FHA 203(k) Loans: A Complete Guide
Scott Steinberg7-minute read
March 19, 2022
A boon to DIYers and home project enthusiasts, an FHA 203(k) loan – also known as a mortgage rehabilitation loan, renovation loan or Section 203(k) loan – is a type of government loan that can be used to fund both a home’s purchase and renovations under a single mortgage. While Rocket Mortgage® does not offer FHA 203(k) loans, read on to find out more about 203(k) loans as well as some other options that may be a better fit for your financial needs.
What Is An FHA 203(k) Rehab Loan?
A 203(k) rehab loan is a form of home financing or refinancing that enables home buyers and homeowners to combine both real estate costs and incurred renovation expenses into a single mortgage. In effect, it allows home buyers who are considering purchasing a fixer-upper that requires multiple repairs and significant rehabilitation efforts to roll the cost of both the property and these projects into one home loan. Keep in mind that a conventional mortgage might be an even better loan option for homeowners looking to make more extravagant updates to their home.
A conventional loan may be a better option.
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Current homeowners can also apply for a rehab loan and use it as a means through which to refinance their property and fund the costs of an upcoming renovation through a single mortgage. If you find that a property you’re wishing to purchase or refinance may require significant repairs and enhancements, a rehab loan could be a good choice for you.
How An FHA 203(k) Loan Works
An FHA 203(k) loan is backed by the Federal Housing Administration (FHA). Funds obtained through a rehab loan, which can take the form of a 15- or 30-year fixed-rate mortgage, or adjustable-rate mortgage (ARM), can be applied to expenses associated with both materials and labor. Because these mortgages are insured by the government, the FHA 203(k) loan may come with more flexible qualification terms and requirements than a conventional home loan. The expenses associated with home improvement and repair efforts are added to the total that you elect to borrow and can be paid off over a period of years as you pay off the monthly premiums associated with your mortgage. Rehab loan offerings can provide a cost-effective way to pay for many home improvements (especially large home improvements). As with any mortgage, you’ll need to qualify to obtain one based on your income, credit history, credit score, debt-to-income ratio and other factors. Bear in mind that work covered under an FHA 203(k) loan must start within 30 days of closing, and projects must be completed within a maximum of 6 months’ time.
Types of FHA 203(k) Loans
There are two types of FHA 203(k) loans for you to choose from: a streamline 203(k) loan and a standard 203(k) loan.
Streamline 203(k) Loan
A streamline 203(k) loan, or limited loan, is frequently utilized for homes that require fewer repairs. It provides home buyers or homeowners with a maximum of $35,000 for renovations. No minimum cost requirement is attached, and applications may be simpler to process due to the lower sums borrowed under the terms of this type of loan. Keep in mind that you won’t be able to roll major structural repairs into the sums that you wish to borrow.
Standard 203(k) Loan
On the flip side, a standard 203(k) loan is typically used for larger jobs and covers major structural repairs exceeding $35,000. Renovations must cost a minimum of $5,000 though, and a U.S. Department of Housing and Urban Development (HUD) consultant must be hired to oversee the project and renovation process. Select rules and guidelines must also be followed to ensure compliance with government code.
What Can An FHA 203(k) Loan Be Used For?
Proceeds from an FHA 203(k) loan and mortgage can be utilized to fund a variety of projects, including, but not limited to:
- Improving a home’s curb appeal
- Installing or repairing roofing and flooring
- Making a home more energy-efficient
- Fixing any health or safety hazards
- Enhancing a home’s accessibility or functionality
- Overhauling plumbing and waste systems
- Redoing landscaping and groundwork
- Repairing or renovating gutters and downspouts
- Making changes that improve or modernize a home’s appearance
Note that luxuries such as a swimming pool, hot tub, outdoor fireplace, satellite dish or BBQ pit are not deemed eligible expenses by the FHA under the terms of a 203(k) rehab loan. As a general rule, any upgrade or enhancement that doesn’t improve the appeal of the property won’t be covered under an FHA 203(k) loan. Certain types of properties may also be prohibited from application, such as mixed-use properties (which combine residential and commercial space) and co-ops.
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FHA 203(k) Loan Requirements
Home buyers or homeowners must meet certain minimum requirements in order to qualify for a rehab loan. These requirements are similar to normal FHA loan requirements. Among them, you’ll find that:
- You’ll need to work with an FHA-approved lender in order to apply for the FHA 203(k) loan.
- Lenders require applicants to possess a credit score of at least 500.
- An FHA 203(k) loan requires a minimum down payment of 3.5% for those who possess a credit score of 580 or above, and 10% for those with a lower score.
- Lenders calculate your debt-to-income ratios, where your front-end DTI should not exceed 31% and your back-end DTI should be no more than 43%. If you have a higher credit score, you may be able to have a slightly higher DTI depending on lender policies.
- A 203(k) loan can only be used if the property is to be the borrower’s primary residence.
- Repairs and renovations must be performed by a contractor and not by the borrowers themselves.
How To Refinance Your Home With A Rehab Loan
FHA 203(k) loans can also be obtained by current property owners hoping to rehabilitate a piece of real estate that they hold within their portfolio. Should you qualify for and proceed with an FHA 203(k) loan, you’ll find that a portion of sums borrowed will go towards paying off the outstanding balance on your existing mortgage. Any remaining funds will be held in escrow until repairs are complete and they’re applied to paying off these bills.
Likewise, if you already have a preexisting FHA 203(k) mortgage, you can refinance it under the terms of the FHA streamline program. Doing so may help you obtain a lower interest rate that leads to lower monthly payments.
Should You Consider A Rehab Loan?
In order to decide whether or not an FHA 203(k) loan is right for you, it’s important to weigh the benefits and drawbacks of this loan type.
Pros Of FHA 203(k) Loans
- Lower credit score and down payment requirements
- Can provide temporary housing while a home is being repaired
- Competitive interest rates compared to other loan types
- Ability to combine home purchase and renovations into a single loan
- Low down payment and credit score requirements
Cons Of FHA 203(k) Loans
- Requires an upfront mortgage insurance premium (MIP)
- Application process can take a lot of time and paperwork to complete
- FHA 203(k) loans cannot be used for investment properties
- Monthly mortgage insurance premium is required
- Projects may require you to hire and work with a HUD consultant
You may find that closing costs associated with FHA 203(k) loans are in line with those associated with alternate types of mortgages and refinancing. These expenses go to cover standard fees such as those for appraisals, inspections, lender origination, title search and insurance, credit reporting, property surveys and more. Select lenders may apply additional fees for extending these loan packages, though.
Conventional Loans Vs. FHA 203(k) Loans
Looking at other options for financing or renovating your home? You may consider a conventional loan, although it differs from an FHA 203(k) loan. Conventional home loans require borrowers to possess higher credit scores and make larger down payments in some cases, but also allow applicants to implement more "luxurious” constructions and updates than the FHA would otherwise approve. If working on a fixer-upper is on your agenda, you can still use conventional loans and find financing options for the renovations you’re looking to complete.
At the same time, conventional loans may also come with more stringent application requirements and higher interest rates attached as well. You’ll want to research potential lending options up-front and make a point to shop around and compare rates and terms before committing to an offer from any lender. Doing some basic financial groundwork here may ultimately help you realize significant financial savings in the end.
The Bottom Line: Does An FHA 203(k) Loan Sound Right For You?
Whether you’re looking for an affordable way to refinance or remodel your home, an FHA 203(k) loan may present you with an excellent option. Before moving forward with the application process, you’ll want to compare lenders, research FHA project rules and terms and consider whether or not this financing vehicle makes sense for your fixer-upper. As part of your decision-making process, we recommend reading more about conventional mortgages – among many other solutions available to those looking to finance an impending home purchase or luxurious upgrades.
If you decide that paying for a renovation through a cash-out refinance rather than a renovation loan is a better option, you can apply online today. or give us a call at (833) 326-6018.
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