Complete Guide to the FHA 203(k) Loan

FHA 203(k) loans are a type of home improvement loan backed by the Federal Housing Administration. They are designed to cover the cost of renovations and repairs - either on a newly purchased property or on the borrower’s existing home (via refinancing).

203(k) Guide Index

• What is an FHA 203(k) Home Loan?
• Using the FHA 203(k)
• FHA 203(k) Eligibility
• How the FHA 203(k) Loan Works
• FHA 203(k) Rates and Fees
• FHA 203(k) Pros and Cons
• 203(k) Alternatives

What is an FHA 203(k) Home Loan?

A 203(k) loan is a mortgage product insured by the Federal Housing Administration and designated for use on homes in need of repair or renovation. They can be used on a newly purchased house or a homeowner’s existing property, should they be interested in refinancing. Sometimes, 203(k) loans are also known as FHA construction loans or rehab loans.

Using the FHA 203(k)

There are several types of FHA 203(k) loans, and the right one depends on your overall goals. You can either use your 203(k) loan to cover both repairs and the purchase of a home, or you can simply use it to cover repairs costs on a property you already own. You may also be able to use your 203(k) to cover the cost of temporary housing while your home undergoes renovations.

Keep in mind, there are limitations to what repairs and renovations your 203(k) loan can cover. Though most structural repairs are eligible costs, things like pools, gazebos and other luxury upgrades cannot be paid for with a 203(k).

Limited 203(k)

The Limited 203(k) (formerly the 203(k) Streamline) is designed for minor repairs and renovations. Costs are typically capped at $35,000. There is no minimum.

Limited 203(k) loans can be used to cover things like:

• Safety and health hazard repairs
• Carpet and flooring replacement
• A new roof
• Painting
• Replacing appliances
• Remodeling bathrooms or kitchens
• Making energy-efficient improvements

These loans don’t cover larger, structural renovation projects — like moving walls, adding rooms or changing the overall footprint of the property. It’s one of the most commonly offered 203(k) loans on the market.

203(k) Standard

The 203(k) standard loan is a more comprehensive rehab loan that covers just about any project, minus luxury amenities/upgrades. The 203(k) standard loan requires a minimum of $5,000 in improvements.

Standard 203(k) loans can cover:

• Structural changes
• Sewer and water connections
• Accessibility renovations
• Relocating the home
• Converting the property into a multi-unit home

Projects must be completed within six months in order to qualify for a 203(k) standard loan.

203(k) Refinance

You don’t have to buy an entirely new property in order to use a 203(k) loan. If you already own a home and need to make repairs or renovations, then a 203(k) refinance can be a solid option to explore. Your repairs must cost $5,000 or more in order to qualify. Lenders will often have their own guidelines in addition to what the FHA requires.

FHA 203(k) Eligibility

FHA 203(k) loans are designed for individual home buyers (or condo/townhome buyers), as well as nonprofit organizations. Investors are not eligible for these products.

Here are some other requirements to keep in mind:

• Credit score: 580 minimum, though some lenders may require a higher score.
• Down payment: 3.5 percent of the total purchase. There may be additional project costs.
• DTI: Typically, 43 percent or less of your income can go toward your new mortgage payment plus other debts.
• Occupancy: You must plan to use the property as your primary residence. The 203(k) is not for fix and flip purchases.
• Loan amount: 203(k) loans offer up to 110 percent of the home’s appraised future value or the home’s purchase price plus the costs of repairs (whichever comes out to less.)
• Contractor requirements: Contractors need to be licensed, insured and in full-time operation.
• Project completion timelines: All projects must be completed within 6 months.
• Home standards: Repairs and renovations must meet basic energy efficiency and structural standards. There also cannot be lead paint, asbestos, outdated electrical systems or other known safety hazards.

Lenders will often have their own guidelines in addition to what the FHA requires.

How the FHA 203(k) Loan Works

The FHA 203(k) loan process is slightly different than with other mortgage products, largely because it requires estimating project and repair costs before the loan can be finalized.

Here’s how the process generally works:

1. Apply for the loan. You’ll need to meet both the FHA’s and lender’s credit, income and DTI requirements (more on that below) to get pre-approved for the loan.
2. Choose your projects and contractors. Decide what repairs you need and what renovations your home will need to undergo. Then, find contractors in the area who can handle the job. They must be full-time, licensed and insured to qualify.
3. Get estimates. Have your contractors create detailed, accurate estimates of your project costs and send them to your lender. Make sure they use the proper forms to do so.
4. Get appraised. Your lender will then submit those bids to an appraiser, who will evaluate the home’s value (and future value once the projects are completed.) This is what your total loan amount will be based on.
5. You’ll close on the loan, and your contractors can begin work. If you’ll need to live elsewhere while renovations are in the works, you may be able to include up to six months of temporary housing/mortgage payments into your loan amount.

FHA 203(k) loans typically come with a bit more paperwork (and legwork) than other mortgage products, so the closing process is often much slower. There’s also paperwork that must be completed by your contractors, so it’s best to deal with someone who’s had 203(k) experience before.

FHA 203(k) Rates and Fees

FHA 203(k) mortgages typically come with competitive rates, though they may be slightly higher than other FHA products due to the higher risk of the property and the additional paperwork required.

Lenders may require additional fees with 203(k) loans, including:

• A supplemental origination fee
• Additional document preparation fees
• Higher appraisal fees

203(k) loans also require a Mortgage Insurance Premium, which amounts to an up-front fee of 1.75 percent of the total loan amount, plus an annual amount depending on your specific scenario. Talk with a lender about all fees and rates that may be associated with your loan.

203(k) Pros and Cons

There are numerous pros and cons to using a 203(k) loan — as well as buying a home in need of repair. Here are some of the most important:

203(k) Pros:

• Homes in disrepair typically come with a lower price point and less competition
• You can customize the home to your needs and preferences
• You may be able to add value and build equity very quickly

203(k) Cons:

• You may pay slightly higher rates than other loan options
• There can be more work and planning required
• You may not be able to inhabit the home for some time
• Not all lenders offer 203(k) loans
• Contractors need to submit the proper paperwork

203(k) Alternatives

If you’re considering buying a home in need of repair (or your existing home needs a pick-me-up), a 203(k) loan isn’t your only option. Depending on your goals and budget, you can also consider one of the mortgage loans instead:

• HELOC and home equity loans - Home equity loans and HELOCs (Home Equity Lines of Credit) can be good options if you already own a home. They allow you to turn your existing home equity into cash, which you can then put toward your repairs and renovations as needed.
• Cash-out refinance - Another option if you’re already a homeowner, the cash-out refinance replaces your existing loan with a larger one, giving you the cash difference. The funds can be used for renovations and repairs, as well as any other costs you might have (medical bills, college tuition, etc.).
• HomeStyle - Fannie Mae’s HomeStyle loan is designed for buyers looking to purchase and rehabilitate a home. It generally requires a 5 percent down payment and has no up-front mortgage insurance cost (though it does have a monthly premium).
• PACE - PACE loans can be used if you’re looking to make eco-friendly improvements to the home, like adding solar panels or other energy-efficient elements.

Personal loans are also an option, those these will likely come with higher interest rates than most mortgage products. The major benefit is that they don’t come with stipulations as to what you can repair, renovate or upgrade on the property.