If you have your heart set on buying a fixer-upper, an FHA 203(k) loan can 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. With a 203(k) loan, the Federal Housing Administration (FHA) 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, which could prove helpful with home renovation trends continuing.
Read on for more information about FHA 203(k) loans and the FHA 203(k) process, as well as your 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 mortgage lenders approved by the U.S. Department of Housing and Urban Development (HUD) and insured by the FHA. The government is interested in rejuvenating neighborhoods and expanding homeownership opportunities.
Because 203(k) 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 the review of the rehabilitation plan, and a higher appraisal fee.
Additionally, 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.
How an FHA 203(k) Loan Works
As mentioned above, you can take out a 15- or 30-year fixed-rate mortgage or an adjustable rate mortgage through an FHA-approved lender. The amount for which you’re approved will depend on how much your home is expected to be worth after all of the renovations are completed, plus the cost of the work.
Additionally, the amount you’re approved for will also depend on which type of FHA 203(k) loan you get — either the limited (also called streamline) or the standard. (Note that both of these options also have a 203(k) refinance option for current homeowners.)
Streamlined or Limited 203(k) Loan
The limited 203(k) loan allows you to finance up to $35,000 into your mortgage for any repairs or home improvements. There is no minimum repair amount. However, the streamlined 203(k) loan does not cover any major structural work.
Standard 203(k) Loan
If you’re buying a real fixer-upper and looking to tackle larger jobs or major structural repairs, you’ll likely want to go for the standard 203(k) loan. A minimum repair cost of $5,000 is required, and you must use a 203(k) consultant, which are HUD-certified professionals who will oversee the project and make sure FHA standards are met.
What Can FHA 203(k) Loans Be Used For?
Purchase and Repairs
For a standard 203(k) loan, other than the cost of acquiring a property, rehabilitation may range from minor repairs (though exceeding $5,000 in 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.
You could do either a remodel or a renovation with the funds, the former of which is making updates to an existing room or structure while the latter is more extensive and can include changing the function or partially the structure of a home. An FHA 203(k) loan, however, will not cover “luxury” upgrades like a pool, tennis court or gazebo.
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.
Project estimates done by the lender or the FHA will determine your loan amount. 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. Those with credit scores of less than 500 are not eligible for FHA-insured loans.
Your debt-to-income ratio typically can’t exceed 43%. Additionally, you must be able to qualify for the costs of the renovations and the purchase price.
Recommended: What Credit Score is Needed to Buy a House?
How to Apply for a 203(k) Loan
To apply for any FHA loan, you have to use an approved lender , a list of which you can find on HUD’s website. It’s a good idea to get multiple quotes.
Once you have a lender, they will assign you a 203(k) consultant who will help you to plan the work that needs to be done on the property you’ve selected and determine how much it will cost. To do so, the consultant will perform a home inspection to identify necessary repairs and improvements, including any health or safety issues.
After that, you will need to find a contractor to write out an estimate for the cost of the labor and materials. Once the lender approves that estimate, they will appraise your home. Your loan can then close and work on your home can begin.
Pros and Cons of 203(k) Rehab Loans
Before you move forward with 203(k) rehab loans, it’s important to understand the benefits as well as the downsides. Here are the major pros and cons to consider:
203(k) Rehab Loans: Pros and Cons
• Combines purchase and renovations into one loan
• Allows you to borrow more than your home is currently worth
• Relatively low credit score and down payment requirements
• Can cover temporary housing or mortgage payments if home is uninhabitable
• Application process can be involved
• May need to work with a HUD consultant
• Cannot be used for investment properties
• Requires upfront and monthly mortgage insurance premiums
203(k) Loans vs Conventional Home Rehab Loans
As you consider whether a FHA 203(k) loan may be a good option, you may be wondering how it compares to a conventional home rehab loan. Both can provide financing to cover the cost of renovating, but there are some key differences to keep in mind — namely the credit score and down payment requirements as well as what types of improvements can be financed.
203(k) Loans vs Conventional Home Rehab Loans: How They Compare
|203(k) Loans||Conventional Home Rehab Loans|
• Lower credit score and down payment requirements
• Requires an intensive application process and possibly a HUD consultant
• Has limitations on what improvements can be done
• May require a higher credit score and down payment
• Can carry higher interest rates
• Allows you to make luxury improvements
Alternatives to 203(k) Rehab Loans
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 alternatives 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
Limited FHA 203(k) Loan: In addition to the standard FHA 203(k) program, there is a limited FHA 203(k) loan of up to $35,000, which we mentioned above. Homebuyers and homeowners can use the funding to repair or upgrade a home.
FHA Title 1 Loans: There also 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.
Fannie Mae’s HomeStyle® Renovation Mortgage: 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.)
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 installing 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. However, other options may make more sense to other homebuyers and homeowners.
One alternative option that SoFi offers is cash-out refinancing, which allows you to turn your home equity into renovation money. A home improvement loan of $5,000 to $100,000 may be another option worth considering to turn your home into a haven.
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