While many homes on the market are move-in ready, others need a little bit of TLC. Buying a fixer-upper has its benefits. You’ll have a wider selection of properties to choose from, and you may face less competition from other homebuyers. What should you do if you think you’ve found your dream home, but it needs a lot of work before it’s ready for your family to move in? That’s where an FHA 203k loan can help.
What is a 203k Loan?
A 203K loan is also known as a renovation loan. In the past, a homebuyer needed two separate loans to purchase a fixer-upper: a mortgage and a loan for the renovations. A 203k loan allows consumers to finance the purchase of a home and the needed improvements with one single mortgage. 203k loans are guaranteed by the U.S. Federal Housing Administration, which reduces the risk to the lender. The money for renovations is kept in an escrow account and is disbursed to pay contractors to complete their work on the property.
Types of 203k Loans
There are two types of 203k loans: a Standard 203k and a Limited 203k (previously called a Streamlined 203k).
With a standard 203k mortgage, you must borrow a minimum of $5,000. There is no maximum as long as the renovation cost plus the purchase price is within FHA limits. You can also borrow up to six months of mortgage payments if you cannot stay in your home while the work is done. Standard 203k loans can be used for almost any type of home improvement project. The homebuyer must work with a 203k consultant who monitors the construction and makes payments to contractors as each stage of work is completed.
A Limited 203k has no minimum amount that you must borrow. The maximum amount you can borrow is $35,000, no matter what the home’s value. A limited 203k must be used for non-structural improvements, such as repairing a roof, upgrading the HVAC system, or installing new flooring. It also has less stringent paperwork requirements than a standard 203k. The home must remain habitable while it’s being renovated. If it is not habitable for any reason, the buyer must use a Standard 203k loan.
Home renovations financed with 203k loans must meet the following requirements:
- Homeowners cannot do any of the repairs or renovations themselves. The work must be done by a contractor approved by the mortgage lender.
- A 203k loan cannot be used to pay for improvements that the FHA considers luxuries—for example, adding a new swimming pool.
- The completed property must meet HUD and FHA requirements. The home must be inspected and appraised after work is complete.
- The home must have been completed for a minimum of one year.
- All projects must be completed within six months.
It’s best to work with contractors who have experience with 203k loans and can handle the paperwork required. Many 203k mortgage lenders will be able to recommend contractors.
Qualifying for a 203k Loan
One of the biggest differences between a traditional FHA mortgage and a 203k mortgage is that with a 203k loan, you must qualify based on the home’s purchase price plus the renovation costs.
Properties eligible for 203k loans include single-family houses, condos or townhomes, and qualified manufactured homes. The home must be the borrower’s primary residence. Vacation homes and investment properties do not qualify.
While the FHA permits borrowers with credit scores as low as 580 to apply for 203k loans, different lenders have different credit score requirements. Many lenders will require higher credit scores. Most 203k borrowers will need a credit score between 620 and 640. Interest rates will depend on the current national interest rate, the borrower’s credit history, the down payment amount, and the loan amount. A 203k can be either a variable-rate or a fixed-rate mortgage.
Borrowers will need a down payment of at least 3.5%. The down payment required may be higher depending on your lender and your credit score.
Contact us to learn more about renovation loans and find out if a 203k loan is right for you.