Buying a home usually means you face a few upgrade costs, but those taking on a true fixer-upper might consider a 203(k) loan, also known as a mortgage rehab loan. Accessible because of provisions by the U.S. Federal Housing Administration (FHA), this mortgage loan combines financing for the home’s purchase price with the cost of remodeling or repairing it, all in a single loan.
What is an FHA 203(k) loan?
An FHA 203(k) loan allows homebuyers to borrow enough funds to cover both the cost of the home and the price of necessary repairs, including the cost of labor and material for those repairs. Certain 203(k) loans may also be expanded to include funding for up to six months of mortgage payments.
The FHA does not directly lend these funds, but rather provides financial protection to lenders that do. The 203(k) loan can either be a 15- or 30-year fixed-rate mortgage or an adjustable-rate mortgage (ARM). The amount you can borrow depends on qualifications like credit and income, and the lender will also assess a down payment based on the total amount.
With the 203(k) loan, the maximum loan amount that can be borrowed is capped at 110 percent of the home’s projected value, as determined by an appraiser. Additionally, lenders require the borrower to pay mortgage insurance.
Interest rates could be slightly higher than those associated with a conventional mortgage; however, they might be significantly lower than interest rates on other loans taken out to cover repairs.
There are two types of 203(k) loans:
- Limited or streamline 203(k): This loan is intended for smaller renovation and upgrade projects valued at less than $35,000. There is no minimum cost requirement, although you can’t fund structural repairs with a Limited 203(k).
- Standard 203(k): The Standard 203(k) loan is intended for more extensive repairs with a total price tag greater than $35,000. The minimum loan amount for this type is $5,000. Structural changes, like additions or full home renovations, are permitted. The homebuyer must obtain architectural exhibits and meet building codes.
It doesn’t happen often, but 203(k) loan borrowers might be able to do some or all of the work themselves, but only with specific approval from the lender. If you’re considering a DIY rehab project, you might need to document your experience and ability with the kind of work you plan to perform, which your lender will need to sign off on, before you’re even considered for the loan.
In most cases, however, the lender will require the work to be completed by a licensed contractor.
Who qualifies for a 203(k) loan?
Borrowers must meet specific criteria from the FHA to qualify for a 203(k) loan, including:
- A minimum credit score of 640 or higher
- 5 percent minimum down payment
- Maximum 45 percent debt-to-income ratio
Some of these requirements may vary slightly among lenders.
203(k) loans are available only to borrowers who will live in the home as their primary residence, although under certain situations, nonprofit organizations can also take out 203(k) loans.
There are also minimum energy efficiency and structural standards that must be met by the project to qualify.
What kinds of renovations does the 203(k) loan cover?
The 203(k) loan covers just about any expense the homeowner can think of, with the exception of certain luxury upgrades. Those renovations include:
- Structural alterations and reconstruction
- Modernization and improvements to the home’s function
- Elimination of health and safety hazards
- Changes that improve appearance and eliminate obsolescence
- Reconditioning or replacing plumbing (e.g., installing a well and/or septic system)
- Adding or replacing roofing, gutters and downspouts
- Adding or replacing floors and/or floor treatments
- Major landscape work and site improvements
- Enhancing accessibility for a disabled person
- Making energy conservation improvements
- Conversion from a single-family to multi-family property (maximum of 4 units) or vice versa
Work on certain kinds of properties is not allowed to be financed with a 203(k) loan, however. Co-op owners, for example, do not qualify for 203(k) loans. Mixed-use properties with both commercial and residential space may be eligible if the work being done is solely for residential usage.
What are the closing costs for a 203(k) loan?
203(k) loans have similar closing costs to other new mortgages and refinances, typically 2 to 7 percent of the sale price. However, some lenders may charge supplemental fees for this type of financing.
Can you refinance with a 203(k) loan?
Yes. 203(k) loans can be used both to purchase a fixer-upper or rehabilitate the home you already live in through a refinance. The process to refinance into a 203(k) loan is similar to a regular refinance, but you must meet the additional requirements of the 203(k) loan.
After refinancing, a portion of the 203(k) proceeds will pay off your existing mortgage, and the rest of the money will be kept in escrow until repairs are completed.
Existing 203(k) mortgages can also be refinanced through the FHA streamline program, which may help borrowers get even lower rates.
Alternatives to a 203(k) loan
A 203(k) loan might not be right for all borrowers. If you’re looking to finance home improvements or buy a fixer-upper, your other options include:
How to find an FHA-approved lender
The FHA has a tool on its website that allows you to search for agency-approved lenders in your area. You can narrow the results by what kind of mortgage product you’re looking for, including 203(k) loans.