The FHA 203(k) Home Renovation Loan: All You Need to Know and Why You Need to Know It
Who should be looking into home renovation loans as an option?
- Have you out grown your home, but don’t like the price or condition of the homes currently on the market?
- Do you like the neighborhood you are living in but need to update your home to fit your style?
- Have you always dreamed of purchasing a “fixer-upper” and bringing it back to life?
Then this post will provide you with a solution to achieving those goals.
Home Renovation Loans and projects are all the over the TV and internet these days. You don’t have to look hard to find an HGTV show about home renovations, or Pinterest Boards on DIY projects. But what is a little more difficult to find out is how these people are able to afford these types of major renovations. Well the good news is that it may not be as difficult or costly as it seems.
You won’t need large amounts of cash stashed away! All you need is the proper financing tools to help you reach your goals. And the FHA 203(k) Home Renovation Loan is one of those tools that can assist.
History of the FHA 203(k) Home Renovation Loan
The Federal Housing Administration, or FHA was created by Congress back in 1934 as part of the National Housing Act. Prior to the introduction of the FHA loan, banks could have their own internal lending guidelines and the home loans they did offer would have some fairly onerous terms. How so? What if you went to a mortgage company to get a home loan and were told you needed a 40-50% down payment, interest only and the loan balance would come due in say three, four or five years? Would you take it? Probably not. Who would?
Yet that was what potential home buyers faced prior to the introduction of the FHA loan program which provided universal lending guidelines that banks could follow while at the same time insuring those loans should the borrowers ever go into default. Homeownership rates began to climb from around 40% in the 1930s and as high as 65% in the mid-1990s where it has remained in this relative range since then.
But there is another FHA loan program that is under-utilized when it shouldn’t be. It’s the FHA 203(k) Home Renovation Loan program and can be the perfect financing answer for those who seek to buy a property that needs a little (or a lot) of TLC before moving in. Let’s look a little deeper into how this program works.
Construction vs. Permanent
When you decide you want to build a new home, you get a construction loan. A construction loan is a short term loan designed to fund the project as it is being built. For example, say you draw up some plans to build a 3,000 square foot home on some land you own. You take the plans and specifications to a construction lender along with a cost estimate from a licensed contractor. The construction costs might be $200,000 and once the home is completed, the lot plus the new home would be appraised at $300,000. The construction lender approves the loan and you attend your closing.
The lender however doesn’t just hand over $200,000 to the contractor at the settlement table. Instead, the funds are held by the lender and delivered based upon a predetermined schedule. For instance, the lender might issue 10% of the funds to clear the lot. Another 20% for slab and plumbing, and so on. Each time a phase is completed, the lender sends an inspector to the property to verify the work has been done and the contractor receives another round of funds. This process is continued until the home is determined to be ready for occupancy. But you’re not done. The bank wants its $200,000 back.
You now need to replace the $200,000 plus any interest that has accrued and you do that with a permanent mortgage. Just as with any mortgage, you’ll need to apply for the funds with a mortgage company and go through another closing with another round of closing costs. Two closings, two rounds of closing fees. But here is where the 203(k) Home Renovation Loan comes in.
The 203(k) Mechanics
Instead of getting two loans, one to buy the property and the other to fix it up, the FHA 203(k) Home Renovation Loan is a combination of a construction or rehabilitation loan and a permanent mortgage. Just one closing, not two since there is only one loan. The 203(k) home renovation loan isn’t used to build a brand new home from the ground up, but used to buy a property that needs some work, make the renovations and put into place the permanent loan. Some properties can be in such a state of disrepair that it doesn’t qualify for a traditional mortgage. During the approval process the lender approves both the borrower as well as the property. A borrower with a large down payment, solid employment history and a stratospheric credit score wouldn’t be able to get a home loan on a property with a leaky roof or other apparent structural damage. The home must be in a “habitable” condition and structurally sound. The property is the lender’s collateral and the lender wants it to be in a marketable condition.
The 203(k) loan provides funds to acquire the property as well as money for needed repairs and renovations and still only requires the FHA minimum down payment 3.5%, based upon the “as completed” value of the property. Fund disbursement for the FHA 203(k) loan is managed by a 203(k) consultant. A 203(k) consultant is licensed as such and is generally a licensed contractor or home inspector. Your FHA lender can provide a list of approved consultants which will oversee your project.
What types of repairs can be included in a 203(k) loan? There are two types of 203(k) Home Renovation loans, a Consultant Loan (loans needing more than $35,000 of repairs) and a Limited Loan, sometimes referred to as a “streamline” 203(k) due to the limited amount of paperwork required. What can be included in each? Such repairs include:
- Structural additions including square footage
- Attached or detached garage
- Decks, landscaping and fencing
- Kitchen and bath remodels
- Relocation of load-bearing walls
- Other major renovations approved by the consultant
Limited (Streamline) Loan
- Minor kitchen remodels
- Appliance repair or replacement
- Windows and doors
- Roof repair
- Other repairs approved by the consultant
This loan can also be used when refinancing an existing property as well.
Just like any FHA mortgage, it can only be used to finance a primary residence and cannot be used to acquire and renovate a rental property. Standard FHA loan limits also apply and can also include up to six months of house payments including not just the principal and interest payment but property taxes, insurance and monthly mortgage insurance while the property is being renovated. But there are Home Renovation Loans available to real estate investors and for second homes.
Standard FHA approval requirements also apply, including a minimum credit score, acceptable employment history and/or income source, qualifying debt ratios and sufficient funds to close as verified with copies of recent bank statements.
The FHA 203(k) Home Renovation Loan is an ideal way to buy and finance that “fixer upper” that needs some work to be done and if this program seems to fit what you have in mind, it’s time to speak with a loan officer experienced with this program who can answer any and all questions you have about this program. It’s important to note however, not all approved FHA lenders know how to navigate the 203(k) waters. You need a lender who knows the intricacies of the FHA 203(k) Home Renovation loan and which program best fits your needs.
Foundations Real Estate Agency has helped many clients work their way through renovation projects. We can assist with the guidance necessary to have a smooth transition into your newly renovated home. We would be happy to discuss in more detail the FHA 203(k) Home Renovation Loan or answer any questions you may have. We have the resources and lenders to help determine the best loan product for your needs.