Learn About FHA 203(k) Improvement Loans
An FHA 203(k) loan allows you to use one loan for home improvement and a home purchase. You can also use these loans just for home improvements, but there might be better options available.
FHA 203(k) Basics
FHA 203(k) loans make it possible for people to rehabilitate properties that need some help and turn them into homes. Sometimes the location is good and the property has potential, but you need to make a few significant improvements. 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 203(k) loans give homebuyers an incentive to take such properties off the market and make them a valuable part of the community again.
Fund Repairs and Purchase
You can borrow enough to purchase a home, plus additional funds to make necessary improvements. Because the Federal Housing Authority (FHA) insures the loan, lenders are more willing to move forward with a property they might not touch otherwise.
Pay for Temp Housing
Unless you want to live in a construction zone, you’ll need funds for other housing arrangements. In some cases, you may be able to borrow funds to help cover the mortgage payments on a property that you can't occupy for up to six months.
Funds go into 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 203(k) process.
Owner/occupants and nonprofit organizations can use FHA 203(k), 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, but as with almost any loan, you need sufficient income to cover the payments.
Depending on the specific improvements you have in mind, other types of loans might be a better fit. For environmentally sustainable projects (like upgrades to energy-efficient heating and cooling systems), a Property Assessed Clean Energy, or PACE, loan can also provide funding. PACE is available for commercial properties, as well.
You must borrow at least $5,000 for a standard loan, 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, and most projects should fall within those limits. For smaller projects, the Limited FHA 203(k)—previously under the name Streamline 203(k)—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.
The interest rate varies, depending on rates in general and your credit. Expect to pay fees somewhat higher than what you’d pay on a standard mortgage loan. Think of this as the cost of easier approval (or bundling both your purchase and improvement loans into one). Plus, lenders perform extra work, like 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 qualify for elsewhere. Compare offers, and get the loan that works best for you. 203(k) loans can be either fixed-rate or variable rate loans with repayment up to 30 years.
With the 203(k) loan, as with other FHA loans, you can pay as little as 3.5% upfront. However, there are several good reasons to make a bigger down payment whenever you can. Doing so can reduce your interest costs and keep monthly payments to a minimum.
Contractors and DIY
203(k) loans give you the opportunity to make significant improvements to your home. You also get to choose projects 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 203(k), but you can make dramatic improvements.
Enjoy hands-on projects? You may be disappointed to hear that the program could prevent you from doing the work yourself. Even if you are a skilled, licensed contractor, you might not be able to complete all of the work.
You must use licensed contractors for all work, and it’s important that they know you’re using 203(k). That could rule out local contractors you’ve used in the past, and with whom you have developed a relationship. The 203(k) process is all about paperwork and following specific 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 probably better options, including sourcing money from private lenders.
Pros and Cons
203(k) loans are great for improving a property in which you hope to live. However, there are always pros and cons.
FHA 203(k) loans might or might not be your most affordable option. You must pay an upfront mortgage insurance premium (MIP), and you also pay a small ongoing fee for each monthly payment.
Your lender may also charge a “supplemental origination fee” to earn additional revenue for processing your loan. Other, non-203(k) lenders will also charge fees. As a result, it’s best to gather quotes from several sources (looking at several different types of loans) before you make a decision.
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.
In addition to the time it takes to deal with paperwork, you’ll have to wait for 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.
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.