Buying a fixer-upper is sometimes romanticized by pop culture. While it’s fun to dream, the reality of home renovation is that it can be laborious and draining, especially if the home needs serious help.
Repair work requires energy and resources, and it can be difficult to secure a loan to cover both the value of the home and the cost of repairs—especially if the home is currently uninhabitable. Most lenders won’t take that sort of chance.
But if you have your heart set on buying a fixer upper, an FHA 203(k) loan can help.
The Federal Housing Administration (FHA), part of the U.S. Department of Housing and Urban Development (HUD), insures loans for the purchase and substantial rehab of homes. It is also possible to take out an FHA 203(k) loan for home repairs only, though it might not be your best option if that’s all you need.
If you have the vision to revive a dreary house, here’s info about FHA 203(k) loans and other home improvement loan options.
What Is an FHA 203(k) Home Loan?
Section 203(k) insurance lets buyers finance both the purchase of a house and its rehabilitation costs through a single long-term, fixed- or adjustable-rate loan.
Before the availability of FHA 203(k) loans, borrowers often had to secure multiple loans to obtain a mortgage and a home improvement loan.
The loans are provided through HUD-approved mortgage lenders and insured by the FHA. The government is interested in rejuvenating neighborhoods and expanding homeownership opportunities.
Because the loans are backed by the federal government, you may be able to secure one even if you don’t have stellar credit. Rates are generally competitive but may not be the best, because a home with major flaws is a risk to the lender.
The FHA 203(k) process also requires more coordination, paperwork, and work on behalf of the lender, which can drive the interest rate up slightly. Lenders also may charge a supplemental origination fee, fees to cover review of the rehabilitation plan, and a higher appraisal fee.
The loan will require an upfront mortgage insurance payment of 1.75% of the total loan amount (it can be wrapped into the financing) and then a monthly mortgage insurance premium.
Applications must be submitted through an approved lender .
What Can FHA 203(k) Loans Be Used For?
Purchase and Repairs
Other than the cost of acquiring a property, rehabilitation may range from minor repairs (though exceeding $5,000 worth) to virtual reconstruction.
If a home needs a new bathroom or new siding, for example, the loan will include the projected cost of those renovations in addition to the value of the existing home. An FHA 203(k) loan, however, will not cover “luxury” upgrades like a pool, tennis court, or gazebo (so close!).
If you’re buying a condo, 203(k) loans are generally only issued for interior improvements. However, you can use a 203(k) loan to convert a property into a two- to four-unit dwelling.
Your loan amount is determined by project estimates done by the lender or the FHA. The loan process is paperwork-heavy. Working with contractors who are familiar with the way the program works and will not underbid will be important.
Contractors will also need to be efficient: The work must begin within 30 days of closing and be finished within six months.
If the home is indeed unlivable, the 203(k) loan can include a provision to provide you with up to six months of temporary housing costs or existing mortgage payments.
Who Is Eligible for an FHA 203(k) Loan?
Individuals and nonprofit organizations can use an FHA 203(k) loan, but investors cannot.
Most of the eligibility guidelines for regular FHA loans apply to 203(k) loans. They include a minimum credit score of 580 and at least a 3.5% down payment.
Applicants with a score as low as 500 will typically need to put 10% down.
Your debt-to-income ratio typically can’t exceed 43%. And you must be able to qualify for the costs of the renovations and the purchase price.
Again, to apply for any FHA loan, you have to use an approved lender. (It’s a good idea to get multiple quotes.)
Common Home Improvement Loan Options
The FHA 203(k) provides the most comprehensive solution for buyers who need a loan for both a home and substantial repairs. However, if you need a loan only for home improvements, there are other options to consider.
Depending on the improvements you have planned, your timeline, and your personal financial situation, one of the following could be a better fit.
Recommended: Looking to upgrade your home this year? Check out our Home Improvement Cost Calculator to estimate your budget and ROI.
Other Government-Backed Loans
In addition to the standard FHA 203(k) program, there is a limited FHA 203(k) loan of up to $35,000. Homebuyers and homeowners can use the funding to repair or upgrade a home.
Then there are FHA Title 1 loans for improvements that “substantially protect or improve the basic livability or utility of the property.” The fixed-rate loans may be used in tandem with a 203(k) rehabilitation mortgage.
The owner of a single-family home can apply to borrow up to $25,000 with a secured Title 1 loan.
With Fannie Mae’s HomeStyle® Renovation Mortgage, homebuyers and homeowners can combine their home purchase or refinance with renovation funding in a single mortgage. There’s also a Freddie Mac renovation mortgage, but standard credit score guidelines apply.
If you have an existing mortgage and equity in the home, and want to take out a loan for home improvements, a cash-out refinance from a private lender may be worth looking into.
You usually must have at least 20% equity in your home to be eligible, meaning a maximum 80% loan-to-value (LTV) ratio of the home’s current value. (To calculate LTV, divide your mortgage balance by the home’s appraised value. Let’s say your mortgage balance is $225,000 and the home’s appraised value is $350,000. Your LTV is 64%, which indicates 36% equity in the home.)
A cash-out refi could also be an opportunity to improve your mortgage interest rate and change the length of the loan.
Recommended: How Does Cash-Out Refinancing Work?
For green improvements to your home, such as solar panels or an energy-efficient heating system, you might be eligible for a PACE loan .
The nonprofit organization PACENation promotes property-assessed clean energy (or PACE) financing for homeowners and commercial property owners, to be repaid over a period of up to 30 years.
Home Improvement Loan
A home improvement loan is an unsecured personal loan—meaning the house isn’t used as collateral to secure the loan. Approval is based on personal financial factors that will vary from lender to lender.
Lenders offer a wide range of loan sizes, so you can invest in minor updates to major renovations.
Home Equity Line of Credit
If you need a loan only for repairs but don’t have great credit, a HELOC may provide a lower rate. Be aware that if you can’t make payments on the borrowed funding, which is secured by your home, the lender can seize your home.
Recommended: Guide to Buying, Selling, and Updating Your Home
If you have your eye on a fixer-upper that you just know can be polished into a jewel, an FHA 203(k) loan could be the ticket, but options may make more sense to other homebuyers and homeowners.
SoFi offers cash-out refinancing, turning your home equity into renovation money.
Or maybe a home improvement loan of $5,000 to $100,000 seems like a better way to turn your home into a haven.
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