About FHA 203k Loans for Home Renovation
Before proceeding with an FHA 203(k) loan, it’s important to understand the two types: limited and standard. While both are available to help pay for home improvements, they are designed for renovations of different sizes.
Limited FHA 203(k) loans are intended for purchasing a nearly turnkey home needing only renovations. You’re not allowed to make any renovations that require structural changes.
For example, you may need to replace the carpet or install hardwood floors, or you might want to replace the kitchen cabinets and countertops. A Limited FHA 203(k) loan would be a great option for these renovations.
Standard FHA 203(k) loans are intended for larger renovation projects that could need structural changes made to the house. Maybe you’re removing a wall or putting on an addition to the home. When using a standard FHA 203(k) loan, you must hire an FHA-approved 203(k) consultant, and the project must have a minimum scope of $5,000.
There is a fair amount of steps when using an FHA 203(k) loan:
Applying for a 203(k) loan is very similar to any other type of loan. Once you complete the application, the lender will start the underwriting process. This includes doing a hard credit pull to assess your credit score and creditworthiness. As part of the process, you’ll also need to submit pay stubs, W-2s, previous tax returns, and bank and investment statements.
Once the lender has completed the underwriting process and approved your application, you can move forward toward closing.
After approval, you’ll need to find a consultant if you’re using a standard 203(k) loan. Many lenders have their own consultants for you to use. Otherwise, resources are available to find a 203(k) consultant.
These consultants are typically state-licensed engineers, contractors, architects, or inspectors. They are required to oversee the work and ensure its completion. Additionally, they approve the funds paid to each contractor after completing the work.
Once you've chosen your consultant, you’ll need to find a general contractor to complete the work on your home. Most lenders will allow you to choose a contractor; you just need to ensure they’re qualified and can complete the work within your budget. Looking into multiple contractors is recommended.
It’s time to get bids from the contractors on your list. Getting multiple bids will help you get the best possible price for the work.
Once you’ve picked a contractor and the lender approves them, you’re ready to close on your loan. The funds to purchase the home will be disbursed to the sellers, while everything allocated for renovations will be held in an escrow account.
Once you’ve closed on your loan, the work can begin. One of the requirements of a 203(k) loan is that all work must be completed within six months. It’s possible to request an extension, but that will be approved on a case-by-case basis.
Once different parts of the work have been completed, your consultant will approve the job and then authorize payment to the contractor out of the escrow account. Once all the work has been completed, you’ll have a final inspection to ensure all the work has been done as planned.
After the renovations are complete, you can move in, and your loan will be converted into a permanent FHA loan.
One of the perks of using an FHA loan is that the eligibility requirements are more lenient than conventional loans. Below are some requirements you’ll need to meet if using a FHA 203(k) renovation loan.
Before moving forward with a 203(k) loan, you also need to ensure the work you want to complete on your home is approved for this type of loan. Here are some of the renovations you can make with a 203(k) loan:
When using a Standard FHA 203(k) loan, you must work with a 203(k) consultant. This person ensures the renovations go smoothly and the budget is allocated appropriately.
The consultant will estimate the cost of completing all the work. Then, as the contractors complete the work, the consultant will approve and disburse the funds correctly.
If you take out a limited FHA 203(k) loan, you won't be required to hire a consultant.
Although you can hire your own contractor to complete the renovations, the contractor must meet a few requirements.
The contractor must be knowledgeable about the 203(k) program and not be listed on the following:
Additionally, the contractor must have your state's appropriate licensing and insurance.
The loan limits on an FHA 203(k) loan are the same as those on a traditional FHA loan. For most parts of the country, you can borrow up to $524,225, except for high cost of living areas where the limit is $1,209,750.
These limits include the costs to purchase the home and the renovations. The one exception is that with Limited FHA 203(k) loans, a maximum of $75,000 can be allocated toward the home’s rehabilitation.
FHA 203(k) loans also require borrowers to pay mortgage insurance premiums (MIP). Because FHA loans have more lenient lending requirements, MIP allows lenders to mitigate the additional risk they assume.
MIP comes in two forms: upfront mortgage insurance premiums (UFMIP) and annual MIP.
If you want to complete home renovations, weighing all your options is important. In addition to 203(k) loans, you could consider a home equity loan or home equity line of credit (HELOC). However, you should be aware of some potential limitations.
203(k) loans can be a great option for first-time homebuyers because they open up a larger inventory of homes. Instead of looking to find a home that checks all the boxes, you could choose a home that might need some work.
Want to learn more about the benefits of a 203(k) loan? There’s no better way to do that than to hear from people who have used the loans.
“I remember one couple I worked with, for whom a 203k loan enabled them to transform an outdated fixer-upper into a modern family home. In a 203k loan, the client can bundle purchase and renovation costs together into one loan, thus negating the necessity of multiple loans or higher-interest financing options. This made the renovation process so much more tenable and simplified for them to get involved with, as opposed to dealing with multiple payment schedules.
They chose the 203k loan because it had a lower interest rate than personal loans or credit cards, and they liked the simplicity of one payment. In addition, the guidelines of the loan ensured they worked with reputable contractors and had clear timelines for projects, making them feel taken care of through the whole renovation process.”
Before getting started with an FHA 203(k) loan, you should be aware of some common challenges.
A common reason why people use a 203(k) loan is because they want to make energy-efficient upgrades to a home. If you’re purchasing a house with older windows, it could cost you a significant amount of money each year in lost energy. Unfortunately, new energy-efficient windows can be extremely expensive. However, there are several government rebates available to help lower the costs.
Once your renovations are completed and you need to convert your 203(k) loan into a permanent loan, you can use an energy-efficient mortgage.
203(k) loans can also be used when you want to complete a home improvement project on your current home. You can refinance your mortgage and include the amount needed for renovations into a single loan. While interest rates fluctuate between lenders, some might offer lower rates on 203(k) loans than other financing options for home renovations.
While it’s possible to use an FHA cash-out refinance to complete home improvements, these require a significant amount of equity in your home. 203(k) loans allow you to borrow based on the future value of your home once renovations are complete.
FHA 203(k) loans can be used to buy a fixer-upper. The cost of purchasing and renovating the home is combined into one loan.
You can use any contractor you want to complete the renovations on a 203(k) loan as long as they are an approved 203(k) contractor.
When using a 203(k) loan, a contingency reserve of up to 20% is required if the project exceeds budget. If the renovation exceeds the budget and contingency, borrowers typically need to pay for the remaining work out of pocket or reduce the scope of work to be completed.
There are no income limits for a 203(k) loan; however, you must prove you can make timely payments when repaying the loan.
The home loan amount for a 203(k) loan is based on the purchase price of the home and the expected renovation costs. It can also be based on 110% of the expected value after renovations.
A 203(k) loan allows you to live in your home while renovations occur.
Additional fees are required when using a 203(k) loan instead of other FHA loans. These include:
You can combine a 203(k) loan with programs like down payment assistance. However, these programs aren’t available through the FHA. Instead, you’ll need to work with your state or local government to receive help through a down payment assistance program.
