203(k) Basics: What You Need to Know
FHA 203(k) loans are perhaps the best home loan option out there for people who wish to purchase and renovate a home without the stress and financial hassles of taking out multiple mortgages. 203(k) loans are available to a variety of different borrowers, including those who want to purchase a home and repair it, those who wish to refinance their current home and make repairs, and even people who want to buy a 2-4 unit multifamily property and live in one unit while renting the others out.
203(k) Loans Carry Many of the Benefits and Drawbacks of Other FHA Loans
203(k) loans are insured by the Federal Housing Administration, or FHA. The FHA does not issue these loans themselves— instead, they are issued by private lenders. The FHA only provides insurance on the loan, meaning that if a borrower defaults, the FHA will compensate the lender for a portion of their losses. In addition, like other FHA loans, 203(k) loans require both a one-time, upfront, and annual mortgage insurance premium (MIP), and are offered in both 15-year and 30-year fixed and adjustable-rate options. Plus, like other forms of FHA-insurance home financing, 203(k) loans are subject to the FHA loan limits in the area in which your property is located. Also, just like other FHA mortgages, borrowers with a credit score of at least 580 can qualify for a low down payment of 3.5%. 203(k) borrowers are eligible for down payment assistance programs (though they may be harder to find than if a borrower is getting a standard 203(b) loan.
How 203(k) Loans Really Work
So far, we’ve addressed the basic purpose of the 203(k) loan, and their similarities to other forms of FHA home financing. Now, we’ll talk a little bit about how they’re different. Unlike other FHA loans, 203(k) loans involve funding for home repairs and renovations. This amount must not exceed 50% of the home’s value, but must be at least $35,000. For smaller amounts, borrowers may choose to go with a Limited 203(k) loan. Unlike 203(k) loans, which can be used for almost any kind of home repair, Limited 203(k) loans have somewhat more restricted uses, including repairing or installing HVAC systems, roofs, appliances, or electrical wiring, weatherizing a home, or updating a septic system.
Also, unlike most other FHA home loans (and most other home loans in general), borrowers will need to hire a 203(k) consultant before beginning the 203(k) loan process. A 203(k) consultant must be certified by HUD, and, once certified, is placed on the FHA’s 203(k) Consultant Roster.
A 203(k) consultant will help you navigate the complexities of the 203(k) loan process, and, specifically, will create important planning documents, such as a work write up and a construction cost analysis. In addition, a 203(k) consultant will help prepare bid packages for 203(k) contractors. The 203(k) contractor you choose will be responsible for actually making sure the renovations you plan get completed. While the FHA does not specifically certify contractors for the 203(k) program, they do require that the contractor be fully licensed in the state in which they’re operating. In addition, most lenders require that contractors have at least $1 million in general liability insurance.
Several times during the renovation process, your consultant will conduct a brief home inspection in order to approve each “draw” (disbursement of money) from your 203(k) escrow account. Once the home renovations are complete (they must be finished in 6 months or less), your consultant will complete a final inspection and your loan will fully close.