Introduction to FHA 203K Loans

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Introduction to FHA 203K Loans

So, you want to buy a fixer upper! 

Buying a home is not an easy thing, especially today when the prices are surging every passing day. You need to pay a lot of upfront cash that no one has. Thus, most of us move to loans. But, why not buy a home that needs a little TLC? Or buy a foreclosure 

Imperfect homes have a number of benefits for the homebuyers.  

  • They come with less competition as compared to the perfect homes. 
  • They cost much less and  
  • You can build tens of thousands in equity in a short time with just some minor improvements.  

But, you will still need money to pay these homes too. If you don’t have so much cash at hand to pay the price of the house, you can opt for a FHA 203K loan. 

What is FHA 203K Loan? 

The Federal Housing Administration offers FHA 203K loans for the homeowners who need some additional funds for acquisition or/and rehab of a house. Also known as FHA Construction Loan or a Rehab Loan, an FHA 203K loan allows you to borrow money for both home purchase and home improvement using only one loan. You can also use these loans for just your home improvements. FHA 203K loan are guaranteed by the Federal Housing Administration, thus these are easier to get than other kinds of home loans. The lenders offering these loans take a lesser risk with these loans as they are sure to get the money back (since it is guaranteed by the FHA). Therefore, these home loans are also easier to get approved and you may also be able to get a lower interest rate on them.  

FHA 203K loan addresses one of the most common problems when buying a fixer upper home: lenders usually don’t approve loans for the properties that are in need of a major improvement or repair. There are certain livability and safety standards that the home must meet. There are some home buyers who have enough money to buy the house and fix it up themselves. However, if the home is too run down, you will not be able to get a loan in the first place.  

Thanks to FHA 203K loan, homeowners are able to buy and fix up a house in a single loan transaction. This allows the lender to approve the FHA 203K loan despite the initial condition of the house.  

FHA 203K Loans – The Basics 

An FHA 203K loan is backed by the federal government and is given to the applicants who are looking to buy an old or damaged home and do repairs on it. There are some properties that are just perfect. The location is ideal too. However, these properties need substantial improvements to be able to live in them. The properties may not be suitable for living until these important improvements are made to them. Thanks to FHA 203K loans, you can now turn such a property into a home.  

Here is how you can use the FHA 203K loan: 

To Fund Purchase and Repairs 

You can get a loan to make enough money to purchase a house and to make necessary improvements to it. Since the FHA 203K loans involve the Federal Housing Administration, lenders are willing to move forward even with those properties that they wouldn’t touch otherwise.

Temporary Housing 

You will need to make other housing arrangements until the improvement and repair work on the property is complete. No one wants to live in a construction zone. Thus, you will also need funds to make your temporary housing arrangements. Under FHA 203K loan, you can also borrow some extra money to cover for the existing mortgage or the rent for up to 6 months.  

Project Overview 

It is essential to work only with reputable contractors when you are making improvements and repairs to the house. This is because the improvement work must be completed within 6 months. The funds under the FHA 203K loan is placed in an escrow account and money is paid out to contractor as the work is completed. Thus, it is best to work with the contractors who are familiar with how the 203K process works and the ones who don’t underbid. 

Eligibility for FHA 203K Loans 

To qualify for a 203K loan, you must meet the following requirements: 

  • Minimum credit score of 620-640 
  • Maximum debt to income ratio of 45% to 50% 
  • A down payment of 3.5% or more 
  • The loan amount applied for must be lower than the maximum FHA loan limit set for your area
  • If you intend to renovate a property using 203K loan, then you must be a co-occupant of the property 

Investors cannot use FHA 203K loan. While the loan program is designed only for one to four-unit properties, townhome and condo owners can use it for their interior projects.  

FHA 203K Loan Details 

The maximum limits for the FHA 203K loan is set by FHA for different locations. However, you must borrow at least $5,000. In case you don’t need such a big amount or have a smaller project in mind, then the Limited FHA 203K loan can be considered.  

Down Payment 

When it comes to FHA 203K loan, you can make as little as 3.5% down payment. However, the bigger down payment you can make, the better. 

Interest Rate 

The interest rates on FHA 203K loan vary. They depend in your credit and the rates in general. In general, 203k home loans generally have a higher interest rate than a standard FHA loan. 

FHA 203K loans can be variable rate or fixed rate loans. The repayment can be spread to up to 30 years.  

Which Repairs Qualify? 

FHA 203K loans have two main types. The standard or regular 203K loan is given for properties that are in need of remodeling, structural repairs, landscaping or a new garage. The second type, limited or streamlined 203K is for projects such as new roofing, energy conservation improvements, new appliances and for non-structural repairs including but not limited to painting etc.  

Here is a list of the other repairs that are covered under FHA 203K loan: 

  • Patios 
  • Decks 
  • Flooring 
  • Kitchen remodels
  • Bathroom remodels 
  • New siding 
  • Plumbing 
  • Heating systems 
  • Air conditioning systems 
  • Adding a second story to the house 
  • And more. 

Luxury improvements such as adding a swimming pool or a tennis court to the property is not covered under FHA 203K loan. Moreover, any improvement that will not become a permanent part of the property is also not included in this loan.  

How to Apply for FHA 203K Loan 

It is always advised to shop around and take rates from at least two to three vendors before you go on and choose one. However, also consider the experience of the lender when you are choosing them. In fact, when it comes to FHA 203K loan, the experience of the lender and the contractors is considered more important than the overall cost. Experienced lenders and contractors will be able to take care of the additional paperwork required by the FHA. Most of the time, the lenders will recommend contractors to you as well. 

Furthermore, you will need at least one bid from a licensed professional for your repair work. While the decision of choosing the contractor rests on you, the lenders need to check if the amount quoted in the bids is reasonable or not. The lenders will also require from you an appraisal of the current value of the home. The loan amount will be based on this appraisal in addition to the cost of repairs as quoted by the contractors. When the job is complete, the lenders require a title policy update and an inspection to make sure that payments have been made to all the contractors and that there are no liens placed on the property.  

The Cons of FHA 203K Loan 

203K loans are a great idea for making improvements to the property you are planning to live in. However, before you go on and do it, consider its cons too. 

Cost 

If you think that FHA 203K loans are the most affordable ones, then you should know that they aren’t. You will have to pay an upfront mortgage insurance premium. Moreover, you will also be paying a small monthly fee. You may also be charged a supplemental origination fee by the lender. Thus, before you go on and make a decision about whether or not go for this loan, it is best to take quotes from other lenders as well.  

Paperwork 

FHA 203K loans are notorious when it comes to the paperwork. There are a number of forms you will have to fill. Contractors will also have to do the same. If you think you will not be able to keep up with all these requirements, it is best to consider another option for your home improvement loan.  

Required Standards 

The FHA requires you to meet all the safety and health requirements in addition to meeting the building code standards. Electrical problems, lead paint and many other such costs may be added to the project list. While dealing with these issues is a good idea, but you will not have a lot of choice on how and when you want to fix these issues.   

Home Renovation Financing Alternatives 

If you think that FHA 203K loan is not suitable for you and you need only a few thousand dollars for the little work the house needs, then you can consider alternate options as well. Similarly, if your home renovation requires much more money that FHA offers in the form of FHA 203K loan, want to do the renovation yourself and don’t want to get bound by a loan that requires mortgage insurance for life, you will then have to look for another way to secure a home renovation or improvement loan.  Here are some home improvement loan options other than FHA 203K loan you can consider: 

Home Equity Loan 

Also known as a second mortgage, these are fixed rate mortgages that have a high interest rate but neither require mortgage insurance nor too much cost to originate. These loans work best for the projects that require a large sum upfront. However, you need some home equity before you can qualify for these loans to improve your property.  

HELOC 

Another good option to consider in case you need money for your home improvement is the home equity line of credit loan. This works best when you don’t have to borrow a lot of money at once or are in need of flexibility. HELOC usually has a variable interest rate. You will only have to pay interest on the amount you draw out. It can be re-used and repaired up to the limit you have set. The setup costs for this kind of loan are also really low to none. However, just like home equity loan, you need some home equity to be considered eligible for HELOC. 

Fannie Mae’s HomeStyle Mortgage 

Another loan option you have is the Fannie Mae’s HomeStyle Mortgage that allows you to buy and improve a house with just 5% down payment. There is no requirement of 1.75% upfront mortgage insurance premium as is required by FHA 203K loan. If you have a good credit, your monthly mortgage insurance can also be cheaper. You can also cancel mortgage insurance when you have the home equity up to 22%. 

Obtaining FHA 203K loan may seem like a complicated process, but it is the best option when you don’t have a lot of home equity or are low on cash reserves. Just make sure to get quotes from multiple lenders before choosing anyone to get the best rates.  

If you have been denied a home loan or have any questions about real estate or mortgage please contact the author, Matt Herbolich, MBA, JD, LLM by phone or text at 786.390.9499 or by email at mherbolich@usa-mortgage.com. Mr Herbolich works when you work, so feel free to contact him any time. 

Matthew Herbolich
Matthew Herbolich
Mr. Herbolich is a Senior Loan Officer at USA Mortgage, #NMLS 227262. He is an expert not only in lending but multiple facets of real estate, particularly the title industry. Matt trains his fellow loan officers on title industry topics, real estate investing, and countless mortgage guidelines. Have any questions? Call at 888-900-1020 or send email to: mherbolich@usa-mortgage.com

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