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FHA 203k loan

What is a FHA 203K loan?

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What is a FHA 203K loan?

FHA 203k loan is a government guaranteed home loan designed to provide consumers with financing to purchase (or refinance) a property in need of home renovations and to simultaneously finance the cost of the improvements in the loan.

The amount of the home loan is based upon the increased value of the property after the improvements are completed. FHA 203k loans have easier qualification requirements and lower down payments / loan-to-value requirements. FHA 203k rehab loans are available as Fixed Rate or 5/1 Hybrid ARMs.

What are the FHA 203K loan limits?

An FHA 203k Rehabilitation Loan is a mortgage that is insured by the Department of Housing and Urban Development (HUD), and is designed to provide consumers with financing to buy (or refinance) a property in need of renovations, and simultaneously fund the improvements. The amount of the loan is based upon the increased value of the property after the improvements are completed, and is generally limited to 110% of the renovated value up to $275,665. In certain high priced real estate markets, the maximum loan can be as high as $636,150. The FHA maximum loan limits by county can be found here.

The types of eligible home renovations or home improvements range from the relatively minor repairs and improvements, such as new paint or kitchen cabinets, to more extensive improvements or structural renovations such as adding rooms to near complete remodeling. HUD does require on FHA loans that any health or safety deficiencies with the property are rectified as part of the repairs or renovations. As an example, if the Appraiser or an Inspector identified that a handrail was missing from a stairway, the borrower would be required to have a handrail added as part of the repairs or improvements.

What are the different types of FHA 203K loans?

There are two types of FHA 203k rehabilitation loans - “Standard 203K” and “Limited 203K”.

Standard 203K: The standard 203K will require more upfront paperwork and cost estimates detailing the home renovation before loan approval, and requires the work be completed by a reputable licensed contractor. In most cases lenders will utilize a designated 203K Project Consultant to help navigate and manage the 203K process, and disperse funds.

Limited 203K: The limited, or streamlined, 203K is intended for simple repairs, upgrades or improvements totaling less than $35,000. The advantage of the limited 203k is that it requires less paper and time to obtain, nor the need of a Project Consultant.

What is the eligibility criteria for this loan?

Since FHA 203k loans are guaranteed by the federal government, qualifying and loan-to-value requirements are more liberal than with conventional financing. This means borrowers can more easily qualify for FHA loans, and for higher loan amounts, than with standard conventional financing. Borrowers with moderately low credit scores (minimum 600 FICO score) or a limited credit history can qualify under FHA requirements. Additionally, FHA debt-to-income ratios and allowable income sources are less stringent than conventional financing. Down payment requirements for purchases can be as low as 3.5%, and on refinances, the maximum loan-to-value (LTV) can be as high as 97.75% of the value of the property. Because of these lower qualifying requirements and higher allowable LTV, borrowers are required to pay mortgage insurance which is financed in the loan by adding the premium to the loan amount. The amount of the mortgage insurance premium depends on the overall LTV.

How does a FHA 203K loan work?

FHA 203k loans are available as Fixed rate loans with terms of 10, 15, 20 or 30 years, and as a 5/1 Hybrid ARM. With Fixed rate loans, the interest rate and payments are fixed over the life of the loan. Each month the borrower makes the same principal and interest payment amount so that by the end of the loan term, the loan is paid off in full. The advantage of fixed rate loans is that the payments are set and do not change over time. The most popular fixed rate term is the 30-Year because the monthly payments are less than shorter term loans since the repayment is spread over 30 years. FHA also offers a 5/1 Hybrid ARM which has an initial fixed rate period for 5 years, and then rolls into a 1-year adjustable rate for the remaining 25 years. After the first 5 years, the rate and monthly principal and interest payment will change annually. The advantage of Hybrid ARM’s is that the interest rate for the initial fixed period is typically lower than a 30-year fixed rate, thus making the loan more affordable over the first 5 years and appealing to those that do not expect to keep the loan for the long term.

The overall advantage of FHA 203k rehab loans are that borrowers can finance repairs and improvements in a single loan, and the loan amount is based upon the value property after repairs have been made. This makes for a simple single loan, one monthly payment and one loan closing. Additionally, borrower qualifying and loan-to-value requirements are less stringent than traditional conventional financing allowing more borrowers to qualify, and to qualify for larger loan amounts.

The general disadvantages of FHA 203k rehab loans are higher monthly payments and time. Even though interest rates on FHA and conventional loans are about the same, the monthly payments on FHA loans are higher because of the required mortgage insurance premium. Additionally, the added upfront paper working, gathering cost estimates and working with contractors tends to lengthen the time needed to close the loan and get funding. Lastly, HUD does require that any health and safety related property deficiencies are repaired.

What are the pros and cons of FHA 203k loans?

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The pros

  • Ability to finance or refinance the property plus the cost of home renovations and improvements into a single loan.
  • One loan closing and one monthly payment.
  • Easier borrower qualification requirements – Easier credit standards (Min FICO score 600), lower debt-to-income ratio, lower reserve requirements.
  • Low minimum down payment of 3.5% for purchases.
  • Higher loan-to-value (LTV) limits for refinance – up to 97.75%
  • Available as a Fixed Rate with terms of 10, 15, 20 or 30 years – fixed principal and interest payments are the same over life of loan.
  • Also available as a 5/1 Hybrid ARM- initial- Initial interest rate and payments are typically lower than 30-year fixed rate mortgage thus making payments initially more affordable.
  • Loan pays off in full by the end of the term – no balloon payment at end.
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The cons

  • Requires mortgage insurance which increases loan balance and monthly payment.
  • Requires full loan application, borrower documentation, appraisal and renovation details which makes longer closing time may take 45 or more days to obtain funds.
  • Extra paperwork and time required to plan and document renovation work and improvements upfront – must have cost estimates, contractors selected before closing.
  • Larger projects require borrower work with 203K Project consultant.
  • Some restrictions on type of work or renovations that can be financed.
  • FHA may require certain work to improve health or safety be completed.
  • Can not be used on properties currently under construction.
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