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FHA 203(k) Loan: What It Is and How It Works
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The Federal Housing Administration’s 203(k) loan allows fixer-upper homebuyers to roll in the cost of home improvements with the added benefit of more lenient qualifying requirements than other renovation loan programs. Understanding how the FHA 203(k) loan program works — and its limitations — will help you decide if it’s the best home improvement financing option for you.
What is an FHA 203(k) loan?
An FHA 203(k) loan is a mortgage insured by the Federal Housing Administration (FHA) that helps homebuyers finance the purchase and rehabilitation of a home with a single mortgage. Current homeowners can also include the cost of home improvements into a refinance and make use of the 203(k) loan.
A portion of the loan is used to purchase the home or pay off an existing mortgage, and the remainder is placed in an escrow account to cover the rehab costs as work is completed, much like a construction loan. A 203(k) loan can be a fixed- or adjustable-rate mortgage (ARM).
Different types of 203(k) loans
There are two versions of the 203(k) loan: the limited and the standard. The limited program comes with more restrictions on the scope and cost of the improvements you can make, while the standard program is designed for larger rehabilitation projects with a higher price tag.
Limited 203(k) loan
The limited FHA 203(k) rehab loan is geared toward minor improvements and repairs. No structural work is allowed, so you won’t be able to knock out walls or add rooms. In some cases, borrowers may be allowed to do some of the home improvement work, but a licensed contractor must be involved in the process.
Standard 203(k) loan
The standard 203(k) loan is for major renovation or remodeling projects and requires the use of an FHA-approved 203(k) consultant to oversee the progress of the licensed contractor’s work from estimate to completion. This version of the 203(k) allows for structural improvements including room additions, but still prohibits any “luxury” improvements like swimming pools or outdoor fireplaces.
What the FHA 203(k) consultant does
The 203(k) consultant is a state-licensed architect, contractor, engineer or inspector who serves as a liaison between the buyer, contractor and lender. Your consultant signs off on the release of funds as the work is finished, and the funds go directly from the lender to the contractor or another service provider.
How the FHA 203(k) loan works
Because the lender is approving both your basic loan and your construction project, there are a few extra steps in the mortgage process.
- Complete an application and provide basic income, asset and credit information.
- Provide information about your planned renovations with an estimate prepared by a contractor.
- If you’re doing a 203(k), you’ll hire a consultant to review the plan, approve it and then oversee it during construction.
- The lender appraises the home and issues an “after-improved” value.
- You’ll finalize your loan amount and the lender will finalize how the money will be given to contractors as the home is built.
- Once the home is complete, the appraiser does a final inspection and if everything is in order, your 203(k) funds are all used. According to FHA guidelines, repairs must be completed within six months for both the limited and standard program. Extensions may be granted on a case-by-case basis as long as payments are being made on time.
- Your loan converts to a “permanent” loan, and you start making payments based on the entire balance of your loan.
How much can I borrow with a 203(k) loan?
The table below gives you an overview of how much you might be able to borrow with each 203(k) option.
|Loan type||Minimum improvement cost||Maximum improvement cost|
|Limited 203(k) loan|| |
|Standard 203(k) loan||Lesser of |
Projects eligible for 203(k) loans
Both types of 203(k) loans can be used to finance renovations on an eligible one- to four-unit property that is more than a year old.
The limited FHA 203(k) mortgage only allows for smaller home improvements that can be completed within six months.
Projects that are a good fit for the limited program might include:
- Installing a new roof
- Painting the interior
- Remodeling the kitchen
- Repairing a well or septic system
- Replacing the carpet
A standard FHA 203(k) loan covers a wider range of home improvement projects, including:
- Altering the structure
- Modernizing and improving functionality
- Eliminating health and safety hazards
- Upgrading the appearance
- Replacing plumbing or installing a well or septic system
- Adding or replacing roofing, gutters and downspouts
- Adding or replacing floors
- Major landscaping work
- Enhancing accessibility for a person with disabilities
- Making energy conservation improvements
Current FHA 203(k) loan requirements
To get a 203(k) loan, you must meet the requirements for a standard FHA loan.
- Credit score, credit history and down payment. If you’re making the minimum 3.5% down payment, you’ll need a 580 credit score. If your score is between 500 and 579, you must put down at least 10%. At least three years must have passed since any foreclosures.
- Mortgage insurance premiums. You’ll pay upfront and annual mortgage insurance premiums. The upfront insurance is 1.75% of your loan amount and the annual insurance ranges from 0.45% to 1.05% of your loan amount.
- Lender. You’ll need to work with an FHA-approved lender.
- Loan limits. Keep your total loan amount below the FHA loan limit in your area. The 2022 loan limit for one-unit properties in most of the country is $420,680.
- Contingency reserves. Depending on the size of your project, your lender may require that you set aside up to 20% of the cost of the improvements for unexpected costs that may arise. If you don’t have enough equity to roll them into your 203(k)loan, the lender may require proof you have the cash to cover them out of pocket.
- Home value. One unique feature of renovation loans is you borrow money based on your “after-improved” value, which gives you more borrowing power than other types of home improvements loans that only consider your current “as-is” value. An approved FHA appraiser inspects your home, and considers the work plan and cost estimate to determine how much the home will be worth with the completed renovations.
Pros and cons of an FHA 203(k) loan
You can buy or refinance a home and renovate it with one mortgage
You’ll pay higher mortgage insurance premiums and fees than a standard mortgage
You can qualify with much lower credit scores than standard renovation loan programs allow
You must finance a home you intend to live in
You can borrow based on the value of your home after it’s improved
You may have to pay out of pocket for reserves to cover unexpected expenses
You’ll pay lower rates than unsecured personal loans or credit cards
Your loan amount will be restricted by FHA loan limits
Alternative home improvement loan options
If the FHA program doesn’t work for your reno needs, consider one of these options (all of them allow you to qualify based on the after-improved value of your home):
Fannie Mae HomeStyle renovation loan
If you’ve got at least a 620 credit score and have plans for a few luxury items in your renovation project, the HomeStyle renovation loan may be worth a look. Added bonus: You can borrow up to the conforming loan limit of $647,200 for a single-family home in most parts of the country.
Freddie Mac CHOICERenovation and CHOICEReno eXPress loan
Both of these programs allow you to finance the cost of buying and fixing up your home up to the maximum conforming loan amounts, similar to the HomeStyle renovation loan. However, the CHOICEReno eXPress loan gives you an easier qualifying option if your renovation costs are below 10% or 15% of the value of your home, depending on you where you live. Both programs allow down payments as low as 3%.
USDA renovation loan
If you live in a rural area of the country, you might be able finance up to 100% of your renovation costs and repairs with the U.S. Department of Agriculture (USDA) renovation loan. Income limits apply and you can’t finance more than $35,000 worth of repairs.
VA renovation loan
Military servicemembers and their families may be able to buy a home with no down payment and add the fix-up costs up to 100% of the home’s after-improved value. If you qualify through the Department of Veterans Affairs (VA), it may be worth it to see if you can get a VA renovation loan.
Frequently asked questions
How do I find FHA 203(k) lenders?
You may need to shop around for FHA-approved lenders that have experience and specialize in the 203(k) loan program.
What is the maximum FHA 203(k) amount?
Lenders can’t lend more than the FHA loan limit in your area.
Is a 203(k) loan worth it?
If you don’t have the cash resources to fix up your home and have some bumps in your credit history, a 203(k) may be worth the extra costs.
Can I flip a house with a 203(k) loan?
No. The FHA 203(k) program is meant for borrowers who plan to live in the home they are financing.
Can I do the repairs myself with a 203(k) loan?
Yes, subject to limitations. However, a contractor must prepare an estimate to verify your fees are in line, and you can’t personally be reimbursed for your labor costs.