The FHA 203k loan bundles purchase and renovations costs into one mortgage, giving homebuyers another option for buying older homes in need of work.
What is an FHA 203k loan?
Thinking about buying a fixer-upper but not sure how you’ll afford the purchase and the renovations? An FHA 203k loan might be the solution.
Also called an FHA renovation loan, homebuyers can use 203k loans to purchase, refinance, and renovate a property.
You can also take advantage of other key FHA loan benefits, including a 3.5% down payment and 580 minimum credit score requirement. However, minimum score requirements are lender specific.
Want to buy a fixer-upper? An FHA rehab loan might be the key.
FHA 203k home loans can be a good option for homebuyers considering a property that won't qualify for traditional financing or will qualify, but is in need of updating. Whether that’s because they’re drawn to the renovation process or want to find an affordable home in the current escalating real estate market.
How much can you borrow?
An FHA 203k loan lets you finance the purchase price of the home, plus up to $35,000 in renovations.
However, this loan also requires an emergency fund, called a contingency reserve, which is set aside in case your renovation costs go over your budget.
These loans are subject to standard FHA loan limits, too. Keep in mind that the total loan including repair financing must be within local loan limits.
Rehab your current home with a 203k loan
The FHA rehab loan is a great way to turn a fixer-upper into your dream home. If you’re on a tight budget, it can also help you buy an older, lower-priced home and finance any needed upgrades affordably.
Existing homeowners can also use FHA renovation loans to refinance their current mortgage and cover home repairs or renovations. This can be a useful strategy if you need more space but don’t want to move — or you don’t want to jump into today’s very competitive market.
Renovating can improve your quality of life at home without having to search for a new home.
203k loan: A great way to build equity
Most people prefer a move-in ready home, meaning one that doesn’t require updates or repairs. For this reason, homes that require a little TLC often sell for below-market prices.
Additionally, you may not have to compete with 20 other offers on the home.
Once fixed up, though, many of these older properties gain value. Homeowners who do a minor kitchen remodel recoup more than 70% of their costs in the home’s value, and window replacements see a roughly 69% return on investment, according to Remodeling magazine.
An increase in value means you’re building equity, which can boost overall financial stability and increase your access to cash from the equity in the future.
How does an FHA 203k loan work?
The FHA 203k loan is a way of financing both a home purchase and repairs or renovations on the home with one single loan.
In addition to applying for the loan, as you would any mortgage, you’ll also need to select the necessary contractors and get accurate bids for your repairs.
After the loan closes, the contractors can move forward with the repairs and you can move into the property.
Two kinds of 203k loans: Standard and Limited
There are two different kinds of FHA 203k loans: The standard 203k loan and the limited 203k loan (previously called the streamline 203k).
With the standard 203k, you can make major structural repairs to the home, and there is no maximum repair limit (besides local FHA loan limits).
There is a $35,000 cap on limited 203k loans and repairs must be largely cosmetic (it does not allow structural changes to the property).
The 203k loan process, step by step
The 203k loan process is a little more complicated than a traditional mortgage, as it requires getting bids and finding a contractor.
Fortunately, choosing a lender who’s experienced in 203k loans can help ease the process. In fact, we would say it’s absolutely necessary to find an experienced lender. These loans require more involved processing and know-how on the lender’s part than the average home purchase loan.
Here’s what the FHA 203k loan process typically looks like:
- Apply with a 203k-approved mortgage lender. The lender will determine if you're preapproved for the purchase price plus your estimated repair costs
- Find a contractor. You’ll need a general contractor to complete a thorough estimate of all planned repairs and submit it to the lender
- Your lender will order an appraisal. The appraiser will take into account the expected repairs and how those will impact your home’s future value
- Submit all your loan documents. Your lender will need things like pay stubs, tax returns, W-2s, and more, depending on the type income you’re using to qualify
- Close on your loan. Once your lender has approved your loan, you’ll head to closing
- Begin work on your home. On a 203K Limited, your lender will issue 50% of your repair costs to the contractor, who can then commence work on the house. The other half of the funds will be disbursed once the project is complete. The repairs must be done within six months
- Move into the home. After the work is complete and your contractor has been paid, you can move into your newly renovated property
FHA 203k loan requirements in 2021
In order to qualify for an FHA 203k loan, you’ll need to meet certain requirements regarding the property, your down payment, and the type of repairs you’ll be undertaking.
Here’s a detailed look at how to qualify:
FHA 203k allowed repairs
With a limited 203k loan, you can’t make major structural repairs to your home. But you can finance upgrades and repairs to various features and systems, including:
- Replacing your roof, gutters, and downspouts
- Remodeling your kitchen or bathroom
- Updating flooring and carpets
- Installing energy-efficient features
- Improving your HVAC or septic system
- Repairing any existing health or safety issues
Anything that requires moving a load-bearing wall or changing the overall layout of your house counts as a structural change and would fall outside of the limited 203k loan eligibility requirements.
Properties financed by any type of FHA loan (including FHA renovation loans) must meet the minimum livability standards set out by the U.S. Department of Housing and Urban Development (HUD), which oversees the FHA.
Here are the property standards your home will need to meet before qualifying for an FHA 203k loan:
- Accessibility: This means there’s direct access to the home via a road, street, or other pathway
- Free from hazards: There’s no lead-based paint, asbestos, exposed wiring, toxic waste, or other known health threats or safety hazards
- Adequate access to utilities: This means it has proper water supply, gas, electric, and sewage systems
- Complete and in good repair: The interior and exterior of the building must be complete and livable, and the roof is in good repair
- Structurally sound: The foundation is in good condition, and water drains away from the house
- Functional: The home’s heating, cooling, and electrical systems all work, and the bathroom includes a toilet, shower, and sink
- Adequate living space: There’s enough space for all household members, as well as designated areas for eating and using the restroom
Essentially, the FHA wants to ensure that borrowers are purchasing safe, hazard-free properties that will maintain their value over time.
Quick tip: In some cases, you can repair the home to get it up to standards. In fact, that’s one of the most attractive things about the 203k loan: you can buy a home that would not otherwise be eligible for any financing.
The home must also be your primary residence. You cannot use an FHA 203k loan to buy a second home or investment property, a guideline that is standard across FHA loans.
Minimum/maximum repair costs
If you’re using an FHA rehab loan, you must finance at least $5,000 in repairs. The maximum you can finance is $35,000, but remember: the lender holds up to 20% back in case you go over budget. Usually, a buyer has about $31,000 total to work with depending on the age and condition of the property.
FHA 203k down payment requirement
The minimum down payment on an FHA 203k loan — or any FHA loan, for that matter — is 3.5% of the loan amount (which, in this case, is your home’s purchase price plus repair costs).
If your credit score is below 580, you will need to make at least a 10% down payment.
The down payment requirements apply to the repair costs as well. For example, if you have $10,000 in repair costs and a 580+ score, you need to make an additional $350 down payment (3.5%).
Maximum loan amount
FHA loans, when applicable, allow the value to be grossed up by 110% to assist in hitting the value of your home. As an example, if your property is appraised at $200,000, FHA says we can increase that value to $220,000 (110%) if needed.
However, that would sort of defeat the purpose of a 203k loan. You want to see an equity gain after the rehab. If the appraiser thinks the home will be worth less than the acquisition plus repair costs, you might want to rethink the purchase.
Use a 203k loan to cancel FHA mortgage insurance premiums (MIP) sooner
All FHA loans require an upfront and ongoing mortgage insurance premium. Upfront MIP is 1.75% of the loan, and most FHA borrowers pay 0.85% in annual premiums. You can refinance to a conventional loan when you have 20% equity to avoid paying mortgage insurance for the life of the loan.
Imagine buying a home that no one else wants below market value. You fix it up with a 203k loan, and suddenly the home is worth a lot more. You might be very close to being able to refinance into a conventional loan soon after the contractors are gone.
Finding a contractor experienced in 203k loans
Getting accurate estimates is vital if you’re using a 203k loan (otherwise, you may end up short on funds!).
These loans also require a significant amount of documentation, which must be passed on to your lender for final approval. Your contractor will provide accurate bids in a timely fashion to help the success of your transaction moving forward. If any errors are found on the bids, it could delay your purchase and hold back your renovations.
For these reasons, choose a contractor who’s experienced in 203k projects. They’ll know how to file the proper paperwork, and they’ll keep your purchase from getting delayed due to time-consuming mistakes and errors.
Why you need to work with an experienced 203k lender
As with your contractor, finding an experienced 203k lender makes all the difference. Because these loans are more complicated than other mortgage products, choosing an experienced lender can ensure your loan goes smoothly and stays on track.
A seasoned loan officer will be able to walk you through the documentation requirements for the estimate, as well as any other verification needed. There are more moving parts with an FHA 203k loan than a standard mortgage, so having an experienced team on your side is key.
FHA 203k loans have quite the learning curve, and letting a loan officer test the waters on your mortgage could be costly, particularly if you end up closing late. A late closing could mean losing out on thousands of dollars in earnest money and losing out on the house entirely.
How to apply for an FHA 203k loan
To apply for an FHA 203k loan, you’ll need to work with a lender that offers them. If you’re not sure whether a company provides FHA 203k loans, contact them directly. It’s a good idea to compare quotes from at least three lenders to make sure you’re getting the best all-around deal.
You can search for FHA 203k lenders through the HUD website. Check the 203k box to bring up lenders that have done a 203k loan in the past 12 months.
A lender can let you know if a property you’re considering qualifies, as well as how much you’ll likely be eligible to borrow. You can then begin the application process and begin securing contractor bids for the planned renovations.
Remember: You’ll need a thorough contractor to keep your loan on track. Start searching for one early on, and have them get started on their work bids as soon as you’re preapproved for your loan.
Once they’ve completed the bids and submitted the proper paperwork, you can send in your final loan documents, close, and get going on your repairs.
Pros and cons of an FHA 203k loan
As with any mortgage product, FHA 203k loans have advantages and drawbacks. Let’s take a look at both sides of the coin.
ProsConsCan help you finance a home purchase and repairs with one single loanMore complicated loans that may take longer to closeMinimal down payment required (3.5% if your credit score is 580 or higher)Not all lenders offer themAllow you to build equity quicklyComes with an upfront and annual Mortgage Insurance Premium
The FHA renovation loan has many perks, but make sure you consider the drawbacks, too. Renovating a home can be exciting, but it can also become a massive headache if you choose the wrong contractor or unforeseen issues crop up during the repairs.
An experienced 203k loan officer can offer personalized guidance based on your goals and finances.
When do you need a HUD-approved 203k consultant?
A 203k consultant is essentially a project manager for 203k repairs. They help you file the proper paperwork and keep your project and loan on track while you're renovating.
You do not need a consultant to get approved for a limited 203k loan. But if your construction budget is over $35,000 or you plan to make structural repairs and therefore need a standard 203k loan, you will need to work with a HUD-approved 203k consultant. All standard 203k purchases require consultants.
To find a 203k consultant, you can ask your loan officer for a reference or search HUD’s database for consultants in your area.
FHA 203k loan FAQs
Still have questions about FHA 203k loans? Here are some common ones.
What does an FHA 203k loan cover? An FHA 203k loan covers the purchase price of a property, plus the cost of qualifying repairs. On a limited 203k, these include largely cosmetic and functional upgrades up to $35,000. Standard 203k loans allow for higher-cost repairs and structural fixes.
How does an FHA 203k loan work? FHA 203k loans work like this: You apply for a loan with an approved 203k lender. You then get bids from an experienced contractor, get the home appraised, and then close on your loan. At that point, you can begin repairs. Those must be completed within six months, and then you can move into the property.
Who qualifies for an FHA 203k loan? To qualify for an FHA 203k loan, you’ll need at least a 3.5% down payment (with a 580 credit score or higher). That means 3.5% of the purchase price plus home renovation expenses.
The home will also need to meet HUD’s minimum property standards, which ensure you’re purchasing a safe and habitable property.
What credit score do you need for an FHA 203k loan? That depends on your down payment. With a 580 credit score or above, the minimum down payment on any FHA loan is 3.5%. If your score is under 580, you’ll need a 10% down payment.
Keep in mind that these are just the minimums set by FHA. Individual lenders can (and often do) set limits higher than this. You’ll need to check with your loan officer to see what credit score minimum you’ll need to meet.
Can I do the renovations myself with an FHA 203k loan? In most cases, you’ll need to use a licensed contractor to do the repairs associated with an FHA 203k loan. Occasionally, you may be allowed to DIY renovations, but only if you can prove you have the ability and skills to complete the work. Additionally, you’ll still need estimates from an outside contractor. This is to ensure your bids are accurate.
Do not include into the bids any repairs you plan to do yourself, assuming the home will meet FHA guidelines without them. Then, after closing, pay for and complete the work yourself.
Keep in mind that some lenders may not allow you to do the work.
Do you pay PMI on an FHA 203k loan? With FHA 203k loans — and all FHA loans — you’ll pay what’s called a mortgage insurance premium, or MIP. This is paid both upfront (at closing) and annually. In some cases, MIP can be canceled after 11 years, but only if you made a 10% down payment or higher.
However, most people refinance into a conventional loan when they reach 20% equity in the home. And this milestone can be achieved much faster when you do a 203k, thanks to the value you’re adding.
Can you buy a fixer-upper with an FHA loan? Yes. That’s one of the best uses for FHA 203k loans. You can finance both the purchase price of the home and the costs of the repairs using a single mortgage. Some homes require a renovation loan, in fact, because lenders won’t finance it in its current condition.
Is it hard to get an FHA 203k loan? It’s not necessarily hard to get an FHA 203k loan, but it is a more complicated process than most mortgages. This is because you’ll need to involve a general contractor, get quotes, and wait for a significant amount of paperwork to be processed before you can close on the loan.
How do I make an offer with a 203k loan? You’ll make your offer just as you would any other mortgage loan. When you get preapproved with your 203k lender, they’ll give you a preapproval letter stating how much you’re qualified to borrow. Include this in your bid to show the seller you’ve secured financing and can afford the property (and its necessary repairs).
What are the requirements for an FHA 203k loan? There are requirements both for the property and the borrower. First, your property must meet HUD’s minimum safety standards. If you’re using a limited 203k, the home cannot require structural changes or repairs.
As a borrower, you’ll need to make at least a 3.5% down payment and have a credit score of at least 580. However, minimum score requirements are lender specific. Generally speaking, your required debt-to-income ratio will be determined by the Automated Underwriting system ran by your lender.
Tap into the benefits of the 203k loan
As you can see, the FHA 203k loan can be a smart way to finance a fixer-upper purchase, build quick equity, or just get in on the ground floor of homeownership if more move-in ready homes are out of your price range right now.
Just make sure you partner with an experienced FHA 203k lender and contractor if you choose to use this loan. They can ensure your loan (and your repairs) go smoothly so you can move into the home within six months.
FHA 203k loan alternatives
If you’re looking to buy a fixer-upper, an FHA 203k isn’t the only renovation loan option you have.
You might also consider these conventional renovation loan programs:
- Fannie Mae HomeStyle: A HomeStyle loan is similar to a 203k loan, except it’s a conventional mortgage. You’ll need a higher credit score than you’d need on an FHA loan in order to qualify.
- Freddie Mac CHOICERenovation: This is another loan program similar to the FHA 203k that lets you roll the costs of repairs into your home purchase loan. Again, this is a conventional mortgage with higher credit score requirements.
Fairway is not affiliated with any government agencies. These materials are not from HUD or FHA, and were not approved by a government agency.
Some references sourced within this article have not been prepared by Fairway and are distributed for educational purposes only. The information is not guaranteed to be accurate and may not entirely represent the opinions of Fairway.