Learn About FHA 203k Improvement Loans

Home Renovation
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An FHA 203k loan allows you to borrow money, using only one loan, for both home improvement and a home purchase. These loans can also be used just for home improvements, but there might be better options available. 203k loans are guaranteed by the FHA, which means lenders take less risk when offering this loan. As a result, it’s easier to get approved (especially with a lower interest rate).

FHA 203k Basics

Some properties are almost perfect – the location is good, and the property has potential, but significant improvements need to be made.

Without those repairs, the home might not be suitable for living, and lenders might be unwilling to fund loans on a property with problems.

FHA 203k makes it possible for you to turn that property into a home (and to get that property off the market and make it a valuable part of the community again).

Fund repairs and purchase: you can borrow enough to make your purchase plus enough to make the necessary improvements. Because the Federal Housing Authority (FHA) is involved, lenders are willing to move forward with a property they otherwise wouldn’t touch.

Temporary housing: unless you want to live in a construction zone, you’ll need funds for other housing arrangements. In certain cases, you can borrow extra to cover rent or your existing mortgage for up to six months.

Project overview: your project must be completed within six months. Funds are placed in an escrow account and paid out to contractors as the work is completed.

It’s essential to work with reputable contractors who don’t underbid and who are familiar with the 203k process.

Eligibility: owner/occupants and nonprofit organizations can use FHA 203k, but not investors. The program is designed for one to four unit properties, but condo and townhome owners can use the program for interior projects.

You don’t need perfect credit – because the FHA protects lenders in case you default, it’s easier to qualify. You still need sufficient income to cover the payments. It’s best to have a debt to income ratio better than 31/43, but you might be able to go higher.

Depending on the type of improvements you have planned, other types of loans might be a better fit. For environmentally sustainable projects (like upgrades to more energy-efficient heating and cooling systems) a PACE loan can provide funding. PACE is available for commercial properties as well.

Loan Details

You must borrow at least $5,000, and there are maximum limits set by the FHA that vary by location. For most people buying a single-family home that is not extravagant, you’ll fall into these limits. For smaller projects, the Streamlined FHA 203k allows you to borrow less (with an easier process).  

You can borrow enough to finance 110% of the home’s projected value after improvement. Appraisers will review your plans and take the future value of your home into account.

Interest rate: the interest rate will vary, depending on rates in general and your credit. Expect to pay a rate that’s 1% or so higher than you’d pay on a standard loan.

Think of this as the cost of easier approval (or bundling both your purchase and improvement loans into one). Plus, lenders need to do extra work tracking the progress of your project and handling payouts. At the same time, the loan is insured by the FHA, so lenders might offer a lower rate than you’d get elsewhere. Compare offers and get the loan that works best for you. 2023k loans can be either fixed-rate or variable rate loans with repayment up to 30 years.

Down payment: with the 203k loan, like other FHA loans, you can pay as little as 3.5% up front. But there are good reasons for making a larger down payment whenever you can.

Contractors and DIY

203k loans give you the opportunity to make significant improvements to your home. You also get to do the things that matter most to you: if you want to use green or energy-efficient appliances and materials, you’re free to do so.

You can’t fund luxury items through 203k, but you can make dramatic improvements.

Unfortunately, you’re generally not allowed to do the work yourself. Even if you are a skilled, licensed contractor, don’t expect to handle all of the work.

You must use licensed contractors for all work, and it’s important that they know you’re using 203k. This might rule out certain handymen you’ve used in the past and have developed a relationship with. The 203k process is all about paperwork and following certain rules, so brace yourself for less freedom than you might have imagined when remodeling your home.

If you're an investor hoping to flip houses, there are better options, including money from private lenders.

Pros and Cons

203k loans are great for improving a property that you hope to live in. However, benefits never come for free.

Cost: FHA 203k loans might or might not be your most affordable option. You’ll pay an up-front mortgage insurance premium (MIP), and you’ll also pay a small ongoing fee with each monthly payment. Your lender may also charge a 'supplemental origination fee' (the greater of 1.5% or $350). Other non-203k lenders will certainly charge fees, so you need to get quotes from several sources (looking several different types of loans) before you make a decision.

Paperwork: these loans are notorious for the paperwork. You’ll fill out numerous forms, and your contractors are also subject to some of this pain. If you don’t have the patience to follow through on everything, consider other options.

Time: in addition to the time it takes to deal with paperwork, you’ll have to wait on answers from the FHA and your lender. They’ve got just as much (or more) paperwork to do on their end. Especially if you’re trying to buy a property in a competitive market, this can be a dealbreaker.

Required standards: you might have certain improvements in mind, but the FHA also requires that you deal with health and safety issues and meet all building codes. Lead paint, electrical problems, and other items may be added to your project list unexpectedly. Dealing with those issues is probably a good idea anyway, but you have less choice on when and how to fix those problems.