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Do you want to buy a fixer-upper, but don’t have the cash to fix it up? Would a home addition give you the extra space you want without having to move, but you don’t have enough equity to get a home equity loan?
Whether you’re buying a home or refinancing one, an FHA 203(k) loan can help in situations like these. This government-backed home rehabilitation loan provides a guarantee to lenders so borrowers can get a mortgage for more than a home’s current value. You must use the extra money to repair and improve the home under an approved and carefully supervised plan.
An FHA 203(k) loan works like a regular FHA loan in many ways. What’s different are the requirements related to using part of the loan to rehab your current or soon-to-be home.
You’ll need to find lenders that offer 203(k) loans. You can do this using the Department of Housing and Urban Development’s lender search tool. Check the box for “203(k) Rehabilitation Mortgage Insurance Program” at the end of the submission form. Once you’ve located the lenders you’re interested in working with, it’s a good idea to apply with several of them. This way, you’ll be able to compare loan estimates and get the best rate and lowest fees.
In addition to the usual mortgage underwriting requirements, you’ll need a two-part appraisal for a 203(k) loan. The first part shows the property’s current value, which can be based on an FHA appraisal or the net purchase price. The second part shows the property’s estimated value after the improvements you want to make with the loan.
You must use an FHA-approved appraiser, and the appraiser will need a copy of your improvement and repair plans. We’ll talk more about those plans in the next section.
When the loan closes, the lender will disburse the funds to cover the home’s purchase price or pay off the old mortgage. The renovation funds go into an escrow account. As the approved contractors you’ve lined up complete the home repairs and renovations in your plan, the lender will pay them from the escrow account. You’ll make payments on a single mortgage, and the principal will cover both the purchase price and the repairs.
The FHA limits how much you can borrow with a 203(k) loan. You can borrow a maximum of 110% of what the home will be worth after renovations. However, the loan amount can’t be more than the property’s pre-renovation value plus renovation costs, so your borrowing limit may be lower than 110%. You can finance up to $350 in loan origination costs and a percentage of borrower-paid discount points.
You also can’t borrow more than the FHA loan limit for your area. For 2020, the limit is $331,760 in most parts of the country. It reaches as high as $765,600 in high-cost areas.
How much money will you need for repairs and improvements? Will any of them be structural? The answers to these two questions determine whether you’ll need a standard FHA 203(k) loan or a limited FHA 203(k) loan.
Use a standard 203(k) loan if the home you’re financing needs at least $5,000 in repairs. You’ll have to hire an FHA-approved 203(k) consultant to inspect the property, create architectural exhibits and prepare a scope of work and cost estimate.
You can do the work yourself to save on labor costs. However, you can’t use the loan proceeds to pay yourself for your labor. The work must be completed to professional standards, so this isn’t the time to try hanging drywall after watching a few home improvement videos.
It’s a good idea to have contingency reserves in case the repairs go over budget, and you may be able to finance these reserves if doing so won’t put you over the maximum loan amount. You also may be able to finance mortgage payment reserves to pay your loan while the home is being repaired if you aren’t living in it.
Use a limited 203(k) loan if you won’t be making any structural changes to the home. There’s no minimum repair amount for a limited 203(k) loan, but the maximum is $35,000. You don’t have to hire a 203(k) consultant, but you do have to create a work plan.
You’ll need to hire a professional contractor to prepare this plan, which includes itemized cost estimates for labor and materials. For work that the FHA calls “specialized,” you will need estimates from a licensed and bonded contractor.
You can’t use a limited 203(k) loan if the repairs will prevent you from occupying the home for more than 15 days or if the work will take more than six months to complete. You also can’t use this loan for landscaping or site improvements.
You can finance a contingency reserve fund if you want. However, it can’t be more than 20% of the repair and improvement budget.
An FHA 203(k) loan can be used to repair and remodel these types of properties:
The home must be at least one year old, and you’ll need to live there for at least 12 months.
Here are some examples of the many repair and remodel expenses you can use the loan proceeds for, whether you’re using a standard or limited 203(k) rehab loan:
With a standard 203(k) loan, you also can make these types of changes:
Here are some examples of ineligible expenses for either type of loan:
Other costs associated with improving the property—such as permits, inspections, architectural and engineering fees and hiring a 203(k) consultant—can be included in your loan.
As a borrower, what qualifications do you need to get an FHA 203(k) loan? They’re the same as for a regular FHA loan: