The Ultimate Guide to FHA 203K Rehabilitation Loans
Over the years of working as a real estate agent, quite a few home buyers have asked me about buying and fixing a house with one loan. The answer, of course, is an FHA 203k rehabilitation loan.
If you want to buy a home that you can fix up, a regular loan will not give you the funds to complete the work.
An FHA 203k loan, however, is designed to help you buy a home that needs some repairs, as well as giving you the money to fix it up.
It’s a type of rehab loan that allows you to make home improvements without having additional mortgage loans. When buying a home in need of repair, a rehabilitation loan could be the perfect solution.
There are many good reasons to choose a fixer-upper, including quickly increasing your equity and the lack of competition from other buyers. We look at the things you need to understand about the FHA 203k loan program and how it can help you.
What Are FHA Loans?
A regular FHA loan is a type of mortgage that the Federal Housing Administration backs. The FHA is part of The U.S. Department of Housing and Urban Development.
An FHA-approved lender provides standard FHA loans. One of the significant benefits of FHA loans is their low down payment requirements.
With an FHA standard loan, you can have as little as 3.5% down. The minimum credit score is also relaxed when compared to other mortgage loans. FHA mortgages are excellent options for borrowers that have lower credit scores. They are often used as bad credit home loans.
Now that you know about the basics of standard FHA loans let’s take a deep dive into what to know about FHA 203k rehab loans.
What Are FHA 203k Loans?
Instead of a traditional home loan where the money allows you only to finance the purchase of the property, a 203k mortgage also covers the repairs needed.
Sometimes referred to as rehab or construction loans, the 203k program can give you around $35,000 to spend on renovation work as well as helping you buy the home.
Ordinarily, it can be difficult to get a mortgage when the home needs a lot of repairs. With a 203k loan, the lender will check the progress of the repairs being made to the home. Despite this increased flexibility from the lender, you shouldn’t assume they will approve any fixer-upper.
There are certain minimum standards, including safety and habitability rules. So if the property requires too much work, you may not get approved for a 203k home loan.
How Do 203k Loans Differ from Regular FHA Home Loans?
The basic application process of a 203k loan is similar to a standard FHA loan with some extra steps:
- Find and apply to a lender that offers 203k loans
- Have your loan approved
- Find a good contractor
- Get estimates for the renovation work or home repairs
- Close on the loan
- Complete the renovations
There are more things to do with this type of loan, like finding contractors and making sure their estimates are correct to approve your loan. There is certainly potential for more stress when buying a fixer-upper, as home buying can already be stressful when things are straightforward.
What Renovations Are Needed?
One of the first things you need to do is decide what work needs to be completed on the home.
With those basic things taken care of, you can decide on the more exciting remodeling projects.
Choose which rooms of the house need the most attention, perhaps replacing cabinets or appliances in the kitchen or remodeling the en suite bathroom.
Whatever you choose, you need to check that it is allowed under the loan terms, and you need to stay within the budget.
Selecting Your Contractors
Once you have chosen the jobs that need to be completed in your renovation, you need to find good contractors.
If you know a skilled friend in certain repair jobs, you can only hire them if that is their profession. Likewise, you can’t take on some of the work yourself unless you are a contractor.
If you can find some experienced contractors who have done 203k renovations previously, you should have an easier time with better results.
Problems can arise because your contractors are required to supply more paperwork than they might normally provide. This can slow down the time it takes for the loan to be approved, so it might be better to add this to your agreement with the contractor.
Estimates Are Crucial
If you believe you have a reliable contractor, you’ll need accurate estimates of the repair costs involved from them. The appraiser will use these cost estimates to help find the finished value of the home.
Your lender will want to know that the cost of repairs and renovations will increase the home’s value. This will show them that loaning money to you isn’t a risk for them.
The estimates should be final when they are sent to the lender. If an estimate changes, it could lead to additional charges for another appraisal, and the lender might need to process your application again.
Your general contractor should be made aware of how vital the estimate’s accuracy is for the project, especially with major renovations. The normal closing time frame could be delayed if this phase is not followed properly.When using a 203K mortgage make sure you use a trustworthy contractor that understands the timeliness of getting their home improvement estimate.Click To Tweet
Lender-approval is Necessary
When you submit your estimates, the lender will use this along with all the other information they have to approve your mortgage. They will have your credit report and income details so they can approve your 203k home loan.
There Will Be a Closing
As with a regular mortgage, you will have to check and sign the loan documents at closing. When this is complete, the home is yours.
Repair and Renovate
With everything signed, the work can begin on your home renovations. You might be able to move in as well when your contractor starts on the repairs and the remodeling. This will depend on the level of work that is planned for your home. But if it isn’t possible, you can add that expense to your 203k for up to 6 months.
When the work is complete, you will own a newly renovated home that should have created a lot of equity for you.
What an FHA 203k Loan Requires
What requirements will you need to meet? While this type of loan from the FHA is easier to qualify for than many other types of construction loans, there are still requirements to meet.
In theory, the FHA program allows borrowers to get a 203k loan with only a score of 580. However, in practice, most lenders will need you to have a score of at least 620 and perhaps 640 before they will consider you.
Though that might seem fairly high, it is a lot lower than you would require for a conventional construction loan.
Without the FHA loan program, you would probably need to have a good credit score of at least 720 to begin your project.
A solid credit history always helps to get the best mortgage terms. It is a good idea to work towards improving your financial standing whenever you’re buying a house.
Lenders will consider your debt-to-income ratio. Your monthly debt payments are compared to your monthly income to assess whether you are suitable for the loan.
Debt-to-income ratio requirements between lenders might vary, but you can expect to need your debt to be less than 43% of your income before tax.
For example, on a monthly income of $4,500, your debt payments would need to be less than $1,935 to stay within 43%.
However, if you can pay more than the minimum, you might benefit from better interest rates and lower fees.
If the purchase price of your house is $300,000, with the cost of renovations being $30,000, this would mean a minimum down payment of $11,550.
How Much Can You Borrow With an FHA 203K?
An FHA 203k loan will potentially let you borrow up to 110% of the home’s future value or the cost of the home plus repairs. Whichever of these loan amounts is lower will be the amount you can borrow.
You are also restricted in the amount you can borrow by the FHA loan program limits. And this can vary depending on your location.
What Are The FHA Mortgage Limits?
The FHA lending limit is the highest amount they will insure. For 2021, the FHA floor is $356,362 for a single-family home. The FHA loan ceiling was set at $822,375. The FHA mortgage limit is different for duplex, triplex, and four-plex properties.
These properties have a higher mortgage limit. They also vary depending on whether the location is considered a high-cost area or not. The total loan amount cannot exceed these limits.
Other Requirements With an FHA 203K Loan
The FHA 203k loan requirements allow only U.S. citizens or people who are lawful permanent residents to apply. The lender will check this during your application.
FHA 203k loans are also only designed for people who intend to live in the home. The property needs to be your primary residence. You have to remain in the home for 12 months before you can rent it or sell it.
If you are looking to buy a property to flip, this loan isn’t suitable for you.
FHA Mortgage Rates and Loan Terms
FHA loans come in both 15 and 30-year mortgage terms. You can get either fixed-rate mortgages or an adjustable-rate mortgage based on your needs.
Finding 203k Mortgage Lenders
Since this isn’t a standard home loan, not every lender will offer it. And you may well find that not every loan officer and mortgage broker you speak to knows about how this type of home loan works.
You will want to work with an approved lender who has experience with these types of FHA loans.
To reduce your chance of problems when getting a 203k loan, you can use the HUD’s search page to find companies that have done many of these loans before. Doing so can narrow your search to only lenders who have done at least one 203k mortgage in the past year.
Are FHA 203k Loans More Expensive?
You can generally expect the mortgage rates on a 203k to be slightly higher than a normal FHA mortgage.
Higher interest rates could mean you find yourself paying up to 1% more in interest payments.
This still makes a 203k loan competitive since the base rate for the FHA program is normally lower anyway.
You can choose an adjustable rate or a fixed rate over a 15 or 30-year term.
The adjustable-rate might save you some money in the short term if you expect to sell the home within a few years.
There Will Be Mortgage Insurance to Pay
You also need to pay mortgage insurance on the loan. While you can avoid paying private mortgage insurance with conventional loans if you pay a 20% down payment, this isn’t the case with FHA loans.
With a 10% down payment, you might be able to cancel insurance premiums eventually, but it will often be better to refinance the loan.
FHA mortgage insurance is going to cost you 1.75% of the loan value. This will need to be paid upfront, though this can be added to the loan amount. They will also need yearly payments of 0.85%, divided into monthly payments.
There is also likely to be an extra origination fee that will cost another 1.5% of the loan value. As well as that, you’ll get charged a HUD fee for a consultation. This can cost up to about $1,000 for larger projects.
With these types of improvement loans, you will also have to pay a supplemental origination fee. The mortgage lender will charge 1.5% of the rehab costs or $350, whichever is higher. The fee is used to set up and take care of the escrow account.
These additional expenses can increase the closing costs to between 3% and 6% typically.
Can You Use a 203k to Refinance?
While most people use their 203k to buy a home, it is possible to use it to refinance as well. Your renovations should cost at least $5,000, and you don’t currently need to have an FHA loan.
The home will have to be appraised for the lender, with the current value and the value after improvements are assessed. This will show the lender the maximum amount the home can be refinanced for.
There could be FHA loan limits that restrict how much you can refinance for, but otherwise, they look at three calculations to find your maximum.
- Current value plus renovation costs
- 110% of the improved value
- The debt before the renovation, along with improvement expenses and some of the closing costs
Whichever of these calculations is the lowest will decide the maximum 203k mortgage available.
What Types of Repairs are Eligible for an FHA 203k Loan?
There are two types of 203k loans, and they allow you to do different renovations to the property. The type of 203k you choose will depend on the amount of work you need to complete on the home.
Limited Work 203K Loan
If the property needs non-structural renovations, the Limited 203k program will probably be the best answer.
The limited work 203k will give you up to $35,000 to pay for repairs, though you won’t be able to use all of that money.
The FHA requires a 15% contingency fund for cost overruns. It’s referred to as a contingency reserve. So, in reality, you have around $30,000 for contractor bids.
If this contingency fund isn’t used, it will be credited back, and you won’t have to pay interest on this unused money.
Pretty much anything that is considered non-structural repairs is allowed under this program. So if you don’t need to move load-bearing walls or add on rooms to the property, you should be fine.
The Limited loan allows, among other alterations, the following:
- Repair or replace roofs, HVAC systems, plumbing, electrical systems, flooring, decking, and more.
- Repainting, inside and out.
- Accessibility access for people with disabilities.
- Basement remodeling and waterproofing.
- Replacing or repairing windows and doors.
- Replacing appliances.
- Minor repairs
You can’t use the loan to buy things like furniture, which will be considered non-permanent.
The Limited option is better for many homebuyers as the approval process is easier, and more lenders offer it.
Standard 203k Loan
The other option is the standard 203k loan. This allows you to do more and most of the remodeling jobs you could think of. However, the loan can’t be used for non-permanent changes to the home or for upgrading to luxury amenities. But it does cover the following:
- Repairing structural damage and other extensive repairs.
- Adding new constructions such as an addition.
- Repair work that will take longer than 3 months.
- If you will need to live elsewhere for more than 30 days during renovations.
- Repairs that need architectural drawings.
- Larger work could include moving load-bearing walls.
Limited requires less paperwork and is a more streamlined process that will typically take less time to close. But if you need more substantial repairs and alterations to the home, a Standard 203k will be the better choice.
Limited only allows for $35,000 of construction costs, but the standard FHA 203K is held to FHA lending limits in your area.
Things Not Covered by an FHA 203k Loan
Luxury items cannot be financed through FHA 203Ks.
If you would like to add something like a swimming pool, tennis court, or even a barbecue area, adding luxury facilities like this is not allowed under the rules of a 203k. But also, some minor changes can’t be funded through a 203k loan, for example, fairly minor landscaping jobs.
When the home renovation is expected to take longer than 6 months, a 203k isn’t right for you. For projects that 203k doesn’t cover, it might be better to get a home equity loan later on, but there are other options.
Other Renovation Loan Options
FHA 203k loans aren’t right for every situation, but some alternatives might be more suitable. Perhaps you only need a small amount of cash to complete your remodeling project, or maybe you’d like to do the work yourself, and you aren’t a contractor.
Whatever your situation, other loan programs could offer advantages over getting a 203k. Have a look at some of the home improvement loans available.
Home Equity Loans
Often known as second mortgages, these loans are normally have fixed rates though they tend to have higher interest applied to them. Despite this, the loan can be cheaper in some ways. Home equity loans do not require origination fees or mortgage insurance.
However, you will need some equity in the home for this type of lending. Even if the home will be worth more after the remodeling, only the property’s value when you apply for the loan is considered.
The HomeStyle mortgage program from Fannie Mae allows you to purchase and refurbish the home, though they have a higher minimum down payment requirement of 5%.
You can save money, though, because you are not required to pay a large upfront mortgage insurance premium as you do with the 203k.
There is still mortgage insurance to pay each month, but this could be cheaper than the FHA loan if you have a decent credit score.
Also, these monthly payments can be canceled once you have 22% equity in the home, saving you from having to refinance.
Choosing a home equity line of credit is a more flexible approach to renovating a property. While you will need to have some equity in the home to be approved by a lender, you will only pay interest on the money you need for your project.
The flexibility allows you to draw money from the line of credit to pay contractors when you need to, without paying interest on your credit limit.
This line of credit is normally subject to variable interest rates, but set up costs tend to be very low, if there are any costs at all.
Another option that also requires you have home equity is to refinance your mortgage. These refinancing options give you some cash to allow you to cover the costs of your renovations.
Since you are refinancing, you might be able to get better terms on your new mortgage. This might mean lower interest rates, or you could take the opportunity to reduce the loan term so that you are done with your mortgage sooner.
What Happens When You Buy a Home Using a 203k Loan?
When you’re buying a home with a 203k, there are more stages to go through. You need to list the repair works that need to be carried out on the home, and not all the money will be available until the renovations have been completed.When you're using a 203k to buy a home, you'll need to go through the following steps before purchasing.Click To Tweet
Finding a Lender
Not every lender offers 203k loans, so you’ll need to find some that do. And to make sure you get a good deal, you need to get quotes from the different mortgage companies.
Applying to The Lender
Once you found the lender that you think will offer you the best terms for your mortgage, you need to apply to them for pre-approval. This will give you a better idea of how large a mortgage you can get and give you a pre-approval letter to show sellers you are serious.
Finding a Home
Your real estate agent should be able to find a perfect home for you. When you make an offer to the seller, it needs to mention that you will be using a 203k mortgage to finance the purchase.
Using a Consultant
A 203k consultant can help you arrange a proposal from a licensed contractor. It should set out the range of repair work that needs to be completed, with detailed costings.
Since you aren’t allowed to do the work yourself unless that’s your full-time job already, you’ll need to find licensed contractors. They’ll need to provide an estimate and a breakdown of all the costs.
If the lender is happy with the cost estimate and the work required, the home will be appraised. This will assess the value before and after the proposed renovations. If the lender still approves, you can move to the closing. And once the seller has been paid, the home is finally yours, and then your contractors can begin work.
The money from your lender that is for the remodeling goes into an escrow account. When the work is completed on your home, the lender or an agent working on their behalf will release funds to your contractor.
When all the work has been completed, and the contractor has gone, you will be left to enjoy your newly renovated home. Your new home will probably even be worth more than you paid for it at this stage.
Not only will you have created a home renovated to your requirements, but you’ve also made a great investment.
The Pros and Cons of an FHA 203k Rehabilitation Mortgage
Before you decide that a 203k home loan is right for you, the advantages and disadvantages need to be carefully weighed up.
You can often get a great deal on homes that need repairs and updates, even when the necessary work isn’t going to be that costly. You could find a house for far less money than it is worth because of the state of repair it is in.
Purchasing a fixer-upper property could leave you with a sizable increase in value when the repair work has been completed.
Distressed homes tend to get sold at a good discount because it is more difficult for buyers to get finance. This means as well as getting a better deal; you will have less competition from other buyers.
Lenders normally only want to approve mortgages on homes that are in almost perfect condition. But if you are willing to go through the extra stages required by a 203k, you can really boost the equity you have in the home when the project is finished.
FHA 203Ks offers a lower interest rate than using credit cards or personal loans. You’ll have a single loan with one lender rather than having a second mortgage.
There is more work and responsibility for homebuyers that choose this option. It will also mean that you have contractors in your home for the first few months of ownership.
You will have to work harder to find reputable contractors and make sure that they fill out the paperwork correctly. Even then, don’t be surprised if your lender takes issue with your contractor.
You might find yourself going back and forth between your lender and contractor to make sure there aren’t any details missing.
This type of loan also doesn’t allow you to do the work yourself, and there are some restrictions on the renovations you can undertake. You have to stick to a budget for your renovations, and this can be difficult.
It could mean fast decisions are required so that things don’t slow down any further.
This type of home loan is likely to take longer anyway, as there are more steps in the approval process. It can potentially take 15 to 30 days longer to close a 203k loan when compared to a regular FHA mortgage.
If you are realistic about the extra work required and don’t assume your home loan will close in record time, getting a 203k mortgage won’t be as stressful as it could be.
You should try to make sure that the seller realizes that things might take longer, as well. If you are a real estate investor, it won’t be possible to use this type of loan.
But the benefits of FHA 203k loans should be well worth the extra hassle and delays if you want to increase your equity quickly.
Popular FHA 203K Mortgage Questions
Is a 203K Loan worth it?
Almost always, the answer is yes. You can take beat-up properties or older homes that need work and turn them into something special. More often than not, you will create wealth by making a home purchase where sweat equity can be achieved.
A fixer-upper property is the perfect housing choice for a rehab loan.
Can I Do Home Repairs Myself With a 203K?
Usually, you cannot unless you hold a contractor’s license. If there is some do-it-yourself work you would like to take care of, just don’t include it with the bids for the work.
Is it Difficult to Get a 203K Loan?
No more difficult than other loans. There are minimum credit score and down payment requirements, as previously mentioned.
Other FHA Articles Worth Reading
Use these additional FHA articles to make smart business decisions.
- FHA-approved condos – having FHA approval in a condo community is worthwhile for both buyers and sellers. Having FHA approval increases property values and allows more buyers to purchase.
- FHA condition requirements for a home – see what you need to know about the condition of a house to get standard FHA financing.
- Making your property eligible for an FHA mortgage – see what you will need to do in order to have your house meet the FHA’s mortgage standards for lending.
FHA 203k loans are an excellent mortgage product offered by the federal government. When buying an existing property in need of major repairs, it can be an outstanding financing vehicle.
Hopefully, you have found this guide on rehab loans to be helpful. Best of luck with your project!
About the author: The above Real Estate information on FHA 203K Loans was provided by Bill Gassett, a Nationally recognized leader in his field. Bill can be reached via email at firstname.lastname@example.org or by phone at 508-625-0191. Bill has helped people move in and out of many Metrowest towns for the last 34+ years.
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