FHA 203(k) Loan: Renovating Your Dream Home

A Federal Housing Authority (FHA) 203(k) loan can be a stepping stone to creating your dream home. With up to $35,000 on a streamlined loan rolled into your mortgage for renovations and larger amounts for major repairs through a standard FHA 203(k), that fixer-upper could become a spectacular home. You could add a new kitchen, finish the basement or put an apartment above the garage. Read on to understand FHA 203(k) loans and whether they will work for you.

What Is an FHA 203(k) Loan?

An FHA 203(k) loan is a special type of government-insured mortgage that allows you to roll a loan for home renovation and a home purchase into a single loan. By combining two purposes in one — home purchase and home renovation — you can fix up a good home and make it one step closer to your dream home. This saves you the time of making two applications and increases the chances of approval for the amount you need.

To get an FHA 203(k) loan, the home must be your primary residence. Then, you can wrap rehabilitation or repairs into the mortgage. What’s included in renovation or repairs? All the costs of the renovation, including materials and hired labor. If needed, it can also include temporary housing or rent for the home renovation or rehabilitation period.

How Is an FHA 203(k) Loan Different From a Traditional Home Loan?

FHA 203(k) loans are government-backed loans insured by the Federal Housing Administration and offered through U.S. Department of Housing and Urban Development (HUD)-approved mortgage lenders nationwide. In contrast, conventional home loans aren’t government-backed. They also don’t allow you to roll renovation costs into the mortgage amount, except for Fannie Mae HomeStyle or conventional rehab loans.

In addition, with an FHA 203(k) loan, you’ll need to pay mortgage insurance for the duration of the mortgage loan or until you sell or refinance. On a conventional rehab loan, you can avoid private mortgage insurance with a down payment of 20% or stop paying it once your home equity reaches 22%. But with a 203(k), mortgage insurance never stops. Learn more about the differences between an FHA loan and a conventional home loan.

Types of FHA 203(k) Loans

There are two types of FHA 203(k) loans to consider: standards or limited. Here’s what to know about them.

Standard 203(k) Loan

A standard 203(k) loan is what you’ll want when looking at larger jobs that could exceed $35,000, such as major structural repairs. To get a standard 203(k) loan, the renovations must cost a minimum of $5,000. 

You’ll also need to hire a HUD consultant to oversee the renovation project and ensure compliance with government code. HUD also sets basic energy efficiency and structural standards for all financed properties.

A standard 203(k) loan can be used on one- to four-unit properties. According to the HUD website, renovations that can be financed through these loans include:

• Functional modernization and home improvements
• Removal of health and safety hazards
• Structural alterations 
• Reconstruction 
• Improvements to appearance 
• Reconditioning or replacing plumbing
• Adding a well 
• Adding a septic system
• Adding or replacing the roof, gutters or downspouts
• Additions or replacements to floors or floor treatments
• Major landscape work 
• Site improvements
• Adding accessibility for a disabled person
• Energy conservation home improvements

Limited 203(k) Loan

A limited 203(k) loan, also called a streamlined 203(k) loan, is the best option for homes that don’t require major structural repairs. A limited 203(k) loan offers homebuyers up to $35,000 rolled into the mortgage. 

A limited 203(k) loan has no minimum renovation cost requirement, so you could borrow just $3,000 for a simple renovation. The application process is also simpler than a standard 203(k). However, the $35,000 limit usually means that you won’t be able to roll major structural repairs into the mortgage.

Repairs and renovations that can be financed through a limited HA 203(k) loan include:

• Modernizing the home’s appearance
• Improving the curb appeal
• Making repairs to roofing or flooring
• Adding energy-efficient upgrades
• Repairing health or safety hazards
• Improving accessibility or functionality
• Improving or overhauling plumbing and waste systems
• Redoing landscaping or groundwork
• Repairing or improving gutters and downspouts

Because of the $35,000 limit, you won’t be able to perform several major structural repairs, such as replacing the roof, HVAC system and floors. 

Benefits of FHA 203(k) Loans

Using an FHA 203(k) loan for homebuyers and homeowners has numerous advantages. An FHA 203(k) loan can help finance both the purchase or refinance of a property and the cost of renovations. These loans have low down payment requirements and flexible credit guidelines. You’ll only need to make a down payment of 3.5% if your credit score is 580 or higher. 

In addition, by securing renovation costs as part of the mortgage, you could purchase a property in an older, gentrifying or growing neighborhood and potentially benefit from greater increases in property value over time. 

How to Qualify for an FHA 203(k) Loan

To qualify for an FHA 203(k) loan, you’ll need a down payment of 3.5% of the loan value if your credit score is 580 or higher.

If your score is between 500 and 579, you’ll be required to make a down payment of 10% of the loan value. In FHA guidelines, this is sometimes called the minimum required investment (MRI).

In addition to credit score requirements, the property must be the borrower’s primary residence. You must hire a contractor to perform the renovations and cannot perform them yourself. 

You must provide identity documents, verification of income and debts and your Social Security number while working with an FHA-approved lender.  

How to Apply for an FHA 203(k) Loan

To apply for and obtain an FHA 203(k) loan, you’ll need to:

1. Shop for offers and choose an FHA 203(k) lender 
2. Create a rehab proposal with licensed contractors
3. Get a property appraisal
4. Work with a 203(k) consultant to complete all the extra paperwork, including architectural exhibits, through construction supervision
5. Lender orders a second home appraisal of the “after-improved” value
6. Finalize your loan amount and confirm with the lender how the money will be given to contractors during the renovation
7. Complete repairs within six months (you might be able to apply for an extension)
8. Appraiser performs a final inspection after repairs are complete
9. The loan converts to a permanent loan. You’ll start making payments on the entire loan balance for the rest of the loan term.

A 203(k) consultant will work to approve the architectural plans and then oversee the project through construction and renovation. 

As the contractor will play a key role in the renovation process, selecting a reputable contractor is important. You can ask for recommendations from friends, colleagues or local craftspeople you trust. You can also check online reviews and any licenses or certifications the contractor holds. A general contractor can also assist in managing the renovation project and ensuring the renovations are completed on time.

Things to Consider Before Applying

While FHA 203(k) loans offer many advantages, taking on any renovation project comes with significant potential drawbacks or challenges. The renovation process can also be complex and time-consuming.

Likewise, when applying for an FHA 203(k) loan, you must meet strict qualification requirements and government criteria throughout the renovation process. The property being financed must also meet certain criteria.

Applying for FHA 203(k) loans also means more paperwork and slow processing times, with the potential for higher interest rates compared to other renovation loans.

You can address renovation challenges by securing a trusted contractor. Likewise, if you’re willing to be patient through the application process and negotiate interest rates, FHA 203(k) loans have much to offer. 

Should You Get a FHA 203(k) Loan?

An FHA 203(k) loan offers a simplified solution to roll home renovation costs into your mortgage value. You’ll benefit from a single application and low down payment requirements. In addition, you could get an FHA loan with a credit score as low as 500. However, any loan that involves renovation can require significant work and possible delays. You might also have to face higher interest rates. Will it work for you? That depends on your financial situation, credit score, budget, income and home value. For many borrowers, an FHA 203(k) loan is the stepping stone to creating the home of their dreams. 

Frequently Asked Questions