FHA 203k Loans: Everything You Need to Know
What is an FHA 203(k) Loan?
FHA 203k loans provide flexible home financing to purchase or refinance a home while simultaneously funding its renovation. It’s an all-in-one program, rolled into a single FHA-insured mortgage. It’s used for home renovations of all shapes and sizes, either for smaller repairs or large scale improvements.
The program comes in two flavors, the Standard 203k which has been around since 1978 and the Limited 203k which has been around since 1995 (the flavor formerly known as "Streamline 203k").
The Standard 203k program is used for larger rehabilitation projects over $35,000 like tearing down and rebuilding an unlivable dwelling. As long as you keep the foundation, you’re good to go. If you’re going to rip and replace everything, including the foundation, a construction loan would be a better bet. For the Standard 203k program, the minimum allowable loan amount for improvements is $5,000.
The Limited 203(k) provides a smaller loan option -- up to $35,000 -- for less extensive repairs, upgrades and improvements. There is no minimum requirement for the cost of a project. The Limited 203k cannot be used for structural repairs; this program is meant for projects like a kitchen remodel.
How FHA 203k Loans Are Used
Both 203k programs can be used by either homeowners or homebuyers.
For example, a homeowner might make improvements, property repairs or prepare their home in order to put it on the market for sale.
Homebuyers might use the Limited 203(k) for projects like painting, replacing carpet, or repairing a roof.
In nearly every case, the work must be completed by approved contractors. Loan proceeds are held in a renovation escrow account until the repairs or construction is completed. Do It Yourself (DIY) folks are discouraged but accepted if the borrower(s) can demonstrate experience and expertise. If you’re not in the construction trades for a living, this will be a tough hurdle to clear.
Why Do They Exist?
The FHA 203k is one of several FHA loan programs insured by the Federal Housing Administration (FHA), an agency within the US Department of Housing and Urban Development (HUD). The 203k is the “home fixer-upper” program. The reason HUD provides it is to help keep older homes in the United States in good condition.
Just so you know, HUD and it's subsidiary the FHA don’t loan money to people. Lenders like banks, mortgage companies and credit unions do that part. HUD actually insures privately-funded mortgages so that lenders carry less risk and have an ability (and incentive) to create more of them. Even though FHA and HUD are part of our government, they do not provide mortgage insurance using taxpayer money. In fact, borrowers actually pay for the insurance.
The whole point of renovation loans is this: When more 203k Loans are made, older neighborhoods are revitalized and more people become homeowners. This our government's way to create incentives within the housing market.
FHA 203k Rehabilitation Loans - How Are They Different?
203k loans are different than other types of construction and fixer-upper financial instruments in a couple ways:
- Borrowers can get one mortgage that will finance both the acquisition and remodeling of a property.
- For a Standard 203k, the loan amount is determined on the projected value of the property once the rehab work is finalized.
Other construction and remodeling loan programs often require as series of short-term loans that “stair step” their way through each phase; buying the property, taking out a rehab loan, then taking out a permanent loan at the end to pay off the interim loans. In the case of the 203k, the cost of the home and renovation are combined; there’s just one loan.
The 203k cannot be a subordinate lien, so any existing mortgage would need to be pulled into the new loan (as is the case when refinancing).
Private lenders receive the backing (insurance) from HUD as soon as the loan is funded the proceeds are disbursed to a rehabilitation escrow account (where the money is kept and released during the construction process).
Here’s What You Can Do
- Purchase a home and the land where the dwelling is located and remodel it
- Purchase a home originally on another site, move it onto a new foundation on the newly mortgaged property and remodel it
- Refinance an existing mortgage and repair or remodel it
203k Improvements That Are Allowed
As mentioned above, the Limited 203k and Standard 203k programs cover two general project scopes. The Limited 203k is meant for smaller repairs and improvements. The Standard 203k is meant for structural improvements including complete home reconstruction from a demolished or razed building (provided the complete and original foundation system remains). If the home is torn down all the way to the footings, you can’t use a Standard 203k loan but instead could be qualified for an FHA 203(b) which is meant for new construction.
Standard 203k Projects
Here are some examples of larger projects allowed under the Standard 203k program:
- Room additions
- Major energy conservation improvements
- Floor treatments
- Free-standing appliances
- Add heating/cooling systems
- Moving a house
- Add a storm shelter
- Structural Work
- Repairs over $35,000
There are a couple additional Standard 203k requirements to know about.
First, properties must meet certain energy efficiency and structural standards and comply with local building codes. All FHA minimum property standards must be met. Improvements must include weather stripping, insulation and other thermal efficient measures. Adequate safety measures must be met such as working smoke detectors and fixing peeling paint.
Second, for Standard 203k loans, an FHA-approved 203k Consultant will oversee and inspect the rehab efforts from start to finish. Here are some things you’ll want to know about Consultants, they are:
- Selected by the lender
- Enter into written agreement with the borrower which outlines fees ($400 to $1000) and duties
- Prepare cost estimates for the improvements and/or repairs
- Reviews plots if there are additions, floor plans, cabinetry, elevation, grading and drainage plans
- Inspect home at each at each work milestone so that draws from the escrow account may be released
- Complete a final inspection of the home
Limited 203k Projects
Here are some examples of smaller, more "cosmetic" projects that can be financed with a Limited 203k:
- Replace cabinets
- Interior or exterior painting
- Improve accessibility for people with disabilities
- Add major appliances (dishwashers, free-standing ranges, refrigerators, etc.)
- Repair or replace existing flooring and carpeting
- Lead-based paint abatement
- Minor remodeling (non-structural)
- Repair or replace existing HVAC systems, heating, plumbing and electrical systems
- Repair roof, gutters and downspouts
- Repair decks, patios or porches
- Repair septic systems
Major rehabilitation, like relocating a load-bearing wall, is not allowed with a Limited 203k. Nor could you add new rooms or repair major structural damage. Any project that takes more than six months to complete or requires two or more payments per contractor is not allowed. To summarize, bigger projects are better-suited for the Standard 203k.
203k Improvements That Are Not Allowed
Neither the Standard nor the Limited programs may be used for the following:
- Luxury items like swimming pools, hot tubs, tennis courts
- Satellite dishes or TV antennas
- Alterations or additions for commercial use
- Outdoor barbecue pits or fireplaces
- Landscaping or fencing
- Swimming pools (although you can fill one in for health and safety issues)
Eligible Properties for FHA 203k Loans
The property and dwelling must meet the following criteria:
- Owner occupied (you gotta actually live there)
- 1 to 4-unit family dwelling, completed for at least one year (with Certificate of Occupancy), unfinished homes do not qualify
- FHA-approved condos
- Manufactured homes (built after June 15, 1976) can likely be rehabbed if they’ve been on a permanent foundation for over one year.
- Co-ops are not eligible
You may also be able to fund the rehabilitation of a living area of a property with non-residential usage. It’s also possible to convert any property to a 1 to 4-unit structure (e.g. convert a single-family residence to a duplex) or vice versa (e.g. convert a duplex into a single-family home).
FHA 203k Borrower Eligibility
The borrower requirements for the 203k are the same as if you were buying or refinancing any other home with an FHA program. You would need to meet standard FHA credit qualifications such as down payment requirements and pay for mortgage insurance (upfront and annual) depending upon the loan to value. Standard FHA underwriting guidelines apply including verification of employment, income, debt, credit scores, etc.
However, there's one thing that’s very different. In the standard FHA underwriting process, there’s the usual inspection to check livability and an appraisal to find the fair market value of the property. In the FHA 203k underwriting process, finding fair market value doesn't make sense on a property in need of repair. In this case of the 203k, there’s an “As-Repaired” appraisal. Meaning, the appraiser is going to be looking at the current structure and the documents that outline what repairs will be made. From that, the appraiser creates an estimate of what the final fair market value will be after renovations. Makes sense, right?
FHA 203k Mortgage Terms
Below, you will recognize familiar types of mortgages. The length of time, known as the term, can vary quite a bit. There are several options available:
- Fixed Rate Mortgages (FRMs): 15/20/25/30-year term
- Adjustable Rate Mortgages (ARMs): 1 year, 3/1, 5/1, 7/1 / 30-year amortization
- 2/1 Buy Down
Another unique thing about FHA 203k loans is that a portion (0% to 20%) of the renovation loan amount is held as a contingency reserve. It acts as an extra piggy bank to pay for potential cost overruns. If all the repairs and improvements go smoothly and none of the contingency reserves is spent, it can be used a couple different ways. First, the borrower may make additional improvements (with approval, of course) or the lender may make one-time principal balance reduction. Contingency reserve accounts are required for Standard 203k loans. While not required by FHA for Limited 203k loans, lenders have the option to establish one and it is often recommended.
FHA 203k Loan Limits
203k Standard - Loan Limits
$5,000 is the minimum and loans can go up to the FHA county loan limit. Here’s how that works. FHA sets loan limits for each county (and sometimes metro areas) across the country. By evaluating median home values, each county is designated as a low-cost or high-cost area. The maximum 203k loan amount, in a high-cost area, would be $679,550. You can look up your county’s loan limit using HUD’s tool.
After you know the maximum loan amount that the FHA will insure, the second part is figuring out how much you can borrow for the specific property you want to buy (or refinance) and rehabilitate.
The maximum loan amount for your property (assuming it is less than the FHA max) is the lesser of these two amounts:
- The value of the property before rehabilitation plus the cost of rehabilitation
- 110% of the appraised value of the property after rehabilitation
You can also roll costs and fees into the Standard 203k loan amount as long as the FHA county maximum is not exceeded after adding them. They are:
- Total cost of rehabilitation
- Contingency reserves
- Supplemental origination fee
- Mortgage payments for up to 6 months
- Total loan amount cannot exceed standard county FHA loan limits
203k Limited - Loan Limits
$0 is the minimum and $35,000 is the maximum. The Limited program is not constrained by FHA county loan limits.
The following costs can be included in the Limited 203k loan amount, assuming the $35,000 cap is not exceeded:
- Total cost of rehabilitation
- Contingency reserves
- Inspections (if required)
- Supplemental origination fee
- Discount points
The image below summarizes all of the items we've covered so far, comparing the 203k Limited and 203k Standard programs.
Standard 203k loas vs Limited 203k loans
FHA 203k Loan Approval
Getting an FHA 203k loan looks a lot like this:
- Borrower selects a property and puts in an application with a lender of their choice
- Lender selects 203(k) Consultant (required for all Standard 203k loans and sometimes used for Limited 203k loans). Consultant visits property with borrower and a “Work Write-up” is prepared.
- Borrower hires contractor and the “Work Write-up” along with bids are sent to the lender for review.
- Lender processes, underwrites, closes and funds the transaction.
- Funds are released to a rehabilitation escrow account and HUD/FHA insures the loan.
- The improvement to the property begins (covered in detail below).
FHA 203k Construction Process
A 203k Loan Consultant -- who is a HUD-approved "construction manager" of sorts -- will oversee and inspect the rehabilitation project from start to finish. Standard 203k loan programs require it. Limited 203k loan programs do not. At the lender's discretion, they may still be used.
Another clue that this is not a "free for all" is that there's an expected timeline. Once repair/improvements begin, the project must be completed within 6 months.
The repair/construction process looks a lot like this:
- Initial draw of 50% of the estimated material and labor costs. Statement from the contractor that they are not willing or able to defer receipt of payment until completion of work.
- Work begins.
- Contractor completes the first phase of the project.
- Homeowner prepares Draw Request form and contacts 203(k) Consultant. Consultant inspects work completed thus far. If everything checks out, the Consultant and homeowner sign the Draw Request.
- Draw Request is submitted to the lender. Lender disburses a check made payable to borrower and contractor.
- This process continues until the work is complete.
- Final Draw is requested.
- Borrower provides Release Letter indicating that the work is completed. The Consultant/Inspector verify completion.
- Lender releases remaining funds.
Whether it's a new kitchen or a whole lot more, the two flavors of FHA 203k Loans provide a considerable range of home rehab options.