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FHA 203k Loan Program: The All-in-One Renovation Mortgage

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In a nutshell, the FHA 203k loan program allows prospective home buyers to finance the cost of a property and improvements in one convenient mortgage.

Instead of buying a fixer-upper, taking out a mortgage, and then later taking out a home equity line or executing a cash out refinance to fund necessary improvements, home buyers can apply for a single FHA 203k loan at the time of purchase and get all the money they need in one shot.

This means they can finance the property and get funds to repair or improve/upgrade their home in a single mortgage loan. This is both convenient and at other times necessary to qualify for FHA financing.

An FHA 203k loan can also benefit existing homeowners looking to improve upon their homes – they can get funds for improvements based on the after-improvement value of the property, helpful if they’ve got limited equity.

The value of the property is determined by using the lower of the value of the property before renovations plus the cost of those fixes, or 110% of the appraised value of the property after it has been rehabbed.

Like a traditional FHA loan, it is a government-backed loan that must be originated by an FHA-approved lender, making it easier to qualify for in some instances and also attractively priced.

They are also advantageous to the originating lender because they can get insurance for the loans before the improvements to the underlying collateral are actually made.

FHA 203k Loan Requirements

FHA 203k

  • Property must be at least a year old
  • And must have been occupied at some point
  • Some portion of existing foundation must remain
  • Borrower must occupy the property as their primary residence

The typical FHA loan you hear about most is technically known as the “FHA 203(b)” loan program. It’s just that very few people refer to it as such because it’s the default option. So there’s no need to add those numbers and that letter to the end of it.

It allows borrowers to purchase or refinance a home using FHA financing that is more or less move-in ready. You come up with your down payment and the remaining balance is the loan amount you pay back, simple as that.

Then there’s the FHA 203k loan program, which is referred to as such because it’s not the flagship product offered by the FHA. It’s more specialized, though also fairly common.

As noted, it’s a rehabilitation FHA loan, but like the FHA 203b, you must meet the same credit and down payment qualifications.

This is generally good news as you might be able to qualify with a credit score as low as 550, or if you have a score of 580 and above, a down payment of just 3.5%.

Additionally, just like a standard FHA loan, the 203k mortgage requires you to pay both upfront and annual mortgage insurance premiums.

You are able to take out a 203k loan on a one-to-four unit owner-occupied property (primary residence), including condominiums and townhomes. Also, manufactured homes built after 1976 are eligible, as are mixed-use properties.

However, the property must be at least a year old (for renovations to make sense), and existing homes must have been occupied (no new construction).

Remember, it’s a renovation loan, not a build a new home loan…

And while a complete teardown is possible, at least some portion of the existing foundation must remain in place. Think of it as a loophole.

If it’s a condo, any rehab is limited to the interior of the unit and the max loan amount cannot exceed 100% of the after-improved value.

Second homes and investment properties are not eligible, and luxury items and/or improvements aren’t permitted.

This includes swimming pools, spas, saunas, tennis courts, built-in BBQs, outdoor fireplaces, satellite dishes, and other similar items that aren’t exactly necessities.

How the FHA 203k Loan Program Works

  • It’s a renovation loan and standard mortgage in one
  • That requires FHA loan approval
  • And lender review of any proposed construction
  • Everything is financed in a single loan (renovations and core loan amount)

It starts off similar to any mortgage application, in that you must qualify for a home loan based on certain income and credit requirements, as discussed above.

An added step requires the borrower to get bids for the work they’d like to complete, or need to complete to get the property up to necessary standards.

In the case of a full 203k loan, a consultant is selected (by the lender) and works with the borrower to determine necessary/wanted repairs, which are then presented to the lender.

They start with a home inspection to address health/safety needs, then move on to borrower’s wants.

If it’s a limited 203k loan, the borrower must still gather contractor bids and send them to the lender for review.

This is a good time to estimate the market value of the property once the proposed changes have been completed.

Assuming everything looks good, the loan is underwritten per usual, the home is appraised with an as-is value and an after-improved value, and eventually funded (hopefully).

The additional loan proceeds (beyond the base loan amount) earmarked for the improvements are placed in a rehabilitation escrow account.

Once the project begins, draws can be taken from this escrow account at different intervals to pay the contractor(s).

Once all the work is completed, it is verified by the consultant (if applicable) and/or an inspector and remaining funds are released.

The project should start within 30 days of loan closing and be completed within six months.

Advantages of the 203k Loan Program

  • You only need one loan for two purposes (purchase and repairs)
  • Rehabs funds are financed into the original loan amount
  • You can use the “after improved” value of the property
  • The property doesn’t have to meet minimum property standards at closing
  • Necessary improvements/repairs can be made after closing
  • These improvements can increase property value and build home equity
  • May alleviate inspection and appraisal concerns (e.g. coming in low)
  • One set of closing costs and a single close
  • Non-occupant co-borrowers are permitted
  • Not limited to first-time home buyers
  • Gifts acceptable source of funds
  • You can have the house you want now, even if you don’t have the money for repairs
  • May increase your home buying options with limited housing inventory (can consider fixers)

Disadvantages to the 203k Loan Program

  • More fees not found on a traditional mortgage
  • Potentially a higher mortgage rate
  • Restrictive in nature because you don’t just get cash in hand
  • Money must be kept in an escrow account
  • Unused cash must be used for additional renovations or to pay down principal balance
  • Must get contractor bids and manage mortgage process at same time (stressful?)
  • Can’t be used on second homes or investment properties
  • More paperwork, potentially a longer loan process
  • Generally need to work with a contractor who understands 203k loans to avoid headaches

FHA 203k Loan Types

  • There are a variety of home loan options available
  • Including both fixed-rate mortgages
  • And adjustable-rate mortgages
  • But most will likely go with a traditional 30-year fixed

The FHA 203k loan also offers flexibility in terms of home loan type. You aren’t just restricted to the 30-year fixed.

Assuming the lender you’re working with offers it, you might be able to get a 15-year, 20-year, or even a 25-year fixed as well.

And adjustable-rate mortgage options are also permitted, such as a one-year ARM, 3/1 ARM, 5/1 ARM, and 7/1 ARM.

The ARMs might come in handy if you expect the property value to increase significantly as a result of the changes, thereby allowing a profitable sale in the near future or a more cost-efficient refinance to a conventional loan.

While the 203k can be an all-in-one solution, it can also be a short-term loan, so it’s wise to look at all financing options.

Standard 203k Loan (Full)

  • Allows for bigger renovation jobs
  • No cap in terms of what you can borrow
  • But minimum cost of improvements is $5,000
  • A HUD-approved 203k consultant is required

There are two main types of 203k loans, including the standard, or “full 203k loan,” and the streamline 203k loan.

Let’s take a look at the full 203k loan first to get a better idea of how it works.

While both programs serve the same main purpose, to finance renovations into a single home loan ahead of time, the standard 203k allows for bigger jobs.

So if you need to tear down the house and rebuild, or add a bedroom or bathroom, you’d likely be using the full 203k loan program because it allows for structural improvements.

Additionally, you aren’t capped in terms of what you can borrow, up to the FHA max loan amount that is. But the minimum cost of improvements must be $5,000.

But because it’s a major renovation, a HUD-approved 203k consultant (selected by your lender) is required to supervise the project.

This individual basically oversees the construction project from start to finish, and acts as a liaison between the borrower, lender, and contractor(s).

They assess the property, review proposals, and inspect the work in order to release funds to contractors.

There is also a fee for the consultant, which cannot be financed into the loan.

Their fee might range from $400 to $1,000, and is based on the cost of the work to be completed.

The full 203k loan also requires a contingency reserve, which is money that must be set aside for the unexpected.

Because the jobs are typically pretty significant, it’s possible something might be discovered along the way that requires additional funds to get the property in acceptable condition.

You won’t want to run out of money on the job, so a certain percentage of the total cost of repairs is required.

Any leftover funds can be used to do additional work or to pay down the principal balance of the mortgage. Just note that the latter option won’t lower the monthly mortgage payment. It will only result in interest savings.

The standard 203k loan also allows for up to six monthly mortgage payments to be included in the loan. This is handy if the homeowner won’t be able to occupy the property due to the renovations taking place.

Examples of typical improvements or renovations for a full 203k loan:

– Room additions
– Structural work
– New flooring
– New HVAC
– Plumbing
– Electric
– Roofing
– Septic
– Swimming pool repair

Streamline 203k Loan (Limited)

  • Ideal for smaller renovation jobs
  • Capped at $35,000 in property improvements
  • No major renovations (like foundation work) allowed
  • 203k consultant isn’t required

We’ve already discussed the full 203k loan, now let’s take a look at the newer “streamline 203k loan,” which as the name suggests is more simple and straightforward.

First and foremost, with a streamline 203k loan you may only borrow up to $35,000 to finance property improvements. Anything above this amount will push you into a standard FHA 203k loan. But there is no minimum cost of repairs as there is with the standard 203k.

Additionally, the scope of the work you may do is more limited. For example, you can’t use a streamline 203k to do foundation work, as that would be considered a major renovation.

However, you can use a limited 203k to renovate a bathroom or a kitchen, or to do other more minor upgrades to the property. In that respect, the streamline might be looked at as a more cosmetic loan, though relatively large jobs are still possible.

The upside to the streamline is that it’s an easier process than the full 203k loan, which keeps it an attractive option for a borrower not looking to get entangled in red tape.

The smaller job also means a consistency reserve isn’t explicitly required (but could be a specific lender requirement), nor are 203k consultants, though one will still be strongly encouraged.

The streamline version also requires the borrower to occupy the property within 30 days of closing.

Like the full version, you have the option to do a streamline 203k refinance if you already own the home you want to renovate. This home refinance option could allow you to make improvements even if you have limited home equity.

Examples of typical improvements or renovations for a limited 203k loan:

– Minor remodeling (non-structural)
– Painting (interior or exterior)
– Weatherization
– New flooring
– New windows
– New kitchen cabinets
– Upgrade appliances (fridge, stove/oven, washer/dryer)
– Repair existing HVAC system
– Repair roof, gutters, downspouts
– Repair deck, patio, porch, etc.

How Much Can You Borrow on a 203k Loan?

As discussed above, it depends which type of 203k loan you choose. The full 203k doesn’t have a maximum borrowing cap, but does have a minimum improvement cost of $5,000.

The limited 203k has a maximum improvement cost of $35,000, but no minimum.

In either case, the total value of the property must still fall within the local area FHA loan limits.

And remember, the value of the property is determined by the lesser of the value of the property before improvements (plus the cost of improvements), or 110% of the appraised value of the property after improvements.

HUD offers a free 203k calculator to let you accurately calculate the maximum mortgage amount by loan type chosen.

What Can’t Be Financed with a 203k Loan?

The whole point of the FHA 203k loan program is to improve the value of a property. This may entail making repairs and eliminating healthy/safety hazards, or simply modernizing a property.

That being said, those looking to make their property “nicer” might find it’s not allowed.

For example, HUD doesn’t allow funds to be used for luxury items, such as a tennis court, gazebo, or new swimming pool (but you can repair an existing pool).

Additionally, improvements for commercial use aren’t allowed, nor can you purchase furniture for the property.

But you can upgrade or replace appliances such as a stove, oven, microwave, washer, dryer, or dishwasher, especially energy-efficient ones.

And when it comes to landscaping, “major landscape work and site improvements” are permissible, but not cosmetic stuff.

Interestingly, you can add a porch, deck, or patio, which seems like an add-on that’s not absolutely necessary, but I digress.

Are FHA 203k Loans a Good Deal?

  • It depends on the contractors you use
  • And what the alternatives are
  • But if you only qualify for FHA financing
  • It might be your only option if the repairs are a necessity

Like everything in life, it depends. If you can only obtain FHA financing and the home won’t qualify without the repairs, there’s not much of an alternative. This might be the case if you have a low credit score and illustrates why maintaining excellent credit is so important (it gives you the full slate of options).

You also have to consider all the fees involved, which will outweigh those on a traditional mortgage and/or result in a higher mortgage rate.

As noted, you might have to pay a consultant fee, along with inspection fees, permit fees, title update fees, a plan review fee, a supplemental origination fee, and so on.

Those can all add up, and should be considered if you have other options, such as a traditional cash out refinance or a second mortgage. I’ve even noted that some smaller home improvements could be covered with a credit card if it offers 0% APR and a high enough credit limit.

Also note that there is a renovation product available via a VA mortgage if you happen to be active duty or a veteran.

One potential winning aspect to the 203k is that it’s highly regulated, so it could be safer for someone working with contractors who isn’t knowledgeable about construction costs and what such projects entail.

In that case, it could help someone avoid getting taken for a ride.

Choose Your 203k Lender (and Contractor) Carefully

While on the topic, you may want to select a contractor who has 203k experience so they know how to navigate the lending process.

It may also be advisable to seek out 203k lenders specifically, those that specialize in these types of mortgage loans above all else. Otherwise it might prove to be a really aggravating month or three.

Make sure the loan officer you choose to work with is well-versed in the loan program to avoid any hiccups or delays. If they mainly originate conventional loans, they might be in over their head.

At the end of the day, the restrictive nature of 203k rehab loans can be limiting, with certain items not allowed (like new swimming pools), and the stringent guidelines and deadlines might be frustrating to some.

A homeowner might just want cash in hand to do with as they please, despite it potentially requiring two loan approvals instead of one.

Also consider the fact that FHA 203k loans require borrowers to pay mortgage insurance premiums, another cost you may want might want to avoid.

Of course, there’s always the possibility of refinancing away from the FHA down the road. Or selling the home once the renovations are complete.

If you want to avoid an FHA loan, you can also consider the newer Freddie Mac CHOICERenovation Mortgage that serves a similar purpose.

Read more: The best ways to pay for home renovations.

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