The FHA 203k Loan – A Mortgage for Fixer-Upper Home Buyers

It can be very tempting to buy a “fixer-upper” home. There is generally less competition from other buyers and you can often get a very good price. However, the renovation costs can add up and need to be factored into your overall financing.

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Rather than getting one mortgage loan for a home purchase and a separate loan or line of credit for the renovations, you can do both together with an FHA 203k loan. This program allows you to buy and fix up a home with one affordable mortgage.

FHA 203k Loan

What is an FHA 203k Loan?

It is also known as a Rehab Loan or a FHA Construction Loan. An FHA 203k Loan is a mortgage program backed by the Federal Housing Administration (FHA). It provides funding for both the home purchase and certain repairs or upgrades you want to make to the property.

Mortgage lenders may not approve a standard FHA loan for a fixer-upper home. Properties that need major repairs will often cause problems in the closing stages, especially when it comes to the home appraisal and any required home inspections. Lenders may not be willing to take the risk of offering financing to a buyer who could be getting in over their head with a run-down house or condo.

An FHA 203k Loan requires the lender to track and verify authorized repairs, thus minimizing risk and allowing them to approve the loan. The home itself must meet specific safety and liability standards as set forth by the FHA. If it is in really poor shape, you likely won’t be able to to qualify for a 203k rehab loan.

Who Should Apply for an FHA 203k Loan?

This loan program is ideal for home buyers who want to by a fixer-upper and are willing to make the repairs. Perhaps you are on a budget and this is the best way to afford a home. Or, you just see the potential in a property and know a rehab project will help you make it the home of your dreams. Run-down properties can be purchased cheaper than those in good shape, so this approach could save you money.

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What’s great about a fixer-upper is that you can boost its home equity very quickly. You are investing in the renovations and repairs, thus increasing its value significantly compared to the original purchase price. You can recoup your rehab costs in the form of equity.

How Can I Get Approved for an FHA 203k Loan?

Applying for an FHA Construction Loan is similar to applying for any type of mortgage loan. You will first need to find an FHA-approved lender who offers 203k financing. You will then apply and get pre-approved for your loan. The lender will review your financial standing, including your credit rating (FICO) score, debt-to-income (DTI) ratio, income/employment and down payment amount.

Applying for an FHA 203k loan is simple and fast!. It takes less than 30 seconds to get your personalized Rate Quote and see what you can afford. Then you just pick a rate and closing cost option that fits your situation and speak with a licensed mortgage advisor. It couldn’t be easier!

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After your initial 203k Loan approval, you will then choose a contractor and get bids for the repairs and/or renovation plan. The lender will review and approve these costs before issuing a final approval. Home appraisals and home inspections will also be required. A good lender will be able to walk you through this entire process to make sure all the key details and steps are covered properly.

The long will be funded, allowing you to purchase the property and make the repairs/renovations before you move into your new home.

Here is a more detailed breakdown of the most important steps:

  • Define Your Repairs/Renovations – You will first need to decide which home improvements you plan to make. There are certain qualifying repairs and cosmetic improvements which are allowed and some that won’t be covered by FHA 203k funding.
  • Select Your Contractor – Get bids from licensed and insured contractors to complete your specified list of repairs and/or cosmetic improvements. The contractor must be willing and able to follow the 203k rehab rules and submit specific paperwork.
  • Submit the Plans to Lender – Submit your renovation plan and contractor bids to the lender for approval.
  • Complete Funding & Construction – The lender will approve financing for the loan and the contractor can begin work. Once everything is complete, you can move in and enjoy your new home!

What Repairs Can I Make with an FHA 203k Loan?

There are actually two types of 203k rehab loans. The extend of your repair work will help determine which loan program is best:

Limited 203k Mortgage (Streamline 203k)

The Limited 203k loan will allow you to do more cosmetic repair work, including projects like remodeling the kitchen or bathrooms. The loan limit for renovation costs is $35,000, which will include a built-in buffer that is equal to 15% of the total construction bids. This contingency buffer is there to protect you and the lender in case the rehab costs go over budget. Any contingency funds not used will be credited back to you after construction is complete.

In reality, your maximum repair budget will be $31,000.

A Limited 203k Loan will not allow you to make any structural changes or alter the overall footprint/floor plan of the home.

It mostly covers cosmetic upgrades, including:

  • Kitchen/bathroom remodeling
  • Carpet and flooring
  • Paint
  • HVAC upgrades/repairs/replacements
  • New appliances
  • Critical safety and health issues (mold, asbestos, etc.)
  • Energy-efficiency improvements
  • Roofing upgrades/repairs
  • Septic system improvements

Standard 203k Mortgage (Full 203k)

The Standard FHA 203k Loan allows you much more freedom to make repairs and renovations, with the exception of non-permanent changes and adding unnecessary luxury amenities like tennis courts and swimming pools. No project can take more than six months.

Otherwise, the Standard 203k rehab loan allows you to make the following repairs or remodels:

  • Structure alterations
  • Conversion into a multi-family property
  • Moving house to different location
  • Larger landscaping projects
  • Improvements for disabled accessibility
  • Public water/sewer connections

What are Today’s Rates for FHA 203k Loans?

In general, mortgage rates for FHA 203k mortgage loans will be 0.75% to 1.0% higher than standard FHA loans. The lender is still taking more risk because the rehab process is more complicated than moving into standard home.

FHA mortgage insurance will also be required for 203k rehab loans. It will amount to 1.75% of the full loan amount due as a lump sum upon approval (which usually can be rolled into the loan itself), as well as 0.85% annually. These payments will be divided over 12 months and added to your monthly mortgage payments.

Home Equity Benefits of an FHA 203k Loan

Buying a run-down home and making renovations, upgrades and repairs can provide near-instant home equity. You are investing money straight into home improvements. Once it is ready for you to move in, it should have gained a lot of value.

If you are able to get a great deal on the property and you are smart with your rehab planning and budget, you can really boost your equity quickly. This equity will give you more leverage if refinancing your loan in the future or looking for ways to pay back the loan faster. The FHA 203k Loan program allows buyers to find and fix up these fixer-uppers when most mortgage loans will require the house to be in excellent shape for the borrower to qualify.

Another advantage is the purchase price and rehab expenses are rolled into one mortgage loan with one monthly payment. This helps keep your payoff term simpler and generally provides better interest rates compared to a second loan you may use for home improvements.

Disadvantages of an FHA 203k Loan

Of course, there are some downsides to FHA 203k rehab loans. First, the process is much more complex to get approved. Plus, there is the construction costs and planning that need to be coordinated. You will be working with contractors, and you want to be very careful about selecting reputable service providers. They have to complete specific paperwork and meet set deadlines. There may have to be several back-and-forths between the lender, you and contractor(s) as bids are reviewed and accepted.

Budgeting can also be tricky as you only have so much time and money to work on rehab projects. You may have to sacrifice some plans or limit your spending. There are a lot of big decisions to make—and make quickly—to ensure the loan is approved and everything stays on track. 203k Loans take longer to review and approve. More paperwork needs to be submitted and more steps need to happen throughout the process. It all may be worth it in the end when your renovations are complete, but getting there will take a lot of patience and diligence.

Can I Refinance with an FHA 203k Loan?

For the most part, FHA 203k Loans are utilized by home buyers who are looking to buy and fix up a property. However, this program can also be used for refinancing. If you are planning at least $5,000 in home improvements, this could be a viable refi option.

When refinancing with a 203k mortgage, the lender will require an appraisal that shows both the current value and the potential “improved value” after the approved renovations. Your refinance loan and renovation funding amounts will be subject to current FHA loan limits and the lowest of the following three calculations:

  • Existing debt before rehab, plus the estimated improvement costs and allowable closing costs
  • As-is value plus projected renovation expenses
  • 110% of the after-improved value times 97.75%

You do not have to have an existing FHA loan to qualify for an FHA 203k Loan. If you have owned the property for less than a year, the lender will factor that into the maximum allowable loan amount and mortgage rate.

Alternatives to an FHA 203k Loan

There are other ways you can consider to finance the purchase of a home and then cover rehabilitation costs. It is important to explore your options and talk with your lender to see which solution is best for you.

Here are some of the renovation funding alternatives to FHA 203k rehab loans:

  • Home Equity Loan – These are fixed-rate mortgage loans with higher interest rates, but lower loan origination costs. They also don’t require mortgage insurance. You will need to have built up a healthy amount of home equity from which to borrow, but you may be able to borrow more money and make more extensive renovations than allowed with a 203k.
  • HELOC – A home equity line of credit (HELOC) is a line of credit that is also issued based on your appraised home equity. It allows you to pull funds only when you need them and then pay off as you see fit, kind of like a credit card using your home equity as the funding source. This is a good option for home improvements, especially if you have long-term plans and/or are working in phases and don’t need a lump sum payment upfront. HELOC loans will generally have higher interest rates than 203k, but offer more funding and payoff flexibility.
  • Cash-Out Refinance – A cash out refinance program allows you to refinance your existing mortgage loan while also cashing out some of your equity. Your new loan will be based on the total of what you already owed plus the amount you cashed out. You may be able to refinance your mortgage at a lower rate and you will be moving forward with one monthly payment.

All of these options above require home equity, so you wouldn’t be able to make repairs right away as you will with an FHA 203k Loan. If the repairs are urgent and need to be made before you can move into your home, then a 203k rehab loan may still be better. There is one more alternative you can consider, though:

  • Fannie Mae HomeStyle Mortgage – This is a similar mortgage program as the 203k. It allows you to purchase and renovate a home with just a 5% down payment (FHA loan minimum is 3.5% down). You will not be required to pay the 1.75 upfront mortgage insurance premium, but mortgage insurance (PMI or MIP) will still be part of your monthly payments until you have reached at least 22% home equity. This may be a better option if you have a higher credit score, higher down payment and better overall financial standing.

How to Apply for an FHA 203k Loan

If you are looking to buy a fixer-upper and need to use mortgage funding to handle the repair costs, an FHA 203k loan might be the right solution for you. There may also be other alternatives to consider depending on your unique situation, so talk with a reputable lender and make the right decisions. Moreira Team is a 203k-approved lender. Contact us today to learn more about this financing program and to get started with your application.

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