Thinking about purchasing a fixer-upper? Have you factored in the cost of the work that needs to be done to make the property habitable? What about the cost of materials? Place to stay while the project is underway?
Let’s face it. It is too easy to jump at a great deal on a house when you’re all set to put in some elbow grease to make it into your dream home. But oftentimes, the costs associated with these fixer-uppers can quickly eviscerate any shred of savings from the deal. Many home buyers find themselves stuck taking out multiple loans for home improvement on a newly purchased home, and end up biting off a bit more than they can chew.
Luckily, the good folks at the Federal Housing Administration came up with a solution to this problem in the form of the FHA 203(k) Improvement loan program. With an FHA 203k loan, buyers can get an FHA-guaranteed loan to cover not only the cost of the home, but the cost of the improvements as well! It can even be used as a standalone loan for improvement on a home you already own. Interested in learning more? We knew you would be.
FHA 203k Mortgage Basics
It’s no secret that mortgages guaranteed by the Federal Housing Administration are some of the most popular home loan options for everyone from first time home buyers all the way through to even the most experienced purchasers of homes. FHA Loans are a huge deal because they drop the eligibility requirements for a home loan within the reach of potential borrowers who would have been turned away elsewhere.
What many borrowers don’t know is that the FHA has specialized loan packages for borrowers with different needs or in different situations. Best of all, most of these specialized loans still carry many of the awesome perks that come with a standard FHA guaranteed mortgage, such as lower down payment requirements, less strict borrower eligibility criteria, and stellar refinancing opportunities. The FHA 203(k) loan program is a perfect example.
Under the HUD’s section 203(k), homebuyers and homeowners are enabled to finance not only the purchase or refinance of a house, but also the cost of any work that must be done to make the property habitable. Usage of a 203(k) loan also extends to the rehabilitation of a homeowner’s existing home.
The 203(k) program was created to fulfill an important niche for home buyers and homeowners with properties that are in need of rehabilitation, modernization, and even energy efficiency improvement. Typically, purchasing a home that is in need of this kind of work requires taking out a second loan in order to afford the cost of the improvements. A vast majority of these loans can be particularly problematic with balloon payments, higher than average interest rates, or short repayment terms.
With a 203(k) loan, borrowers and lenders alike can find comfort in a single, long term (up to 30 years), insured home loan offered with either a fixed or adjustable rate that covers the purchase of a home as well as the rehabilitation costs.
The lender is also at an advantage, since the loan is insured regardless of whether or not the property’s value or condition offer enough security as collateral.
Uses for the FHA 203(k) Loan
In general, loan proceeds from the FHA 203(k) program are to be used as intended by the Federal Housing Administration. The loan should be used to cover the purchase of a home or to pay the existing balance on a mortgage in the case of a refinance.
Additionally, a portion should be reserved to pay for the rehabilitation, improvement, or modernization of the home. This extends to properties with non residential portions, however the loan can only cover work being done on the residential portion of the property.
Acceptable Rehabilitation Activities Under the FHA 203(k) Program
The portion of the loan to be used for rehabilitation or modernization purposes cannot simply be used as you see fit. While this loan can be used to cover anything from minor improvements (of at least $5,000) to reconstruction (so long as the foundation remains intact), there are regulations on what is deemed acceptable usage.
Acceptable uses for the FHA 203(k) loan also include:
Conversion of any sized property to a 1-4 unit structure
Alterations to structure
Modernization of a home
Improvements to the Home’s Functions
Getting rid of any Health and Safety hazards
Improving accessibility for a disabled person
Rehabilitation of plumbing system; installation of septic system or well
Alterations to physical appearance and riddance of obsolescence
Rehabilitation of roof, gutters, etc.
Rehabilitation or alteration of flooring
Any large-scale site improvement or landscape work
Improvements on energy efficiency
And sometimes, depending on the lender and circumstances:
Covering boarding fees while rehabilitation is taking place on the property
FHA 203(k) Guidelines
Like with most loan agreements, there are rules as to what the loan can or should be used for. In addition to adhering to the standard eligibility requirements of an FHA loan, some guidelines for FHA 203(k) loan usage include (but are not limited to):
Can be used for a 1-4 unit property for full financing, but usage extends to interiors of town homes and condos if only for rehabilitation purposes.
Properties that need demolition as part of rehabilitation still qualify, as long as the foundation remains in place.
Potential borrowers must be either owner/occupants or nonprofit organizations but NOT investors.
The total value of property must still fall under the FHA mortgage limit for the area in which it is located.
The property’s value can be determined in one of two ways: Either by adding the total cost of the rehabilitation to the value of the home before the rehabilitation took place, or calculating 110% of the total value of the home after the rehabilitation has taken place.
The lesser of the two is the value that the lender will honor.
The cost for rehabilitation or modernization should be no less than $5000
The work must be completed by licensed contractors, who are familiar with the 203(k) process.
The project should be completed within six months
Properties financed under the program must meet basic energy efficiency and structural standards as required by HUD
FHA-Approved lenders reserve the right to charge additional fees to cover appraisal, reviewal of the rehabilitation plan, and preparation of any architectural documents.
Pros and Cons of the FHA 203(k) Loan
As with most other loan packages, there is a lot to weigh before deciding to enter into a loan agreement. The 203(k) program is an awesome alternative to taking out two loans, but it isn’t without its drawbacks.
We strongly believe that some loans aren’t for everyone, and while some may see the FHA 203(k) loan as the best thing since sliced bread, others may very well be better off without it.
Benefits of the FHA 203(k)Loan
It’s the perfect solution for buying a fixer-upper. As we’ve mentioned earlier, a more perfect solution for buying a fixer-upper may not exist. The program caters to homebuyers who would have to have qualified for not one, but two or more loans in order to buy and restore the home they planned to inhabit.
Taking out one loan to accomplish the same feat not only saves a ton of time and money, but is incredibly less stressful!
It opens up buying opportunities. The program also opens up more buying opportunities, since many lenders are reluctant to finance purchases of homes in various states of disrepair. Since it is insured by the FHA and was designed with this purpose in mind, it makes finding and financing a home that much easier.
Loan Proceeds can even be used to increase a home’s energy efficiency. Combine this with the flexibility in acceptable rehabilitation activities, and you might just be able to create your dream home (or something pretty close to it), all while promoting an energy efficient residence.
It comes with the benefits of standard FHA loans. The best part about the program is that it still comes with the many benefits of standard FHA loans. For starters, the eligibility criteria is much more welcoming than with any conventional counterpart -- with less strict credit requirements for borrowers. Worried about a down payment? Don’t be! The FHA 203(k) program still accepts down payments as low as 3.5%. In addition, the interest rate is still highly competitive!
Drawbacks of the FHA 203(k) Loan
While the benefits of the FHA 203(k) loan pretty much speak for themselves, there are a few drawbacks that borrowers should consider.
Depending on your project, there may be less expensive options. If you don’t intend to purchase a property, but just to do rehabilitation work, then there are actually much cheaper options available, such as HUD's Title I Property Improvement Loan program.
Also, borrowers that don’t need such a large sum of money for their purposes might want to downsize to the Limited 203(k) Mortgage, which allows up to $35,000 to be financed into the mortgage to cover improvements, repairs, rehabilitation, etc. Both seem to suit specific situations much better than the standard 203(k) loan.
There’s a bit of red tape. With such a generous offering by the FHA, you can’t really be surprised that there are tons of restrictions and rules that come with the loan package. You may remember the part about being able to finance a reconstruction, but you must keep in mind that the project isn’t allowed to extend past six months.
While it is doable in most cases, it is imperative that the contractors you hire can make this deadline. Don’t forget that you can’t take the helm on repairs or hire your home improvement guru friend either. The work has to be carried out by licensed contractors who can work within the 203(k) guidelines.
Mortgage Insurance Premiums (MIP) are required. In case you were wondering, the not-so-popular mortgage insurance premiums associated with FHA financing are still required. The loan also requires the payment of fees specific to the program.
There is a continuous monthly fee added to your payments, on top of what is known as a “supplemental origination fee” which is a one-time payment of up to 1.5% of your total loan amount or $350 (depending on which amount is greater) that is due at the time of closing.
Who Is the Ideal Borrower for an FHA 203(k) Loan?
Again, after weighing the pros and cons, the FHA 203(k) program has the potential of being an immense help to a lot of people. It might not work out for some, depending on the situation, but if you are planning on buying a home that you know will need some serious work, it's unlikely that you’ll find a better deal.
The ideal borrower for an FHA 203(k) loan package is one who:
Meets the eligibility requirements for a standard FHA loan
Is planning to purchase a home that requires at least $5,000 worth of repairs
Can come up with the funds to make a down payment of at least 3.5%
Is willing to work closely with contractors and lenders to ensure that all efforts adhere to the program’s guidelines
At the end of the day, FHA loans cater to the needs of borrowers a little more than the other loan programs out there. If you don’t mind paying mortgage insurance and qualify for the loan, then it is hard to find a reason not to get one!
The FHA 203(k) Loan: In Review
Buying a home that is a fixer-upper can be a real doozy. There can be months worth of work that needs to be done, and the costs can seriously hurt your finances -- that is, if you don't qualify for FHA 203(k) financing.
With the 203(k), homebuyers and even current homeowners with home rehabilitation needs have a mortgage loan option that includes the costs repairs. This is the textbook definition of killing two birds with one stone. Having all of your needs taken care of with one loan means less stress, less time wasted coming up with funding, and can save a bit of money when utilized for the right reasons.
Sure, other loans exist for homeowners looking to fix up a less-than-habitable home or modernize an outdated one, but this one is truly a lifesaver for the daring homebuyer who isn’t afraid to (metaphorically) get their hands dirty and put in some work to have their dream home. There are a few guidelines that have to be followed as well as some eligibility requirements for both borrower and property, but that’s the case with any loan.
If you plan to buy a home that needs some rehabilitation, the FHA 203(k) Loan should definitely be the first loan you look into when you’re weighing your options. And, as always, help is free: ask the home.loans team anything about mortgages and we’ll help point you in the right direction.