FHA 203(k) rehab loan explained
Whether you’re an existing homeowner looking to rehab your current home or a prospective homebuyer looking to purchase a home you know demands immediate renovations, there’s an interesting federal loan that might come in handy: the FHA 203(k) loan—also known as the mortgage rehab loan.
For qualified borrowers, this uniquely designed home loan provides an enterprising way to not only obtain necessary funds to rehabilitate a property, but to conveniently roll it into your mortgage. That in itself can alleviate numerous potential headaches and complexities that might otherwise affect homebuyers whose ambitions aren’t just to purchase property, but to fix it up and add value.
The combined strengths of the FHA 203(k) rehab loan also make it appealing to existing homeowners who can use the 203(k) loan for dual rehab and refi purposes. Depending on financing preference, that could mean a new 15-year or 30-year fixed rate mortgage or a hybrid 5-, 7- or 10-year adjustable rate mortgage (ARM) with lower initial interest rates. Whatever term you choose, the FHA 203(k) loan is designed to provide you with affordable mortgage rates and the necessary financing to undertake specific home renovation projects.
In this article, we’ll take a closer look at the FHA 203(k) rehab loan; what it does, the kinds of projects you can use it for and current eligibility standards. We’ll even run through some pros and cons so you can determine if a 203(k) renovation loan is right for you.
FHA 203(k) rehab loan explained
- Bucket 1: You’re house hunting and discover a home you really love—but its deficits are glaring. If only it could be fixed up with the help of some additional funds.
- Bucket 2: Your current house offers several challenging projects you’ve long wanted to tackle, but you just haven’t found the right loan instrument that affords you the simplicity of one monthly payment for mortgage and renovation.
Whether you fall into bucket one or bucket two, there has long been an industry need for a home loan that encompasses both mortgage acquisition and home rehabilitation. Previously, homebuyers who wanted both were forced into a process that was typically less convenient, more complicated and more expensive. To fund renovations, borrowers frequently had to choose from loans with higher rates and shorter payment schedules, some of which culminated in balloon payments.
The FHA 203(k) loan solved all that. No more scrambling for second mortgages or wondering if your lender will close on a property in need of major renovation that you can’t afford to fix. By putting a premium on simplification and affordability, the 203(k) loan allows homebuyers and homeowners to make one monthly payment while achieving two key objectives.
Importantly, because the Federal Housing Administration (FHA) stands behind these loans (and the full faith and credit of the U.S. Government stands behind the FHA), approved lenders are protected from loss in the event of default. This means more loans are extended to borrowers at affordable rates. It also means the FHA 203(k) loans come with more lenient loan requirements than conventional loans backed by Fannie Mae and Freddie Mac. This has been a boon for homeowners who intend to acquire a fixer-upper.
Types of FHA 203(k) rehab loans
The FHA offers two types of 203(k) loans for homebuyers / homeowners looking to combine rehab and mortgage in one convenient payment:
- Standard FHA 203(k) loan
- Streamlined (or Limited) FHA 203(k) loan
Standard 203(k) loan
If your property demands significant repairs (beyond $35,000), you will want to explore the standard version of the FHA 203(k) loan. With the standard version, there is no limit on the specific amount of money that can go toward rehabbing your property, making the loan appealing to those trying to buy and subsequently rehab a property in foreclosure. Some of these properties can be in serious states of disrepair, requiring significant funds to make them safe, sound and appealing. At the same time, the 203(k) renovation loan can also be used for cosmetic improvements to the home, making it an appealing and versatile loan for homeowners considering a wide range of renovations.
Although the rehab component is not limited to a set dollar amount, as an FHA loan it is subject to certain overall lending limitations for single-family homes within a specific area. In a low-cost county, that limit for 2021 is $356,362 while single-family properties in higher-priced counties have a loan ceiling of $822,375. FHA mortgage limits change every year.
In addition, the FHA requires that the improvements meet certain energy efficiency and structural standards. The FHA 203(k) also has requirements governing home types. They are intended for single family homes. Condos and mixed-use homes are not unlikely to be eligible, but to be sure, always check with your lender and do your own due diligence on the HUD website as well.
There are various types of improvements borrowers can undertake using FHA 203(k) loans, including the following:
- Major and minor structural alterations and improvements
- Modernization and enhancements to the home
- Improvements that eliminate or address health and safety hazards
- Cosmetic improvements and changes that eliminate obsolete functionality
- Updating and/or replacing plumbing, water well and septic system
- Replacing and repairing roofs, gutters and downspouts, etc.
- Redoing or replacing floors throughout the home
- Landscaping improvements
- Improving accessibility for disabled persons
- Energy conservation improvements
While cosmetic improvements are allowed, luxury improvements are not eligible to be initiated with an FHA 203(k) loan. In other words, if you have your heart set on a swanky hot tub, swimming pool, tennis court or fire pit, you’ll have to fund them through other means. The 203(k) is for renovations, not opulence.
One further note: In most cases, the renovations must be performed by a licensed contractor and not by the actual borrower.
Streamlined 203(k) loan
Also known as the limited 203(k) mortgage, the streamlined version comes with a stipulation that no more than $35,000 can be apportioned for upgrades, repairs and renovations. The overall loan is subject to the same ceilings that govern the standard version. Like the standard 203(k) loan, the streamlined version can be used both by homebuyers and homeowners, for purchases and refinances. Homebuyers can use the money to address concerns raised by the home inspector and appraiser to make the property move-in ready, while existing homeowners can apply the loan toward repairs and renovations around the house that upgrade appearance and functionality; this can come in handy especially when prepping a home for sale.
The streamlined 203(k) loan can be used to finance all the projects listed above that pertain to the standard 203(k) loan. Additional good news: This loan typically requires less paperwork.
Eligibility for an FHA 203(k) loan
Loans backed by the Federal Housing Administration are primarily meant for families and individuals who may have trouble qualifying for conventional loans. In plain English, that means the eligibility standards are not as demanding. However, there is still a threshold of creditworthiness, income and DTI (debt to ratio) that you need to meet. Let’s take a look:
- Credit score: FHA loans are forgiving to borrowers with less than exceptional credit histories and credit scores, but they still need to maintain a certain standard. Generally, to qualify for an FHA loan (including the 203(k)), borrowers need to have a credit score of at least 500 (600 minimum at Guaranteed Rate).
- Down payment: The minimum down payment option for an FHA 203(k) loan is 3.5% of the principal amount. However, that’s only if you have a credit score of 580 or higher. For individuals below that threshold, a minimum 10% option may be required.* Your lender will tell you the exact amount, as well as advise you on other down payment assistance programs that may be available.
- DTI: Borrower DTI ratio is a reliable measurement of the ability to pay back a loan, and it is a key element in determining lender approval. DTI is essentially the ratio of your recurring monthly debts divided by gross monthly income and then multiplied by 100. FHA guidelines state that DTI should be below 50%; however, some lenders prefer to approve candidates with a lower percentage: 43% or less.
- Employment: In general, it’s important to have two years of employment you can verify in order to qualify for an FHA loan. However, exceptions do apply (military service, homemaker, self-employment, etc.).
- Residency status: To qualify for any FHA loan, you need to be a legal resident of the U.S. Individuals known as “Dreamers” who are classified under the “Deferred Action for Childhood Arrivals” program (DACA) are also eligible to apply for mortgages backed by the FHA.
- Home type: To qualify for the 203(k) rehab loan, the property needs to be a single-family dwelling.
- Foreclosure history: You cannot have foreclosed on a property within the last three years.
Is an FHA 203(k) rehab loan right for you?
OK, now that you know what an FHA 203(k) loan is, how it can help you as a homebuyer and a homeowner with much-needed renovations in and around your home, are you a good fit? Let’s look at some pros and cons:
- Simplicity: Combines a mortgage (new purchase or refi) with a renovation loan, creating an appealing seamlessness that’s reflected in one monthly payment.
- Convenience: Less paperwork, less time and less complexity.
- Affordability. FHA 203(k) loans come with lower rates, lower down payment options and very reasonable credit score requirements.
- Built-in flexibility. You can choose from fixed rates associated with 15- or 30-year mortgages or a variety of ARMs while still tapping the unique benefits of the 203(k) loan.
- Only available in the form of an FHA loan**
- Must purchase mortgage insurance
- May require the oversight of a HUD consultant
- Depending on the complexity of th renovations, there may be additional costs such as architectural assessments and supplemental origination fee
The FHA 203(k) rehab loan is not the only loan available to fix up your home; however, it may be the one that delivers the most value at the best price.
If you’re looking to buy a home whose current condition is clearly less than optimal, you’re probably going to look into not just a traditional mortgage, but some extra financing to pay for the necessary rehabilitation costs. Same thing if you’re a current homeowner. If there are significant renovation projects that you’ve long desired to conquer, the FHA 203(k) rehab loan may be the ideal answer. For qualified borrowers, it can provide ample funds for rehabilitation while setting you up with a new mortgage.
The best part? You save time and you save money by meeting two objectives with one loan (and one monthly payment). That makes getting a 203(k) loan a streamlined process. If this sort of financing seems appealing and relevant, consider talking to a trusted lender today to see if an FHA 203(k) rehab loan is right for you.
*Not applicable at Guaranteed Rate.
Guaranteed Rate, Inc. is a private corporation organized under the laws of the State of Delaware. It has no affiliation with the US Department of Housing and Urban Development, the US Department of Veterans Affairs, the US Department of Agriculture or any other government agency.
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