FHA 203(k) Loans: Your Guide to FHA Renovation Loans

So, you’ve decided it is time to strike out on your own and purchase a home. It’s a great time to do so. Interest rates remain low (although they're set to rise). Lenders have relaxed their stringent requirements stemming from the Great Recession and the housing industry meltdown. The national real estate market is pretty competitive, too, and while there are shortages of new homes in some states, like California, there is enough of a supply to ensure that you have at least a few good options within your local area.

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What if you fall in love with a home that’s not new, though? What if that home needs a little bit of TLC? A home is generally the single largest purchase you will ever make, but the need for repairs or renovation work can drive that price substantially higher.

There is also the fact that conventional lenders don’t really like to take on additional risks. Make no mistake – a home in need of renovation is a greater risk than a new home, or even an existing home that has already been repaired.

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In most cases, you might be able to find a lender willing to work with you if your credit is perfect, and you can afford to make a significant down payment (think over 20% of the price of the home). The problem is that most Americans are not in that position. Perfect credit is almost an impossibility, and coming up with tens of thousands of dollars as a down payment isn’t all that practical, either.

One option available to buyers in this situation (buying a home that needs renovation work) is the FHA 203(k) loan, not to be confused with the more common 203(b) loan. How does the 203(k) loan work? What is the FHA? What are the requirements to obtain a 203(k) loan?

This guide will explore the answers to those questions and many others. The goal is to provide you with all the information you need concerning the FHA 203(k) loan and whether it is a good fit for your home-buying needs.

The Role of the FHA and How FHA Loans Work

Before we delve into what a 203(k) loan is and how it works, it is important to understand what the FHA is, and how this organization operates. The Federal Housing Administration, or FHA, was founded in 1934 in an effort to help everyday Americans afford to purchase a home to call their own, even if they lacked deep pockets or had less than stellar credit.

Today, the FHA is part of the Department of Housing and Urban Development, or HUD, but the organization remains the single largest insurer of home mortgages. To date, the FHA has backed over 48 million home loans.

However, do not make the mistake of thinking that the FHA (or HUD) issues home loans. They do not. The USDA does, but the FHA exists solely as an insurer of mortgages. What this means is simple – the FHA guarantees your loan to a lender. This reduces the risk you pose as a consumer, meaning that you are able to be approved for a mortgage loan even if your credit score is very low and you are not eligible for a conventional home loan.

Think of it as the FHA providing a lender with protection against a potential default on your part. If you were to walk away from your loan unpaid, the FHA would step in and make good on the mortgage. The lender stands to lose little, if anything, which means they will work with those they would otherwise turn down.

This is true for all types of FHA loans, not just the 203(k) loan. It applies to the 203(b) loan, Home Equity Conversion Mortgages, GPM/GEM and other loan programs offered by the FHA/HUD, as well.

What Is an FHA 203(k) Loan?

Now that we have clarified on what the FHA is and how this organization guarantees loans, it is time to turn our attention to the question at hand. What is an FHA 203(k) loan, anyway? Actually, it is pretty simple. The 203(k) loan program was designed specifically for consumers who want to purchase a home that is need of renovations. Thus, the nickname “renovation loan.”

According to HUD, “Section 203(k) insurance enables home buyers and homeowners to finance both the purchase (or refinancing) of a house and the cost of its rehabilitation through a single mortgage or to finance the rehabilitation of their existing home.”

In the past, it required two different loans in order to purchase a fixer-upper with an FHA loan. However, the 203(k) loan allows you to purchase a home and finance major renovations with a single loan. You essentially wrap both the costs of the home and the costs of the renovation into a single loan. In general, the costs of the renovations necessary cannot exceed 50% of the home’s purchase price. However, they must cost over $35,000. If they cost less than $35,000, a Streamlined/Limited 203(k) loan will be necessary, rather than a conventional 203(k) loan.

Note that the 203(k) loan and the Limited/Streamlined 203(k) loan are different. We will discuss those differences later in this guide.

Who Can Use 203(k) Loans?

A number of types individuals can use FHA 203(k) financing, including:

  • First-time home buyers with limited down payment or low credit

  • Homeowners interested in refinancing their home and renovating it

  • Homeowners interested in renovating their home before putting it on the market

  • Investors who plan to make one unit of a 1-4 multi unit property their primary residence (but not for investment purposes if you will not be an owner/occupier).

Of course, there’s more to it than simply desiring to purchase a primary residence that needs a little work. There are some relatively specific considerations when it comes to those who can apply for an FHA 203(k) loan. To learn more, keep browsing the site, check out our loan requirements section, or even take a look at our easy-to-read FAQs!