How does an FHA 203(k) loan work?
A 203(k) loan can be a 15- or 30-year fixed-rate mortgage or an adjustable-rate mortgage (ARM).
The loan amount you can take out depends on criteria such as creditworthiness and income. The down payment requirement for a 2022 FHA 203(k) renovation loan is still 3.5% of the purchase price, or 10% if your credit score is lower than 580. The total borrowed amount must be within the FHA credit limits for the home area. The max amount you can borrow are following:
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The maximum FHA credit limit for the county where the property is located;
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A calculation that includes the "before" value of the home plus the cost of improvement;
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An analysis of the home's "after" value, including improvements.
In most cases, the renovation work will be performed by a licensed contractor, but occasionally a 203(k) borrower may do some or all of the work themselves. This requires the consent of the lender.
A 203(k) rehab loan works well for older homes, but not ones that are relatively new and don't require at least $5,000 in renovations.
A 203(k) rehabilitation loan also offers solid refinancing rates for cash-strapped homeowners who either can't or don't want to tap into their home equity.
203(k) Loans Types
Two types of 203(k) loans are Limited and Standard.
The loans are only for individuals and families who intend to make the property their primary residence. That means real estate investors and house flippers don't qualify.
The work to be carried out must be assigned to a licensed craftsman. If the mortgage lender qualifies as such, they can act as their general contractor and do the repair work, using the money saved for cost overruns or additional improvements. However, they cannot be reimbursed for their work.
Limited 203(k): Minimal repairs
A house that doesn't require much work would usually be paid for with the limited 203(k). This option does not include structural work on the house, such as adding new rooms or landscaping. The home must be habitable throughout the repair. Repairs under the limited 203(k) are limited to $35,000.
Standard 203(k): Extensive work
The 203(k) standard covers all major repairs and structural work needed in the home, with no limited repair costs. The minimum loan amount is $5,000, but the total value of the property must still be within the mortgage limit for the area.
Some of the repairs an FHA 203(k) loan will cover include plumbing, flooring, painting, heating and air conditioning, bathroom and kitchen remodeling, improving health and safety standards, landscaping improvements, implementation of handicap accessibility, the addition of energy-saving systems and replacement of windows and doors.
FHA 203(k) Loan Requirements
Who qualifies for a 203k loan? If you are willing to get an FHA 203(k) loan, it is essential to understand what you need to qualify. First, find a suitable lender if you haven't already. Next, you must ensure that your purpose for obtaining the loan is within FHA 203(k) guidelines. Also, these types of loans can cover:
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Structural changes and conversions;
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Modernization and improvement of the house function;
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Elimination of health and safety risks;
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Modifications that improve the appearance of the property and eliminate obsolescence;
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Overhaul or replacement of plumbing and installation of a well and septic tank;
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Adding or replacing roofs, gutters, and downspouts;
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Adding or replacing floors and floor treatments;
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Major landscaping work and site improvements;
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Accessibility for a disabled person improving;
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Energy saving improvement.
The FHA 203(k) loan requirements are similar to the regular FHA loan in terms of credit history, income, down payment requirements, and FHA 203(k) loan limits. If the property meets these guidelines, you can proceed with the application process. You need a credit score higher than 580 to make the purchase with a 3.5% down payment.
The typical score for a standard mortgage is 620, although some lenders require a score as high as 740.
What is not allowed
Working on certain types of real estates, such as co-ops, may not be funded with a 203(k) loan. Mixed-use properties that include commercial and residential space may be eligible if the work is for residential use only.
Some projects do not qualify for 203(k) funding. If the change doesn't result in a real upgrade in function or improved home desirability, you are prohibited from using a 203(k) loan to pay for it.
Examples of projects not covered by the loan are luxury add-ons such as:
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Swimming pool;
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jacuzzi;
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tennis court;
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BBQ area;
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outdoor fireplace;
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satellite dish.
Keep that in mind.
FHA 203(k) Credit Pros and Cons
As with any mortgage, there are pros and cons to an FHA home renovation loan.
Advantages:
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Credit for purchase and renovation;
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Low minimum deposit requirement;
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Relatively low credit requirement;
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Potentially lower interest rates in comparison to personal loans, credit cards, or other home loans;
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Covers mortgage payments if a home is uninhabitable during renovation.
Disadvantages:
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FHA mortgage insurance is required;
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Interest rates can be higher compared to traditional loans;
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The process may require a meeting with a 203(k) repair consultant;
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More extensive repairs require more paperwork;
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Potential for the additional cost of architecture assessments;
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Property must be your primary residence.
FHA 203(k) loan refinancing
Current homeowners FHA 203(k) loans can be obtained hoping to rehabilitate a property they hold in their portfolio. Should you qualify and proceed with an FHA 203(k) loan, you will find that a funds portion borrowed will be used to pay off the outstanding balance of the existing mortgage. All remaining funds will be held in escrow until repairs are completed and used to pay those bills.
Likewise, if you have a pre-existing FHA 203(k) mortgage, you can refinance it under the terms of the FHA Streamline program. This can help you get a lower interest rate, which translates into lower monthly payments.
Bottom Line
If you want to refinance or remodel your home, an FHA 203(k) loan can provide an excellent option. Before proceeding with the application process, you should compare lenders, research FHA project rules and conditions, and consider whether or not this financing tool makes sense for your fixer-upper. As part of your decision-making process, we encourage you to read more about traditional mortgages - among many other solutions available for those looking to fund an upcoming home purchase or luxury upgrades.
