the home you already live in through a refinance. The process to refinance into a 203(k) loan is similar to a regular refinance, but you must meet the additional requirements of the 203(k) loan.

After refinancing, a portion of the 203(k) proceeds will pay off your existing mortgage, and the rest of the money will be kept in escrow until repairs are completed.You can also refinance an existing 203(k) mortgage through the FHA streamline program, which may help you get an even lower interest rate.

FHA 203(k) loan FAQ

  • An FHA 203(k) loan funds the purchase of a home and qualifying renovations, while a short-term construction loan funds renovations only. Once the project is complete, you can convert the construction loan to a regular mortgage. Depending on your credit and finances, a 203(k) loan might be easier to qualify for, but a construction loan has less restrictions around the types of improvements you can finance.

  • An FHA 203(k) loan can be used for single-family homes (including homes with accessory dwelling units, or ADUs), duplexes, triplexes or another multifamily home up to four units. It can also be used for an eligible condo or manufactured home, or a townhome. You might be able to use it for a mixed-use property, as well, provided the property is majority-residential.

  • If you’re qualified — say, a licensed general contractor — you might be able to do some or all of the work yourself. You cannot reimburse yourself for labor costs with the 203(k) loan proceeds, however.

  • An FHA 203(k) loan allows you to use funds for everything from minor repair needs to nearly the entire reconstruction of a home, as long as the original foundation is intact.

  • FHA 203(k) loans are one of several options to pay for home improvements. These alternatives include a conventional HomeStyle or CHOICERenovation loan; a cash-out refinance; a home equity line of credit (HELOC) or home equity loan; credit cards; or personal loans. You might also explore co-investment or shared equity companies, which provide financing in exchange for a piece of your home’s appreciation when you sell.

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