What is an FHA 203(k) Loan & How to Find a Lender
Unlike traditional mortgages, an FHA 203(k) mortgage offers you an opportunity to combine a construction loan with a regular mortgage — all with a single loan. An FHA 203(k) loan reduces closing costs and the often-dreaded loan application paperwork of long-term and construction financing. FHA 203(k) rates are competitive. This unique loan might be the financing solution for a property you want to buy, but can’t because the property requires repairs that make it ineligible for a traditional mortgage. Simply put, a 203(k) loan saves you time and money.
203(k) Loans At A Glance
If you have ever considered purchasing a fixer-upper, you will probably know how helpful a Standard 203(k) loan can be. The purchase of a house that is in need of repair often falls into a catch-22 situation. A lender won’t typically offer financing to buy the house until the repairs are complete, and you can’t close on a loan to make the necessary repairs unless you own the house.
An FHA 203(k) loan offers a practical alternative to the time-consuming, costly process of applying for two loans.
- Borrowers save time and money with a mortgage that covers both the acquisition and rehabilitation of a property.
- Lenders are encouraged to offer what would otherwise be considered a risky loan.
Keep in mind that, like all government mortgages, a 203(k) mortgage has very specific rules. For starters, its purpose must fall into one of the following categories:
- You can finance the rehabilitation of a property you currently own that has no outstanding mortgage
- You can finance the rehabilitation of a property you own while simultaneously refinancing your outstanding debt.
- You can finance the purchase of a property you would like to purchase and include the money you would need to renovate.
Without a financing option such as an FHA 203(k) mortgage, homebuyers would have to take the following steps to accomplish their goal:
- Find a loan to purchase the property.
- Find a way pay for the renovation, perhaps with a loan.
Following this path, after you complete the renovations, the final step is to refinance the mortgages you took out thus far. Your temporary loans are known as interim loans, and meet short-term financing needs. The primary drawback is that these mortgages often are expensive. They are considered commercial financing and thus come with relatively high interest rates and short repayment terms.
Maximum loan amounts for a 203(k) mortgage loan must stay within FHA loan limits. See the FHA Loan Limits page to learn more. FHA loan limits are based upon the county in which the property is located. These loan maximums reflect local home prices.
Of course, maximum loan amounts are also contingent upon one’s income, so be prepared to document your income in support of the loan amount you are requesting. This is a routine part of the loan application process, and unavoidable.
The FHA offers two different 203(k) loans. Your personal situation will determine which loan you is best for you — either the Standard 203(k) mortgage or the Streamlined 203(k). Borrowers seeking a Standard 203(k) mortgage will be required to hire a 203(k) consultant.
What to Expect When Applying for a 203(k) Mortgage Loan
Getting only one mortgage for both the construction and the purchase of your home might be the preferable choice — since it reduces cost and paperwork — but remember that a 203(k) mortgage is more complicated than a traditional mortgage. This is because it accomplishes two goals with only one mortgage.
Don’t expect your FHA 203(k) lender to write a check to cover planned repairs by simply relying on your smile and promise to use the money as you planned. Borrowers must follow clearly defined steps to complete a 203(k) successfully. If you set your heart on an otherwise perfect home that needs T.L.C., this is how the 203(k) loan approval process works.
203(k) Pre-Approval Process
The most sensible approach to any mortgage financing undertaking is to begin by selecting an FHA-approved lender to analyze your particular financial situation before finding your dream home. Get a pre-approval letter before you even begin looking for a property.
Don’t skip the pre-approval step. It is now a standard practice in real estate for offers-to-purchase to include a pre-approval letter. Most offers are not even considered bona fide if they lack a pre-approval letter.
Learn Your Options
It is also during this initial phase of the mortgage loan process, that you will begin to gather your financial and legal information (see Loan Approval for submission to an FHA lender. The reality is that you give yourself a head start by investigating your financing options upfront. Perhaps the greatest benefit is that you give yourself an opportunity to educate yourself about your mortgage options.
With your pre-approval in hand, you can begin to search for that perfect property, which, remember, must also meet FHA’s 203(k) guidelines.
Repair Wish List
With a specific property in mind, create a wish list of property repairs. Create a list of must-haves and nice-have repairs. Must-haves address the property's structure, and the health and safety of your family. Nice-to-haves are not crucial to your occupancy of the house, and would be completed to improve its value and your comfort.
FHA 203(k) Consultant
Depending on the cost and extent of repairs, you may need to hire an FHA Consultant to act as a coach and referee who decides which repairs are must-haves or nice-to haves, and to authorize payments to your contractors. (More on FHA Consultants later.)
203(k) Offer Preparation
Complete the FHA mortgage application after your lender gives you an approval to move ahead with the loan process. This usually requires you paying an application fee.
Complete 203(k) Forms
A 203(k) mortgage requires the use of very specific 203(k) forms. If you hire an FHA Consultant, he or she will complete a Maximum Mortgage Worksheet to help keep your financing goals both reachable and within guidelines.
Make a Realistic Offer
The next step is to organize and prepare your offer. Stay realistic about the property’s required repairs and its post-repair appraised value. Unrealistic estimates will complicate matters during the construction phase and may even leave you short of funds. You are now ready to present your offer to the seller.
203(k) Offer Acceptance
When the seller accepts your offer, set up a meeting with your contractor and FHA Consultant to prioritize the property’s repairs as either must-dos or like-to-haves. When you have a solid understanding of what repairs are required to meet FHA’s minimum standards, you can now meet with your FHA lender to discuss the particulars regarding the anticipated costs to repair the property.
In your mortgage application, include a comprehensive proposal detailing the scope of renovation work. This is critical, and where you will find the FHA Consultant helpful. This comprehensive proposal should detail both cost and time estimates for each improvement.
Appraisals & Inspections
As a part of the application process, your lender will order an FHA appraisal, survey, and inspections for pest, septic, and well water. This is also when the lender’s processing department will issue a credit approval based upon the income, assets and credit history information you submitted.
Maximum Loan Amount
The lender will calculate the maximum loan amount for your transaction based upon a value determined by your recent appraisal. Once approved, the lender will finish its paperwork and schedule a closing date shortly after.
Once the closing date is set, it is very important to advise your contractor of this date as soon as possible because this gives the contractor the time to coordinate the many facets involved in construction.
If you have never been involved in to a mortgage closing, you might be surprised at what seems like an endless pile of paperwork you must sign and initial at closing.
Where the Money Goes
When the paperwork is complete, the funds will be disbursed to pay either the seller or to pay off your current mortgage. The remaining funds from the FHA 203(k) mortgage will be placed in an interest-bearing escrow account managed by the lender during the construction phase.
Call Your Contractor
The moment you close your 203(k) loan, call your contractor and ask him or her to pull the necessary building permits so the repairs and rehabilitation can begin. In fact, the planned construction must begin within 30 days of the your loan closing.
Send copies of your building permits to your lender. This lets the lender knows you are moving forward as promised.
The lender will begin to disburse funds from the escrow account as the planned construction is completed.
When all work is complete, the lender will order a final inspection by an FHA-approved appraiser.
Closing of the Escrow Account
When the FHA inspector issues a final inspection report, the lender will disburse the final escrow payment.
Behind the Scenes
Expect the lender to order a title update to ensure the title to your property remains clear. The lender closes the escrow account and the 203(k) mortgage becomes a standard FHA loan.
The final release of the escrowed rehabilitation funds will occur after the local jurisdiction, such as the county building inspector provides its final acceptance of the work.
The Standard 203(k) Mortgage
Will a Standard 203(k) or Streamlined 203(k) work for you? Let’s find out.
Loan Eligibility Requirements
It’s easy to understand the eligibility requirements for a Standard 203(k) mortgage by dividing them into the following categories:
To be eligible for funding through a Standard 203(k) mortgage, the property must be either:
- A one- to four-unit property
- The renovation of the residential portion of a mixed-use building, which is both retail/commercial space and residential
- A conversion from a larger number of units to four or fewer units
- The relocation of an existing house to a new foundation.
- Interior renovations on an FHA-approved condo
- Uninhabitable properties (as also called a "tear-down"), provided that a part of the existing foundation will remain
203(k) Maximum Loan Amounts
For home purchases, the maximum loan amount is determined by the lesser value of:
- The purchase price of the property before rehabilitation, plus the estimated cost of rehabilitation
- 110 percent of the projected market value of the property after the rehabilitation is complete
For Refinances, the maximum loan amount is determined by the lesser value of:
- The estimate of "As-is value" before rehabilitation, plus the estimated cost of rehabilitation
- 110 percent of the projected market value of the property after rehabilitation is complete
The FHA loan process requires that an FHA-approved appraiser complete two appraisals of your property. The first appraisal estimates the market value of the property in its current condition, or what is typically known as "as-is." The second appraisal estimates the market value of the property based on the assumption that the rehabilitation has been completed.
The scope of rehabilitation permitted when financing with a 203(k) mortgage varies greatly. Although renovation costs must exceed $5,000, the reality is planned renovations can range from relatively minor work to virtually a complete reconstruction of a home that has been demolished, providing the existing foundation remains.
A good starting place is to begin to determine if your planned renovations include at least one of the following types of construction:
Structural Alterations and Reconstruction
This includes additions to the structure, finished attics, repair of termite damage and the treatment against termite infestation.
Changes for Improved Function and Modernization
This includes remodeled kitchens or bathrooms
The Elimination of Health and Safety Hazards
This includes defective paint surfaces or lead-based paint problems in homes built before 1978
Changes for Aesthetic Appeal
Such as new exterior siding and other elimination of obsolescence
Reconditioning or Replacement of Plumbing
This includes connecting to public water and sewer systems, heating, air conditioning and electrical systems
Exterior Weather & Water
Includes roofing, gutters and downspouts
Includes tile, and carpeting
Energy Conservation Improvements
This includes new double-pane windows, insulation, solar domestic hot water systems
Major Landscape Work and Site Improvement
This includes patios and terraces that improve the value of the property or to preserve the property from erosion.
Includes improvements for accessibility to the handicapped.
How the Standard 203(k) Loan is Disbursed
At your 203(k) loan closing, a portion of the proceeds will be used either to pay the seller, or, if the transaction is a refinance, to pay off the existing mortgage.
The remaining funds — those that have been earmarked throughout the loan process as a cost of rehabilitation — are then placed in an escrow account and eventually released as each phase of the planned rehabilitation is completed.
Situations Ineligible for a Standard 203(k) Loan
As one would expect, not every renovation or financing scenario will meet the eligibility requirements of a Standard 203(k). These examples are not eligible for Standard 203(k) loans:
The property must be a freestanding home or a condo.
Where the home has been completely razed, including the demolition of the foundation, the property is not eligible for a 203(k). (This could be acceptable as new construction under Section 203(b)
Minor or Cosmetic Repairs
These are unacceptable for Standard 203(k) loans. These could qualify for the minimum requirements of a Streamlined 203(k).
These include barbecue pits, bathhouses, dumbwaiters, exterior hot tubs, saunas, spas and whirlpool baths, outdoor fireplaces or hearths, photo murals, swimming pools, television antennas and satellite dishes, tennis courts, and tree surgery are not eligible.
Additions or alterations that provide for commercial use are not eligible.
A Simplified 203(k) Loan
Through decades of experience, the FHA began to recognize the challenges faced by borrowers when choosing a Standard 203(k) mortgage loan. All too often, the process was cumbersome and paper intensive. As a result, the FHA created the Streamlined 203(k), which is a loan similar to the Standard 203(k) loan, but simpler to navigate.
Streamlined FHA 203(k) mortgages have been developed to meet the needs of borrowers who have less extensive planned improvements.
The Streamlined 203(k) can be used to improve the energy efficiency of your home by, for example, upgrading the insulation or correcting the size of the heating and air conditioning systems.
As its name suggests, a Streamlined 203(k) mortgage simplifies the application and approval process by first, limiting the loan amount to $35,000 and by also limiting the type/extent of renovations allowed. If your desired renovations require drawings, consultants, engineers and/or architects, hire a 203(k) Consultant and consider a Standard 203(k) mortgage.
The FHA Streamlined 203(k) is a practical option for homeowners who want to make minor repairs without exhausting their personal savings to do so. There is no minimum repair cost of a Streamlined 203(k) mortgage.
Both the Standard and Streamlined 203(k) mortgages permit financing to:
- Rehabilitate a property you own that has no outstanding mortgage
- Rehabilitate a property you own while refinancing your outstanding debt
- Purchase a property that includes the funds you need to renovate.
A Streamlined 203(k) can also be used to:
- Augment an FHA Energy Efficient Mortgage (EEM)
- Purchase a single-family property that has been sold from the HUD’s REO inventory.
Streamlined 203(k) — Eligibility Requirements
The easiest way to understand the eligibility requirements for a Streamlined 203(k) is to divide them into the following categories:
Streamlined 203(k) guidelines allow for financing on FHA approved condominiums, townhouses, mixed use, storefront properties, and one-to-four-unit properties.
The purchase price of the property before rehabilitation, plus the estimated cost of rehabilitation or, 110 percent of the projected market value of the property after rehabilitation is complete
The estimate of "as-is value" before rehabilitation, plus the estimated cost of rehabilitation or 110 percent of the projected market value of the property after rehabilitation is complete
FHA 203(k) mortgage guidelines require that an FHA approved appraiser complete two appraisals. The first appraisal estimates the market value of the property in its current condition, or what is referred to "as-is." The second appraisal estimates the market value of the property assuming the rehabilitation has been completed.
Generally, planned repairs being financed with a Streamlined 203(k) loan should take between 1.5 to 3 months to complete. When rehabilitation is finished, a HUD-approved inspector performs a final inspection to ensure the work was finished as planned.
A Streamlined 203 (k) loan permits the following discretionary improvements:
- Repair or replace roofs, gutters and downspouts
- Repair, replace or upgrade existing HVAC systems
- Repair, replace or upgrade plumbing and electrical systems
- Repair or replace flooring
- Minor remodeling projects that do not involve structural repairs
- Exterior and interior painting
- Weatherizing of storm windows and doors, including insulation, weather stripping
- Purchase major appliances such as ranges, refrigerators, washer/dryers, dishwashers and microwave ovens
- Accessibility improvements for persons with disabilities
- Stabilization or abatement of lead-based paint hazards
- Repair, replace or add exterior decks, patios and porches
- Basement remodeling projects that do not involve structural repairs, such as waterproofing
- Window and door replacements, including exterior wall re-siding
- Repair or replace septic system or well
How Streamline 203(k) Loans Are Disbursed
Upon closing, a portion of the proceeds will be used to either pay the seller, or if the transaction happens to be a refinance, to pay off the existing mortgage.
The remaining funds — those that have been earmarked throughout the loan process as a cost of rehabilitation — are then placed in a lender-managed escrow account and eventually released as each phase of the rehabilitation is complete.
Ineligible Financing Scenarios
A Streamlined 203(k) mortgage is designed to fulfill the financing needs of borrowers who want to improve their homes, but to do so with only relatively minor repairs. Therefore, it logically follows that a Streamlined 203(k) mortgage would not allow major construction.
The following construction projects are ineligible for financing with a Streamlined 203(k) loan:
- Major structural repairs
- Repairs requiring detailed plans and specifications
- New construction such as the addition of a room
- Any repair that will require more than 3 months to complete
- Repair of structural damage
- Repairs require more than two draws from the escrow account
- Luxury items that are not consider to be a permanent part of the real estate, such as saunas, hot tubs, or pools.
203(k) Energy Efficient Mortgage (EEM)
FHA loan programs reward homeowners and home buyers who want to make their homes more energy efficient. The Energy Efficient Mortgage (EEM) program finances the addition of energy efficient features and products to new or existing homes. The borrower rolls the cost of qualifying added features to the FHA 203(k), 203(h) or 203(b) loan.
Qualifying for the EEM
All borrowers who qualify for FHA loan programs are eligible to apply for EEMs. To get an EEM loan approval, an FHA-approved energy consultant must evaluate the cost and features of energy efficient appliances and improvements.
EEM funds can be used to build a new home or upgrade an existing home. Typical improvements for energy efficiency include:
- Installing active or passive solar technology
- Installing geothermal heat pumps
- Insulating an attic or crawl space
- New doors and windows
- Replacing or adding a furnace or cooling system.
To learn if your planned improvement qualifies for an EEM, consult an energy rater in your area. Energy raters measure your home’s energy efficiency and certify the savings from you proposed improvements will exceed their cost. Check the Energy Star website for more information.
203(k) EEM Loan Amounts
Maximum EEM amounts equal the cost of the energy efficient improvements or the lesser of 5 percent of:
- 115 percent of the median price of the same property type for your area
- 150 percent of the conforming Freddie Mac limit
- The value of the property
The additional money for energy efficiency improvements goes into an escrow account after the FHA loan closes. Once the improvements are completed, these funds are released to the borrower and an inspection is done to confirm proper installation.
Loan Options Similar to 203(k) Mortgages
The FHA 203(k) mortgage is one of several mortgage programs designed to allow you to buy a property that is in a state of disrepair while, at the same time, giving you the money and tools to renovate it. Both Fannie Mae and Freddie Mac offer similar programs.
The Federal National Mortgage Association’s (Fannie Mae’s) HomeStyle Renovation (HSR) mortgage lets borrowers include the financing necessary to complete the proposed home improvements as either a purchase or refinance. You must have a good credit history to be eligible for a HomeStyle Renovation mortgage.
The Federal Home Loan Mortgage Corp. (Freddie Mac) has also jumped into the renovation mortgage arena by offering a similar loan called the Renovation Mortgage. As with Fannie Mae’s renovation loan, you need a positive credit history to be eligible for a Renovation Mortgage.
If you have a bruised credit history, then focus on finding a lender offering a great rate on an FHA 203(k).
203(k) Questions & Answers
Ray Roeske is a renovation and construction sales manager at George Mason Mortgage LLC. Roeske offered the following guidance to borrowers who are considering an FHA 203(k) mortgage.
How do the costs compare between FHA 203(k) mortgages and the more traditional loans?
For these types of loans, both mortgages require mortgage insurance to be paid by the borrower. Although these mortgage insurance premiums can vary from year to year, the current cost of mortgage insurance between both loans is relatively similar. But, FHA 203(k) mortgages are currently available with a slightly lower interest rate.
How important is the FHA consultant in closing a 203(k) loan?
Remember that you really don’t have a choice about hiring a 203(k) consultant if you plan to apply for the full or Standard 203(k) mortgage. The application process requires that you hire one. Hire an FHA-approved consultant for either 203(k) mortgage to help guide you through the process. It is simply a prudent business practice.
What should a borrower look for when seeking a 203(k) consultant?
Hiring an FHA Consultant who is knowledgeable in both the lending side of the program and also in the construction side of the program is your best bet. The lender and the consultant must work together for the transaction to go smoothly and according to plan.
Any other advice you would offer for homeowners planning to apply?
Be imaginative when envisioning planned renovations, but do your homework too so you don’t overlook the essentials For example, ask how old the roof is — it might look okay, but actually be nearing the end of its 25-year projected life. Remember the must-haves when you tackle a rehabilitation.
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