Renovating a home is not cheap. With the average cost of a total home renovation project ranging from $33,500-$150,000, it can be difficult to pull together the cost for the entire project.
Often, these projects can be extensive, and difficult to finance; whether you have a home that’s fallen into a state of disrepair as a result of deferred maintenance, or have discovered a sudden and serious issue that arises unexpectedly; one that requires you to take action right away.
One solution that many homeowners aren’t aware of is using an FHA 203(k) rehab loan to pay for the repairs or renovations. If you’re looking to fix up your property, and don’t have the cash on hand to do so, then this loan is something that you may want to consider.
In this article, we’ll take a look at the different types of 203(k) loans. Read on to see what they’re all about and whether this may be a good option for you.
What’s an FHA 203(k) Loan?
First up, what is an FHA 203(k) loan? This loan, sometimes called a Rehab Loan or FHA Construction Loan, allows you to finance two major items:
- The house itself (In some cases)
- Needed/wanted repairs
There are two different types of FHA 203(k) refinance loans: Limited 203(k) Loans and Standard 203(k) Loans.
Limited 203(k) Refinance Loan
With a limited 203(k) refinance loan –also referred to as a streamline 203(k), you can borrow up to $35,000. There’s no minimum cost requirement either, making this option ideal for smaller repairs and updates. If you are looking to do a minor remodel, or update countertops, painting, or flooring, then this type of loan is ideal. With this type of loan, no inspections are required for projects under $15,000.
Standard 203(k) Refinance Loan
The standard 203(k) refinance loan is best for major improvements and extensive rebuilding projects. With this loan, there’s no price cap, however, projects must total $5,000 or more. This option also requires inspections on all work regardless of the cost. Borrowers who use a 203(k) standard loan must hire a HUD consultant to oversee the entire renovation process.
You can also use 203(k) loans when purchasing a home. With this loan, you finance the house itself and the cost of repairs or renovations.
FHA Refinance Loans: What You Should Know
FHA 203(k) loans allow you to finance a home purchase and improvements –or in some cases, home improvements alone. These loans often have lower interest rates, and can be relatively easy to obtain.
This loan program is issued by the Federal Housing Administration (FHA), an agency within the US Department of Housing and Urban Development (HUD).
The HUD and the FHA don’t actually loan money to people, instead, they insure these loans so that banks, mortgage companies, and credit unions can issue these loans with confidence. Since these loans are guaranteed by the FHA, lenders take on less risk. This means that you might find it easier to get approved. However, as with any loan, there are certain lending standards and requirements in place that you’ll need to meet first.
Just like when buying or refinancing through any FHA program, you’ll need to meet standard FHA credit qualifications, and pay for mortgage insurance. The standard FHA underwriting guidelines also apply such as verification of employment, income, debt, and credit scores.
In almost every case, the work must be completed by approved contractors. The loan proceeds are held in an escrow account until the repairs are completed. In rare cases, a homeowner may be approved to do some of the work if they can demonstrate experience in the field. However, this isn’t always the case. For homeowners who’d like to do some of the work, it may be an idea to obtain a loan for the portion of work that you plan to outsource to contractors, and then tackle the other tasks on your own.
Here are some additional requirements:
- The property must have been purchased at least 12 months earlier
- There may also be an appraisal required to determine the as-is value of the home, as well as the after-improved value
- The maximum mortgage amount for the FHA loan limit depends on the county where the property is located (See what the limits are for your county). The maximum loan amount for your property is the lesser of these two amounts:
- The value of the property before rehabilitation plus the cost of rehabilitation
- 110% of the appraised value of the property after rehabilitation
Occupancy Rules
These loans are also designed for homes that are a primary residence. You must also live in the home as your primary residence for 12 months before you can rent it out or sell it. This makes the loan a poor choice if you are trying to do a quick fix-up before Selling a House in Poor Condition.
Because of this occupancy requirement many of the buyers I work with will use these loans to purchase Homes For Sale In Colorado Springs that need work. It's a great program for buyers with the skills and energy to do these types of projects.
Credit Score Requirements
The FHA allows credit scores that are as low as 500, although some lenders might require a score of 620-640. This is lower than the 720 or higher you would usually need for a conventional construction loan.
Debt-to-Income Requirements
As with other loans, these loans usually have a maximum debt-to-income ratio. This is 43% in most cases, although some lenders may allow more.
A Six-Month Timeline
These loans also require the project to be completed within 6 months. However, if an unexpected issue comes up and you’re running over time, you’ll need to create and execute an extension request. The extension request should include the following:
- The reason for the delay
- A timeline with a list of items not yet complete and an estimate of when you expect each line item to be completed. This timeline should be on the contractor’s letterhead and signed by both the contractor and borrower.
- A new estimated date of completion
What Type of Improvements Can I Make?
The FHA has rules about the types of improvements you can pay for with a 203(k) refinance.
Improvements that are not allowed are things that are considered to be luxury items; such as adding a swimming pool. Renovations that are for commercial use or any improvement that’s made with the sole purpose to help you run a business out of your home are also not allowed.
The extent of the rehab that’s covered can range from minor improvements (exceeding $5,000) to extensive; for example, for a home that’s been demolished and needing to be rebuilt –as long as the foundation is still in place. These loans can also cover the rehab of a residential portion of a property that also has non-residential uses, and the conversion of a property into a one-to-four-unit structure.
The HUD also requires that properties that are financed under this program meet certain basic energy efficiency and structural standards.
Eligible Uses for FHA 203(k) Rehab Loans
Some examples of eligible 203(k) rehab loan purposes include the following as described in HUD 4000.1:
- Making structural alterations such as the repair or replacement of structural damage, additions to the structure, and finished attics and/or basements
- Rehabilitating, improving or constructing a garage
- Eliminating health and safety hazards that would violate HUD’s Minimum Property Requirements (MPR)
- Installing or repairing wells and/or septic systems
- Connecting to public water and sewage systems
- Repairing/replacing plumbing, heating, AC and electrical systems
- Making changes for improved functions and modernization
- Making changes for aesthetic appeal
- Repairing or adding roofing, gutters and downspouts
- Making energy conservation improvements
- Creating accessibility for persons with disabilities
- Installing or repairing fences, walkways, and driveways
- Installing a new refrigerator, cooktop, oven, dishwasher, built-in microwave oven, and washer/dryer
This list is not exhaustive. There are many other projects that may be approved for FHA 203(k) loans as well.
FHA 203(k) Rehab Loan Funds - Ineligible Projects
FHA 203(k) loan rules include a list of projects that are not allowed, which includes:
- Purchase or repair of any luxury item
- Any improvement that does not become a permanent part of the property
- Improvements that solely benefit commercial functions within the property
- Swimming pools (existing swimming pools can be repaired)
- An exterior hot tub, spa, whirlpool bath, or sauna
- Barbecue pits, outdoor fireplaces or hearths
- Bath houses
- Tennis courts
- Satellite dishes
- Tree surgery (except when eliminating an endangerment to existing improvements)
- Photo murals
- Gazebos
- Additions or alterations to support commercial use or to equip or refurbish space for commercial use
FHA loan rules aren’t the only ones that apply to FHA 203(k) transactions. State law and lender standards along with building codes may apply as well, so you’ll want to make sure you’ve checked into these regulations first.
At the end of the day, obtaining a 203(k) loan for renovation can be a good option, but in some cases, there may be better loan options available. The HomeStyle loan from Fannie Mae and the CHOICERenovation loan from Freddie Mac are two more conventional renovation loans that may be worth considering as well. These are options for those who have higher credit scores, or for those who would like improvements that the FHA considers to be luxuries and doesn’t allow with the 203(k) loan option. Your best option is to look into the various loan options to find one that works best for you.
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