What is an FHA 203 (k) loan? – Councilor Forbes
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Want to buy a renovator, but don’t have the money to fix it? Would a home addition give you the extra space you want without having to move, but you don’t have enough equity to get a home equity loan?
Whether you are buying a home or refinancing one, an FHA 203 (k) loan can help you in situations like these. This government backed home improvement loan provides security to lenders so borrowers can secure a mortgage in an amount greater than the current value of a home. You must use the extra money to repair and improve the house under an approved and carefully supervised plan.
How does an FHA 203 (k) loan work?
An FHA 203 (k) loan works like a regular loan FHA loan In many ways. What is different are the requirements for using part of the loan to rehabilitate your current or future home.
You will need to find lenders who offer 203 (k) loans. You can do this using the Ministry of Housing and Urban Development lender finder. Check the “203 (k) Rehabilitation Mortgage Insurance Program” box at the end of the submission form. Once you’ve located the lenders you want to work with, it’s a good idea to apply to several of them. This way you will be able to compare loan estimates and get the Best rate and the lowest fees.
In addition to the usual mortgage underwriting requirements, you will need a two-part appraisal for a 203 (k) loan. The first part shows the current value of the property, which can be based on an FHA appraisal or the net purchase price. The second part shows the estimated value of the property after the improvements you want to make with the loan.
You should use an FHA approved assessor, and the assessor will need a copy of your improvement and repair plans. We’ll talk more about these plans in the next section.
When the loan closes, the lender will provide the funds to cover the purchase price of the house or to pay off the old mortgage. Renovation funds are deposited into an escrow account. As the approved contractors you’ve lined up complete your plan’s home repairs and renovations, the lender will pay them out from the escrow account. You will be making payments on a single mortgage, and the main will cover both the purchase price and the repairs.
The FHA limits the amount you can borrow with a 203 (k) loan. You can borrow a maximum of 110% of the value of the home after renovations. However, the loan amount cannot be more than the property’s pre-renovation value plus renovation costs, so your borrowing limit can be less than 110%. You can fund up to $ 350 in loan origination fees and a percentage of rebate points paid by the borrower.
You also cannot borrow more than the FHA loan limit for your region. For 2020, the limit is $ 331,760 in most parts of the country. It reaches up to $ 765,600 in high cost areas.
FHA 203 (k) loan types
How much money will you need for repairs and upgrades? Will one of them be structural? The answers to these two questions determine whether you will need a standard FHA 203 (k) loan or a limited FHA 203 (k) loan.
Standard Rehabilitation Mortgage 203 (k)
Use a standard 203 (k) loan if the home you are financing needs at least $ 5,000 in repairs. You will need to hire an FHA approved 203 (k) consultant to inspect the property, create architectural exhibits, and prepare a scope of work and cost estimate.
You can do the job yourself to save on labor costs. However, you cannot use the loan proceeds to pay yourself for your labor. Work should be done to professional standards, so now is not the time to try hanging drywall after watching a few home improvement videos.
It’s a good idea to have contingency reserves in case repairs go over budget, and you may be able to fund those reserves if that doesn’t take you over the maximum loan amount. You may also be able to fund mortgage payment reserves to pay off your loan while the house is being repaired if you do not live there.
203 (k) Limited Rehabilitation Mortgage
Use a limited 203 (k) loan if you won’t be making any structural changes to the house. There is no minimum repair amount for a 203 (k) limited loan, but the maximum is $ 35,000. You don’t have to hire a 203 (k) consultant, but you do need to create a work plan.
You will need to hire a professional contractor to prepare this plan, which includes detailed estimates of labor and material costs. For work that the FHA calls “specialized”, you will need estimates from a licensed and bonded contractor.
You cannot use a 203 (k) limited loan if the repairs will prevent you from occupying the house for more than 15 days or if the work will take more than six months. You also cannot use this loan for landscaping or site improvement.
You can fund a contingency reserve fund if you wish. However, it cannot exceed 20% of the repair and improvement budget.
What can an FHA 203 (k) loan be used for
An FHA 203 (k) loan can be used to repair and renovate these types of properties:
- Single-family homes with one to four units
- An FHA approved condo or townhouse
- A prefabricated house, as long as you don’t make any structural changes
- Mixed-use properties that are more than half residential, where the residential part has one to four units
The house must be at least one year old and you will need to live in it for at least 12 months.
Here are a few examples of the many repair and renovation expenses that you can use the loan proceeds for, whether you use a standard or limited 203 (k) rehab loan:
- Repair or replace plumbing, heating, air conditioning or electricity
- Repair or replace the roof
- Improve energy conservation
- Add or repair fences, walkways or walkways
- Modernize the house
- Make the house accessible to a disabled person
With a standard 203 (k) loan, you can also make these types of changes:
- Increase or decrease the number of residential units, as long as the final number is one to four units
- Demolish the structure and rebuild a new house on the same foundations
- Repairing a damaged foundation
- Add a garage
- Add a living space
- Fit out an attic or basement
Here are some examples of expenses that are not eligible for either type of loan:
- Adding a swimming pool
- Creation of an outdoor fireplace
- Build a gazebo in the backyard and put a hot tub underneath
- Build tennis courts in your backyard
- Conversion of part of the property to a cannabis dispensary, or other commercial use
- Installation of a satellite dish
Other costs associated with improving the property, such as permits, inspections, architectural and engineering fees, and hiring a 203 (k) consultant, may be included in your loan.
FHA 203 (k) Qualifications
As a borrower, what qualifications do you need to get an FHA 203 (k) loan? They are the same as for a regular FHA loan:
- Your credit score is at least 500 if you contribute 10%, or at least 580 if you contribute 3.5%
- You are not past due on federal debt (tax or other)
- You will live in the house that you finance
- You don’t want to borrow more than the FHA loan limit for your area
- Your debt to income ratio is not more than 43%, or 50% if you have a credit score of 580 and lots of cash reserves
Benefits of the FHA 203 (k) loan
- Finance a home and renovations with one loan
- Pay for repairs over time, not up front
- Choose from a large list of eligible repairs and upgrades
- Borrow up to 110% of the value after renovating the house
- Get a lower interest rate than other financing options
- Make structural, functional or cosmetic improvements
- Finance up to six months of mortgage payments on a standard 203 (k)
- Take advantage of a generous credit score and down payment requirements
- Get a package or adjustable rate mortgage
FHA 203 (k) Disadvantages of the loan
- Borrower pays in advance and on-going FHA mortgage insurance bonuses
- Long-term costs may be higher than other home improvement finance
- Not for investors who want to repair and return
- You cannot borrow more than the FHA loan limit for your area
- The loan requires additional documents and approvals from the lender
- Can be difficult to find contractors with 203 (k) experience in tendering and paperwork
- A smaller pool of lenders to choose from
- Individual lenders may have higher credit score requirements
- Loan approval can be slow
FHA 203 (k) Rehabilitation loan statistics
- 203 (k) loans closed from October 2019 to September 2020 (fiscal year 2020): 7,669
- 203 (k) loans closed from October 2018 to September 2019 (fiscal year 2019): 2,165
- Cities with the most FHA 203 (k) loans in fiscal 2020 and 2019: Newark, Boston, Chicago
- Region with the most FHA 203 (k) loans in FY2019 and FY2020: East Coast
- Lenders with the highest number of 203 (k) loans in fiscal 2020: LoanDepot (607), Homebridge (436), Home Point (345)
- Lenders with the highest number of 203 (k) loans in fiscal 2019: Homebridge (621), LoanDepot (492), Home Point (322)