Looking to buy a fixer upper?
The FHA’s limited 203k rehab loan program permits homebuyers and homeowners to finance up to $35,000 of their mortgage to repair, improve, or otherwise upgrade their home. Homebuyers as well as homeowners can easily secure cash for diverse property repairs and improvements. A home inspector or FHA appraiser can help identify areas where the home needs the most improvement.
Homeowners are able to make property repairs, improvements, and prepare their home to sell for top dollar. Meanwhile, homebuyers can make their new home move-in ready with a revamped kitchen, fresh coat of paint, new flooring, and more.
Standard and streamline FHA loans
There are two types of 203k rehabilitation loans. They are the streamline and standard 203k, also known as the construction 203k loan. The standard 203k loan is considerably more difficult to acquire. Even though there is no cash limit to this loan, it requires substantial paperwork, and you must hire a 203k consultant to oversee the project.
On the other hand, 203k streamline mortgages allow for cosmetic home upgrades and various basic repairs as defined by the FHA. For streamline FHA loans, the maximum loan amount is $35,000. Notably, you have the option to do the work yourself, rather than hire a HUD contractor.
Standard 203k loan
The standard 203k loan allows you to secure a single loan for both the home purchase and cost of repairs and rehabilitation. It is designed for homes in need of major repair. There is no set limit to the amount you can receive for repairs.
A standards 203k loan requires extensive paperwork, so gather any documentation you think may be relevant. You won’t be permitted to occupy the property while repairs are underway. Moreover, a HUD consultant will oversee any needed repairs and renovations. Because the amount of paperwork for these loans is quite substantial, many lenders shy away from offering them.
Standard 203k | Types of Repairs Allowed
- Major rehabilitation and repairs, such as rebuilding a load-bearing wall
- New construction such as a room addition or building a patio
- Structural repairs to the foundation and other major elements
- Repairs requiring architectural planning
- Landscaping and other ‘site amenity’ improvements
- Any repairs requiring over 3 months of work, or rehabilitation requiring more than 2 payments per contractor
- Improvements that are extensive enough to require a plan reviewer
- Improvements that result in work not starting within 30 days of loan closing, or that cause the homeowner to be displaced for more than 30 days while work is completed
Streamline 203k FHA loan
Streamline 203k loans, same as standard 203k loans, give you the option to cover the cost of a home purchase and repairs under a single loan with a single mortgage payment. However, it only covers cosmetic and basic repairs, with a maximum cash amount of $35,000. You receive a bid from a HUD contractor, and pass it along to your lender. Once repairs are complete, the home undergoes a final appraisal, and you’ll be ready for closing.
Streamline 203k | Types of Repairs Allowed
- Repair and replacement of roofs, gutters, downspouts, and other roof elements
- Existing heating and air conditioning systems
- Electrical and plumbing systems
- Exterior and interior painting
- Replacement of old dilapidated flooring
- Replacement of outdated or broken down appliances
- Weatherization measures
- Waterproofing the basement and other parts of the home
- Repair and replace decks, porches, and patios
- Window and door replacement, as well as exterior siding
- Septic tank repair and replacment; well repair and replacement
- Improvements to make home more accessible to the disabled
- Lead-based paint stabilization or elimination of lead-based paint hazards
Repairs that are not allowed with a 203k loan
Not all home improvements and repairs are allowed under a 203k loan. Basically, anything that is not essential to making the home livable. In these cases, more conventional loans will be a better fit.
Standard 203k | Types of Repairs Not Allowed
- Minor landscaping such as planting a few trees or trimming some hedges
- Luxury amenities like a tennis court, swimming pool, or entertainment center
- Any projects that take longer than 6 months to complete
Finding a FHA 203k lender
Not all mortgage lenders provide 203k loans, and many loan officers and mortgage brokers have little understanding of the product. It’s important to ensure the lender you choose is approved to provide this type of loan, and has many in the past.
Am I eligible for a 203k loan?
A 203k loan is a sub-type of the more well known FHA loan, which is designed to help buyers who might have trouble qualifying for a traditional mortgage. It’s much easier to qualify for a 203k loan versus a typical construction loan.
The FHA allows borrowers with credit scores as low as 580. That being said, many lenders require a minimum score above 600 to qualify for a 203k loan. Even so, it is much lower than the 720+ credit score required for most conventional construction loans.
The FHA requires a small down payment representing 3.5% of the total loan amount. The total is calculated as the purchase price plus cost of renovations. For example, if the home price is $250,000, and repairs cost $50,000, the required down payment is $10,500, or 3.5% of $300,000. You have the option to receive your down payment as a gift from family or an approved non-profit organization.
Debt payments and income requirements
To secure approval, lenders examine your current debt-to-income ratio. That is, the percentage of your income devoted to paying debts on a periodic basis. Usually, lenders prefer this ratio be less than 43%, meaning less than 43% of your pre-tax income should be devoted to debt payments.
This means that for every $1,000 you make, less than $430 should be devoted to debt payments. If you make $4,000 a month as an example, less than $1,720 should go toward debt obligations.
Loan amount limits
The FHA allows you to borrow up to 110% of a property’s proposed future value, or the home price plus cost of repairs, whichever ends up being less. Additionally, FHA loans are subject to regional loan limits.
The FHA requires that you live in the property you intend to rehabilitate. If your intent is to fix up and flip the property, you will not qualify for this loan.
203k loans, and FHA loans in general, are only available to U.S. citizens and permanent residents. Your lender will need to verify citizenship status at the time you apply.
203k loan rates and mortgage insurance
Mortgage rates tend to be higher for FHA 203k loans as compared to conventional mortgages.
Alternatives to a 203k loan
If you only need minor repairs and renovations amounting to a few thousand dollars of work, a FHA 203k rehab loan may not be for you. Likewise, if your renovation includes various luxury upgrades, it will be difficult to qualify, with conventional loans offering better options. Moreover, you might prefer a loan that does not require lifelong mortgage insurance.
If this is the case, here are loan options that might be a better fit:
Home equity loan
Often referred to as a ‘second mortgage’, home equity loans typically carry higher fixed-rate interest rates. However, they cost less to originate, and don’t require mortgage insurance. These are ideal for projects that require a lump sum be paid upfront. The only drawback is that you need to have equity in your home. Mortgage lenders only lend up to 90% of the property value in its current state, not its improved state after renovations.
A home equity line of credit is ideal when you want flexibility in the loan amount. You don’t have to borrow the maximum amount all at once. Interest rates tend to be variable, applied to the loan amounts at the moment you draw them out. Whatever you repay, you can re-borrow up to the maximum limit. Financing costs are low to non-existent. As with a home equity loan, you need to have existing equity in your home as is.
Fannie Mae HomeStyle® Renovation Mortgage
With the Fannie Mae HomeStyle® Renovation mortgage you can buy and rehabilitate a home with just 5% down. Unlike an FHA loan, it does not require you to put down 1.75% as an upfront mortgage insurance premium. Moreover, if you have strong credit, your monthly mortgage insurance becomes cheaper. Lastly, you can cancel your mortgage insurance when you reach 22% home equity.