What Is an FHA 203k loan?

Whether you’re buying a home in dire need of complete renovation or just want to modernize the kitchen or flooring of a property before you move in, an FHA 203k loan insured by the Federal Housing Administration could be the solution to your financing issues.

How Do You Qualify for an FHA 203k Loan?

In general, an FHA 203k loan allows you to wrap your renovation costs into your mortgage with one loan and one closing. The amount you borrow is a combination of the price of the home and the estimated price of the repairs, including labor and materials.

Your down payment of 3.5 percent (the minimum required by the FHA loan program) will be based on the full loan amount and, of course, your monthly payments will be higher since you’re including repair costs in the same loan. You’ll need to qualify according to the standards of your lender, typically with a credit score of 640 or higher and with a maximum debt-to-income ratio of 43 percent, including the new monthly payment. The full loan amount must be at or below the maximum limit for FHA loans in your area, which in many housing markets is $417,500.

As with any FHA loan, you’ll be required to provide complete documentation of your income and assets and your credit profile; but you’ll also need a detailed proposal for your home, including a cost estimate. An appraiser will estimate the value of the home in its current state and estimate the home’s future value based on the cost of the renovation.

How FHA 203k Loans Work

There are two types of 203k loans: a streamlined version and a regular version. The streamlined 203k program is meant for homes that don’t need structural repairs and are capped at a maximum of $35,000 in repairs. No minimum amount of repairs must be made. Traditional 203k loans have a minimum requirement of $5,000 and can be used for structural repairs. Both loan programs require the repairs to start within 30 days of the loan closing and to be completed within six months.

The FHA has specific guidelines about types of projects you can finance with a 203k loan, but generally the only home improvements that you can’t finance are luxury items such as adding a swimming pool.

A Few Caveats

All FHA loans, including 203k’s, require you to pay mortgage insurance for a minimum of 11 years, and usually for the entire length of the loan. This could raise your monthly payments higher than anticipated. Interest rates are slightly higher on 203k loans compared to other FHA loans, and they also require an extra fee of $350 or 1.5 percent of the loan amount.

Because of the extra paperwork involved, 203k loans take a little longer to process than other loans, so you’ll need to be patient.

When deciding which home improvement projects to do, consider the neighboring homes in your community. If you’ve improved your home far beyond the level of comparable homes, it can be difficult to recoup your investment when you eventually decide to sell.

If you would like to use an FHA 203k loan, it’s best to work with a lender who has experience with them. Lenders with significant 203k loan experience can recommend contractors and help you with the paperwork.