What Is an FHA 203(k) Loan? How It Works

If you’re looking to finance a fixer-upper, there are several loan options to consider. For instance, you could take out a traditional mortgage for the home and fund the renovations yourself, use a hard money loan, or explore an FHA 203(k) loan. Many fixer-upper homebuyers choose the Federal Housing Administration’s 203(k) loan to combine the costs of buying and renovating a home into a single loan. Today, we’ll review the basics of FHA 203(k) loans, how to qualify for one, and what you can do with these unique home loans. 

Contents of This Article: 

• What Is an FHA 203(k) Loan?
• FHA 103(k) Loan Qualifications
• Types of FHA 203(k) Loans
• What Can You Do With an FHA 203(k) Loan?
• Can You Finance an Investment Property?

What Is an FHA 203(k) Loan?

An FHA 203(k) loan is a type of mortgage offered by the Federal Housing Administration (FHA). It allows homebuyers to finance both the purchase of a home and the cost of renovations or repairs into a single mortgage loan. This is particularly beneficial for buyers who purchase a fixer-upper or a distressed property that requires significant repairs or upgrades. 

With FHA 203(k) loans, lenders base the loan amount on the property’s projected value after renovations are done rather than the current value. In turn, this allows borrowers to finance the purchase and revocation costs with a single loan and a single mortgage payment. 

That said, it’s important to note that these loans have certain requirements and restrictions, and borrowers must meet FHA loan qualifications. Next, we’ll review how to qualify for an FHA 203(k) loan, the types of loans, and what you can do with them. 

FHA 203(k) Loan Qualifications

If you want to get an FHA 203(k) loan, knowing what you need to qualify for it is important. That said, the first step to getting a loan is finding an eligible lender. Next, you’ll want to ensure that your purpose for getting the loan meets the FHA 203(k) guidelines. 

FHA 203(k) Loan Requirements

You must meet the requirements for a standard FHA loan to get a 203(k) loan. Some of the requirements include the following. 

• Credit Score and History- You’ll need a credit score of at least 500 to qualify for an FHA 203(k) loan, though some lenders may require a higher score. If you have any foreclosures within the past three years, you may not qualify for an FHA loan.
• Down Payment- If your credit score is 580 or higher, the minimum down payment is 3.5%. However, if your score is between 500 and 579, you must put down 10%. 
• Mortgage Insurance Premiums- You’ll have to pay upfront annual mortgage insurance premiums when getting an FHA loan. The upfront insurance is 1.75% of the loan amount, and the annual insurance ranges from 0.15% to 0.75% of the loan amount. 
• FHA-Approved Lender- You’ll need to find a lender who offers FHA 203(k) loans. However, not all lenders offer them, so finding the best lender for your project may take time. 
• Home Value- Since you borrow money based on your property’s after-repair value (ARV), an appraiser will need to inspect the home and review your work plan to determine how much your home will be worth after renovations. 
• Loan Limits- You’ll want to keep your total loan amount below the FHA loan limit in your area. For instance, in Washington, DC, the maximum loan limit for one-family properties is $1,149,825. 
• Emergency Fund- Depending on the size of your renovation project, your lender may require you to set aside up to 20% of the cost of improvements. This gives you an emergency fund for unexpected expenses that may arise. 

Steps to Getting an FHA 203(k) Loan

Since the lender is approving both your basic home loan and renovation project, there are some extra steps in the process. Here’s how it works. 

1. Complete an application with the basic criteria, including income, asset, and credit information. 
2. Give information about your planned renovations with an estimate prepared by a contractor.
3. Go over your renovation plan with a consultant who will approve it and oversee it during construction. 
4. Your lender will order a home appraisal to determine the after-repair value (ARV). 
5. Finalize the loan with your lender and determine how the money will be dispersed as the home is built. 
6. Once the home is complete, an appraiser will inspect the home to ensure everything is in order and your 203(k) funds are all used adequately. Per FHA guidelines, repairs should be completed within six months. 
7. Your loan will convert to a “permanent” loan, and you’ll start paying based on the entire loan balance for the remainder of the term. 

Types of FHA 203(k) Loans

There are two different types of 203(k) loans to choose from: Standard 203(k) loans and Limited 203(k) loans. Both types are federally insured mortgages that can be used to purchase and renovate a home. That said, each loan is used for different project types depending on the type and cost of the planned renovations. 

Standard 203(k) Loan

A Standard 203(k) loan, also called a Full 203(k) loan, is used for larger, more complex renovation projects. It allows for structural alterations, major repairs, or even home reconstruction. 

It has a minimum required draw of $5,000 and can be used for full demolition and reconstruction as long as the original foundation stays in place. For instance, if you’re buying a home that needs a new roof, HVAC system, or structural foundation work, this loan type may be a good option. 

Limited 203(k) Loan

A Limited 203(k) loan, also known as the Streamline 203(k) loan, is geared toward smaller and less extensive renovation projects or updates that won’t exceed $35,000. For instance, it covers a range of smaller projects, like painting, updating flooring or appliances, or making energy-efficient upgrades. 

The main difference between the Standard 203(k) loan and the Limited 203(k) is the ability to make structural changes. Since you cannot make structural changes with a Limited 203(k) loan, there’s less paperwork and generally no need for a 203(k) consultant. However, you’ll still need to hire a reputable contractor who’s familiar with the loan and renovation process. 

What Can You Do With an FHA 203(k) Loan?

Both Standard and Limited 203(k) loans can be used to finance renovations on eligible one to four-unit properties over one year old. Here are some examples of projects many homebuyers use these loans for.

Suggested Projects for Standard 203(k) Loans	Suggested Projects for Limited 203(k) Loans
Structural alterations Eliminating health or safety hazards Major landscaping work Upgrading the overall appearance and functionality Adding or replacing floors Improving accessibility for a person with disabilities Replacing or installing a septic system	Installing a new roof Remodeling the kitchen, bathroom, etc. Replacing the carpeting or other flooring Painting the interior Repairing a septic system Replacing appliances HVAC upgrades

Can You Finance an Investment Property?

Generally, you cannot use FHA 203(k) loans to finance investment properties, as they’re intended for owner-occupied properties only. However, there are a few exceptions. For instance, you may be able to use this type of loan if you plan on living in the property while also renting it out. As such, they’re mostly used for owner-occupied properties.

Are you looking for a place to rent while performing home renovations? Bay Property Management Group can help. We manage hundreds of rental properties across Baltimore, Philadelphia, Northern Virginia, and Washington, DC. So, if you’re looking for a well-maintained rental home, check out our current listings. 

On the other hand, if you’re a rental owner looking to streamline your management processes, we can help! We offer comprehensive rental management services, including marketing, tenant screening, maintenance, and more. Contact BMG today to learn more!