FHA 203(k) Home Renovation Loans: A Guide

*Please note that Rocket Mortgage^® does not offer loans through the FHA 203(k) loan program at this time.

If you’re looking for an affordable new home, you might not have many choices in the current market. When there’s low housing inventory, there is typically also fierce competition for available homes.

That means that you may need to get creative. One option you might want to consider is buying a fixer-upper and renovating it. But a renovation – on top of buying a home – can be an expensive endeavor.

One option for those thinking of buying a fixer-upper is applying for an FHA 203(k) loan to cover both the home purchase and needed renovations. Let’s take a look at how these loans work, other options to consider and the pros and cons of FHA home loans.

What Is An FHA 203(k) Loan?

An FHA 203(k) loan is a type of loan insured by the Federal Housing Administration (FHA). An FHA 203(k) loan provides money for home buyers and owners who want to purchase or refinance a home in need of renovation. With one loan, they can purchase the home and get the money to make needed repairs.

This loan was designed to meet the needs of low-income home buyers while also improving neighborhoods with older housing stock by making money available to renovate houses.

How Do FHA 203(k) Loans Work?

FHA 203(k) loans aren’t made or offered directly by the FHA. Instead, the FHA insures loans that are made by private lenders according to its requirements.

You can think of FHA 203(k) loans as a simplified construction loan. The borrower only has to apply for one loan, and the loan amount is split between the purchase price of the home and cost of the eligible repair work.

The Department of Housing and Urban Development (HUD), the agency that oversees the FHA, also requires that properties financed under this program meet certain basic energy-efficiency and structural standards.

FHA 203(k) Vs. Construction Loans: What’s The Difference?

Technically, an FHA 203(k) loan could be considered similar to a construction loan and is available through a simplified process.

The process of undertaking a large-scale renovation of a home with a construction loan can be expensive, and thus the typical borrower would need a significant amount of income and a high credit score. By creating a simplified process, the FHA made a similar loan less costly to its borrowers.

FHA 203(k) Loans

These loans are strictly available for the renovation of existing properties. The existing home can be totally reimagined as part of the rehabilitation process, as long as the existing foundation stays in place.

The FHA’s process replaces the usual construction and mortgage loans with one loan, so you only pay closing costs once. These costs range between 3% – 6% of the home’s purchase price, so this can represent a substantial savings for budget-conscious home buyers. 

FHA loans are a low down payment option with more lenient credit requirements compared to conventional loans. Lenders are willing to offer these “riskier” loans because of the government insurance that backs the loans and limits the lender’s potential costs.

Not all lenders offer FHA 203(k) loans. To find a lender who works with the 203(k) program, you can search the HUD list of approved lenders.

Unfortunately, Rocket Mortgage^® does not offer FHA 203(k) loans at this time.

Construction Loans

The typical construction loan is a type of loan product that is different from a mortgage loan. Most aspiring new homeowners first need to purchase land on which to build, which may require a land loan. Next, they’ll need to get a loan to cover the actual construction costs.

A construction loan must generally be repaid within a year. That means the new home’s owner must either pay off the construction loan with cash or with a mortgage loan, which will be secured with the new home.

If the home construction is not completed within a year, the homeowner might also need a bridge loan to refinance the construction loan before the balloon payment becomes due. Bridge loans are very short-term loans meant to fund the gap between two loans, as in the case when the construction loan must be repaid but the home is not yet habitable, and therefore unable to meet lenders’ appraisal requirements.

Because construction, land and bridge loans are generally considered riskier than mortgages on existing homes, these types of loans are offered at high interest rates. Also, borrowers using loans for land, construction, bridge and the purchase of the completed home end up paying closing and origination costs multiple times.

Rocket Mortgage does not offer land, construction or bridge loans. It does, of course, offer mortgage loans for newly constructed homes, as long as the home is complete.

Pros And Cons Of FHA 203(k) Loans

As always, the best loan for you depends entirely on your individual circumstances. If you’re in a stable housing situation for the foreseeable future, for example, you might not mind weathering the inevitable delays involved with renovating a home.

Pro: Broadens The Pool Of Available Homes

The availability of FHA 203(k) loans broadens the number of homes available to lower-income homeowners by making it possible for them to access the funds they’ll need to buy a home as-is and make the necessary repairs. In a tight market, being flexible about the home’s condition might help you find a home that – with renovation – could better meet your needs than the houses in move-in condition that you’ve seen in your price range.

Pro: Won’t Incur Excessive Loan Closing Fees

Construction loans are not as widely available as mortgage loans for existing homes, and because of the risk inherent in these loans, they are more expensive for borrowers. Most private lenders also have higher credit requirements for these types of loans, which can put them out of reach for many low-income home buyers.

With 203(k) loans, you won’t have to pay three sets of closing fees, though you may have to pay a separate origination fee for the renovation portion of the loan. You’ll also likely enjoy lower interest rates throughout the process.

Pro: May Cover The Interest Payments On Your Mortgage During Renovation

If you can’t live in the home while renovations are being completed, your loan may cover some mortgage costs for up to 6 months. In the first months of your mortgage repayment, the bulk of your payment goes toward interest. That means that, with interest payments potentially covered, you’ll have the cash that would have gone toward your mortgage payment on hand to pay for housing while you wait for the home to become habitable.

Con: FHA Requirements May Create Delays

The FHA is a branch of the government, and as such, you can expect extra requirements and potential delays while you await approvals. For example, qualifying for an FHA home loan means meeting the FHA’s more stringent appraisal requirements. To qualify for a 203(k)-rehab loan, you’ll have to submit plans, work with an FHA-approved contractor and meet their livability standards, which can add to your overall costs.

A note to DIYers: no matter your skill level, you cannot use the loan proceeds to complete DIY renovations. The FHA has strict rules about who can perform work on properties purchased with FHA 203(k) loans.

Con: Costs Can Increase Because Of FHA’s Higher Health And Safety Requirements

Compared to private lenders, the FHA has enhanced appraisal requirements geared toward making sure homeowners will be safe and healthy in their new home. These requirements, which could include testing and remediation of threats like:

• Hazardous materials
• Toxic substances
• Mold
• Damaged or defective asbestos
• Urea-formaldehyde
• Problems with insulation
• Radon gas
• Lead paint

Con: FHA MIP Charges Increase Overall Costs

One of the general downsides to an FHA loan is the required upfront and monthly mortgage insurance premium (MIP). That’s the FHA loan program’s counterpart to the private mortgage insurance required on conventional loans. For MIP, you’ll have to pay an upfront fee of 1.75% of the home’s purchase price, and a monthly recurring fee after that for the life of the loan. You can potentially get out of MIP after 11 years if you made a down payment of over 10%, but otherwise, this cost sticks around until your loan is paid in full.

Con: Renovations Can’t Include Luxury Items

There are limits on what renovations you can make. You won’t be allowed to add a swimming pool, hot tub, gazebo or an outdoor kitchen, for example. As a general rule, renovations that won’t enhance the home’s value are not eligible for 203(k) financing.

Types of FHA 203(k) Loans

There are two types of FHA 203(k) loans, and the difference lies in the condition of the house being purchased.

Limited 203(k)

If the home you’re interested in is habitable and requires renovations costing no more than $35,000, you may qualify for a limited 203(k) loan. This loan won’t cover structural repairs or major landscaping. You’ll be expected to live in the home while renovations are completed, and the loan won’t cover your mortgage interest payments.

These loans tend to require less paperwork and approval oversight.

Standard 203(k)

If the home is not habitable, you can qualify for a standard 203(k) loan. Borrowers must require at least $5,000 worth of eligible repairs to make the house a safe and healthy home. These loans are to be used for major renovations and will cover a wide range of related costs.

The types of improvements that borrowers may make with a Standard FHA Section 203(k) loan include:

• Structural alterations and reconstruction
• Updates and improvements to basic home functions
• Remediation of safety and health hazards
• Refreshing the home’s appearance to modernize its appearance
• Replacing or reconditioning plumbing, including well or septic system installation
• Adding or replacing roofing, gutters and downspouts
• Adding or replacing floors and/or floor treatments
• Major landscaping and site improvements
• Making a home accessible for a disabled homeowner
• Home improvements geared toward energy conservation

What Are The Limits On FHA 203(k) Loans?

You can borrow up to the FHA loan limit of $498,257 for a one-unit property, unless you live in a designated high-cost area, in which case your limit could be as high as $1,149,825. For comparison, you could borrow up to $766,550 with a conventional conforming loan in a non-high-cost area.

You can use the interactive Department of Housing and Urban Development mortgage limits page to find the conforming loan limit in your area.

What Are The Credit Requirements For An FHA 203(k) Loan?

In general, to take advantage of the low 3.5% down payment requirements of an FHA loan, you’ll need a credit score of at least 580. If you have a credit score of at least 500, you may still qualify for the loan, but you’ll generally be required to put down at least a 10% down payment.

Lenders will also consider your housing expense ratio and your debt-to-income (DTI) levels. To calculate your housing expense, divide your mortgage payment by your gross monthly income. To find your debt-to-income rate, add up all of your monthly debt payments – but not expenses like food or transportation costs – and then divide the total of your monthly debts by your gross monthly income.

In general, financial experts advise consumers to maintain an housing expense ratio no higher than 28% and a DTI no higher than 36%. This is known as the 28/36 rule. For lower-income wage earners, those numbers might be out-of-reach. For this reason, borrowers with up to a 31/43 score can qualify for FHA 203(k) loans. 

Are There Alternatives To FHA 203(k) Loans?

Depending on your home equity level or lender availability, there might be.

Fannie Mae HomeStyle Renovation Loan

When you buy a home with a conventional mortgage loan, you may be eligible for a Fannie Mae HomeStyle^® Renovation Loan. Like the 203(k) loan, the Fannie Mae loan allows you to buy and renovate with one loan. There are generally fewer restrictions on the type of renovations you can make with a HomeStyle Loan, and homeowners can include luxury items in their plans.

Fannie Mae HomeStyle loans are available only through approved lenders who offer this specialized type of renovation loan. These loans tend to have more strict requirements to qualify than FHA loans and may require that your credit score be significantly higher.

Home Equity Loan

If you already own your home and have enough home equity, you may be able to do a cash-out refinance to pay for home renovations. Or, you could get a home equity loan and avoid refinancing.

You might be surprised at your level of home equity. As a homeowner, you’ve benefited from increases in home values and that appreciation could be yours to use for home remodeling projects. Home equity loans allow you to take out a second loan that uses your home’s equity as collateral for renovation costs.

HELOC

A home equity line of credit (HELOC) is similar to a home equity loan in that it’s limited by the amount of equity you have in the home. But a HELOC doesn’t offer a lump sum payout – it’s a line of credit, similar to a credit card. If you’re thinking about undertaking a rolling series of improvements as opposed to repairing everything at once, a HELOC might save you money because you won’t have to pay interest on the loan until you actually use the money available.

The Bottom Line: A Home Like New Awaits With An FHA 203(k) Loan

It’s tough out there if you’re looking for an affordable home in move-in condition, and the competition is stiff. If you’re ready to consider a fixer-upper, an FHA 203(k) loan may help make your dreams a reality.

If you’d like to explore your conventional loan options, why not get the approval process going? Initiate the approval process online and start thinking about homes with possibilities.