How does the FHA 203k loan work?
Fixer-upper homes often come with less competition from other buyers. And you can build tens of thousands of dollars in additional equity in a short time by making relatively minor improvements.
If that sounds like your cup of tea, an FHA 203k loan could be your ticket into home equity wealth.
This program lets you buy a home and fix it up, all with one affordable mortgage. Up for the challenge? Here are your first steps.
In this article (Skip to...)
- What is a 203k loan?
- How does the 203k work?
- FHA 203k requirements
- FHA 203k lenders
- Rates and mortgage insurance
- Qualifying repairs
- Pros and cons
What is an FHA 203k loan?
An FHA 203k loan lets you purchase or refinance a fixer-upper and finance the needed repairs — all with a single loan and one monthly mortgage payment.
Sometimes called a “Rehab Loan,” this type of mortgage addresses a common problem when buying a fixer-upper home. Lenders often won’t approve loans for homes in need of major repairs. But because the lender tracks and verifies repairs when using a 203k loan, it is willing to approve a loan on a home it wouldn’t otherwise consider.
That said, for a lender to approve financing, the home must already meet certain safety and livability standards. This will be determined primarily by the FHA home appraisal.
If the fixer-upper is too run down, you won’t be able to use an FHA 203k rehab loan. But this loan program can be a good option for borrowers on a tighter budget and for first-time home buyers who want to buy an older or run-down home and repair it, rather than buying a more expensive turn-key home.
How does the FHA 203k loan work?
The FHA 203k loan works much like any other home purchase loan, but with a few modifications. Most notably, you’ll submit your list of home improvements and hire a contractor before approval.
Here’s the general process of using an FHA 203k loan.
- Find a lender approved to do 203k home improvement loans. Get several mortgage quotes so you can be confident that you’re getting a good deal
- Apply for your home loan and get a preapproval letter
- Find a property. Make sure that your offer contains language indicating that you need a 203k loan in order to complete the purchase. Note that your maximum loan amount calculation is different for purchases. Check out HUD’s Maximum Mortgage Worksheet for more information
- Find an FHA 203k consultant if your home improvement costs will exceed approximately $31,000. This person will arrange for a detailed proposal from licensed contractors. It will contain the scope of the work to be done and a detailed cost estimate
- Find a contractor to write an estimate of the work needed and materials required. You aren’t allowed to do the work yourself unless you are a professional, full-time builder
- Get a home appraisal. Once approved, your lender will issue a home appraisal for the value of the property before and after improvements have been made
- Close the loan and begin construction. After the appraisal, your loan can close and contractors can begin work on the home renovations
Receiving a final approval involves lining up contractors and receiving bids, and some additional hoops to jump through. If that sounds intimidating, don’t stress too much. The 203k lender will drive the approval process and guide you through it. You’re not on your own!
When the loan closes and funds, the seller gets paid. The rest of the money from your lender goes into your escrow account. The lender releases escrow funds to the contractor as work is completed.
Choose your home improvement projects
The first step of an FHA 203k loan is deciding which home improvements or modernizations you want to do (see a list of qualifying repairs below). The lender will require any safety or health hazards to be addressed first, including repairs like mold, broken windows, derelict roofing, lead-based paint, and missing handrails.
From there, you choose which cosmetic improvements you want to take care of such as updating appliances, adding granite countertops in the kitchen, or a new bathroom. These types of updates are all eligible uses for this remodel loan.
Choose your contractors
Once you’ve got your project list together, the next step is to find the right contractors. Qualifying contractors must be licensed and insured, and they typically have to be in full-time business. You can’t use buddies who do construction on the side, and you typically can’t do the work yourself unless you’re a contractor by profession.
Best results will come from experienced and professional remodeling firms that have done at least one 203k renovation in the past. Be aware that your entire project can be held up by one contractor that is unwilling to complete the necessary forms. So you might even go so far as to write the 203k paperwork requirements into the contractor agreement.
Get your bids
Once your contractor is on board with helping you complete your loan application, get official bids. Make sure the bids aren’t guesses. They must be completely accurate because the lender will submit final bids to the appraiser, who builds the value of the work into the future value of the property, upon which your loan is based.
Changing bid dollar amounts later could incur additional appraisal costs and trigger re-approval with the lender. Again, make sure your contractor knows all this!
Submit documentation to the lender
By this point, the lender will have your income, asset, and credit report information. Once it has all the required bid paperwork, your loan can go to final approval.
Close the 203k loan
You will sign the final mortgage documents, and the house is officially yours.
Contractor starts work
Once the loan is finalized, the contractors can start the home improvements. Depending on the extent of the repairs, you may be able to move in at the same time. But for bigger projects, arrange to live somewhere else until work is complete. You can finance up to six months of mortgage payments into your loan amount to allow room in your budget to do so.
Move in to your renovated home
The work is complete, and you’re the owner of a beautiful new home. You’ve built home equity early on, and you didn’t have to engage in a bidding war to buy your ideal home.
“With your renovation project complete, you already may be able to refinance out of the FHA loan and its mortgage insurance premium (MIP),” says Jon Meyer, The Mortgage Reports loan expert and licensed MLO.
FHA 203k loan requirements for 2023
A 203k is a subtype of the popular FHA loan, which is meant to help those who might not otherwise qualify for a mortgage. The FHA 203k loan requirements are flexible, which makes qualifying easier than a typical renovation loan.
203k credit score requirements
FHA allows credit scores as low as 580, although some lenders might require a score of 620-640 to qualify for a 203k loan. Still, that’s much lower than the 720 or higher you would probably need for a conventional construction loan.
Minimum down payment
FHA requires just a 3.5% down payment, based on the purchase price and total project cost. For example:
- Home price: $200,000
- Total project cost: $25,000
- Down payment: $7,875 (3.5% of $225,000)
You can receive 100% of your down payment requirement via a gift from family, an approved non-profit organization, or a down payment assistance program (DPA).
Income and debt requirements
Lenders will examine your debt-to-income ratio, too. This is the comparison of your gross monthly income and debt repayments. Typically, less than 43% of your income should go toward your proposed mortgage payment plus all other debts. That’s $430 in payments per $1,000 of pre-tax income.
For example, if your income is $5,000 per month, your future house payment plus auto loan payments, student loan payments, and credit card bills shouldn’t exceed $2,150 per month.
FHA 203K maximum loan amount
Using an FHA 203k loan, you can borrow up to 110% of the property’s proposed future value, or the home price plus renovation costs, whichever is less. But keep in mind that your total loan amount can’t be higher than your region’s FHA loan limits, which is $ in most parts of the country.
You must plan to live in the property you are buying. If you plan to fix and flip as an investment property, the 203k loan isn’t for you.
All FHA loans are available to U.S. citizens and lawful permanent residents. Lenders will verify citizenship status at the time of application.
FHA 203k loan lenders
When you’re looking for an FHA 203k loan lender, be aware that not every mortgage company originates these loans. Furthermore, not every loan officer or mortgage broker understands the process. You’ll want to make sure that the company you work with is approved to do this loan and does a lot of them.
The U.S. Department of Housing and Urban Development (HUD) has a helpful search page you can use to determine if the lender you want to use has done at least one 203k rehab loan in the last 12 months. You just type in the lender name at the top, scroll down, and check the box for the 203k rehabilitation mortgage insurance program.
203k loan rates and mortgage insurance
Mortgage rates are somewhat higher for FHA 203k loans than for standard FHA loans. Expect to receive a rate about 0.75% to 1.0% higher than for a standard FHA mortgage. Still, base FHA rates are some of the lowest on the market, so 203k rates are often competitive.
You’ll also pay FHA mortgage insurance. This costs 1.75% of the full loan amount as a lump sum (usually rolled into the loan) and 0.85% yearly (broken into 12 equal monthly mortgage insurance premiums). On a $250,000 loan, that’s $4,375 upfront and an extra $177 per month.
What types of repairs and projects can you do with a 203K loan?
There are two types of 203k loans. Which one you choose will depend on the types of repairs your fixer-upper needs.
- 203k limited loan: Provides up to $35,000 for home renovations, but structural repairs and luxury upgrades are not eligible
- 203k standard loan: Most types of home renovations are eligible, including major structural repairs. However, qualifying renovations must cost at least $5,000. Luxury upgrades not eligible
Here’s a little more information about each program.
1. Limited 203k mortgage (formerly known as the Streamline 203k)
This option allows you to do mostly cosmetic repair work, including things like kitchens and bathrooms. The stated limit to costs is $35,000. However, an FHA 203k loan requires a “buffer” equal to 15% of the total bids.
This buffer is called a contingency. It’s a “just in case” fund to cover cost overruns by your contractor. (If the contingency fund is not used, it is credited back to you). So, your “real” maximum repair costs can be around $31,000.
Most non-structural, non-luxury items are acceptable:
- Kitchen and bathroom remodels
- Appliance replacement
- HVAC upgrades or replacements
- Carpet and flooring
- Roofing replacement including gutters and downspouts
- Repairing safety and health issues
- Energy-efficient home improvements
- Septic system improvements
- And much more
In short, you can’t do anything structural (move load-bearing walls, add rooms) or change the footprint of the home.
So why choose the Limited 203k option? Because more lenders offer it than the full 203k standard loan. And, it’s a much simpler approval process, too.
2. Standard 203k rehab loan
With the standard FHA 203k loan, you can do just about anything you want to the home, except non-permanent changes or adding luxury amenities.
Qualifying projects using the standard 203k include:
- Structural alterations
- Converting a single-family home into a 2-, 3-, or 4-unit home, or vice versa
- Connecting to public sewer or water
- Some larger landscaping projects
- Improving accessibility for disabled persons
- Moving the house to a different site
For more information on the standard versus limited 203k, see: Should You Choose A Standard Or Limited 203k?
What you can’t do with the 203k loan
While FHA 203k guidelines are fairly lenient, there are some things you cannot use the rehab funds for. For example:
- Minor landscaping
- Adding a luxury amenity like a tennis court, barbecue area, or swimming pool
- Projects that will take longer than six months
In these cases, other options might be a better fit, such as getting a home equity loan after purchase, or other alternatives mentioned in the next section.
Home renovation loan alternatives
There are several reasons the FHA 203k might not be your best option. You may need only a few thousand dollars for minor work, for example. Or your renovation might be too luxurious or pricey for FHA guidelines. You may want to do the work yourself. Or you’d prefer a renovation loan that doesn’t require mortgage insurance for life.
Thankfully, there are other home improvement loans. One might be a better fit.
Home equity loan
Also called a “second mortgage,” a home equity loan lets you cash out some of your equity without refinancing. A home equity loan is usually a fixed-rate mortgage that has a higher interest rate, but costs less to originate and doesn’t require mortgage insurance.
These are ideal for projects that require a large sum upfront. The catch is that you need some home equity now, before you improve the property, because second mortgage lenders typically lend up to 90% of the as-is property value.
Home equity line of credit (HELOC)
The home equity line of credit is a good option when you need flexibility and don’t need to borrow a lot at once. It usually has a variable interest rate, and you pay interest on the amounts you withdraw. You can repay and re-use it up to your loan limit. Setup costs are low to none. Like a home equity loan, you’ll need some existing equity to get a HELOC.
Fannie Mae’s HomeStyle mortgage
The HomeStyle loan allows you to buy and rehab a home with just 5% down. Unlike an FHA loan, the private mortgage insurance on this loan type is not permanent. And if your credit is good, your monthly mortgage insurance cost should be cheaper than with the FHA 203k.
Like a HELOC or home equity loan, a cash-out refinance can tap into your existing home equity to finance home improvements. But rather than adding a second mortgage, the new loan would replace your existing mortgage and provide cash for renovations.
For more information and help deciding which type of loan to use, see: 6 types of home improvement loans.
FHA 203k loan: Pros and cons
The buy-and-rehab strategy can give home buyers instant equity.
Fixer-uppers in need of repair or updating can be had on the cheap, and the fixes may not be expensive at all. For instance, a house potentially worth $250,000 may sell for just $200,000 when it needs only $20,000 in repairs. That leaves $30,000 in potential equity for a buyer with the initiative to manage the fixes.
Still, this strategy isn’t right for everyone.
FHA 203k pros
- Gain instant equity
- Deal with less competition to buy a home
- Gain valuable experience remodeling a home
According to real estate data website Realtytrac, the median home price in a “distressed” sale was 42% lower than the price netted in non-distressed situations. That’s a big discount.
The problem comes, however, when the buyer goes to finance the home purchase. Most mortgage programs require homes to be in near-top shape before the loan is approved. That’s where the FHA 203k rehab loan comes in.
The Federal Housing Administration’s (FHA) 203k loan allows buyers to finance the home and up to $35,000 in repairs with one loan. It’s possible to have lower monthly payments and higher equity in your home the moment you move in, compared to your friends and neighbors.
FHA 203k cons
As you would expect, there are some pluses and minuses with the 203k loan program.
- Hire reputable contractors and be diligent about having them complete paperwork
- Lenders can require you to send a bid back to the contractor two or three times for missing information
- You will have to decide on the repairs upfront and if they are within your budget
In addition, the loan process will take more time than a standard loan. You are increasing paperwork requirements by two to three times compared to a standard mortgage loan. Go into the process expecting and embracing that fact. Don’t think that you’ll be the exception that closes the loan in 15 days. Set realistic expectations with the seller.
Can I refinance into a 203k loan?
Most people use the FHA 203k loan to buy a home, but it can be used for refinancing, too. As long as you have at least $5,000 in improvements, you can use this refi option. The lender will order an appraisal that shows two values: the “as-is” or current property value, and the “improved value” after renovations.
Your maximum refinance loan amount (subject to FHA loan limits) is the lowest of these three calculations:
- The existing debt before rehab, plus the estimated cost of improvements and allowable closing costs
- The as-is value plus rehab costs
- 110% of the after-improved value x 97.75%
If you have owned the property for less than one year, the lender must use acquisition cost, plus the documented rehabilitation costs, for your maximum loan amount. You do not need to have an existing FHA loan to use an FHA 203k loan for refinancing.
FHA 203k rehab loan FAQ
Generally, most applicants who would qualify for an FHA loan will be approved for a 203k loan, too. You must have at least a 580 credit score (though some lenders require 620-640). You’ll also need at least a 3.5% down payment based on the purchase price plus repair costs, adequate income to repay the loan, and not too much existing debt. In addition, you must be purchasing a home you plan to live in.
The 203k process includes a few extra steps compared to a standard FHA loan. First, you will apply and get approved. Then you find a contractor, get repair bids, and determine your final loan amount including construction costs. Next, the mortgage company has to underwrite and approve your loan. After that the loan can close, the contractor can start renovations, and the mortgage company will pay them as construction is completed. After a final inspection, you’re free to move into your new home.
The 203k loan covers the full purchase price of the home, plus any eligible repairs (non-structural repairs for the Limited 203k program). For example, if the home price is $250,000 and $20,000 in repairs are needed, the new loan will be $270,000 plus a required contingency or buffer percentage.
You can borrow up to 110 percent of the property’s proposed future value, or the home price plus repair costs, whichever is less. But note that your total purchase price plus repair costs must still fall within FHA loan limits for the area.
A 203k loan can be well worth the extra effort, especially if you can buy a home at a discount. For instance, say a buyer pays $200,000 for a run-down home and does $20,000 in repairs. Because the home is now in turn-key condition, it would be worth $240,000 on the open market. The buyer gains $20,000 in equity immediately.
No. These loans are only available to buyers who plan to live in the home for the foreseeable future. Yes, you are able to sell the home someday, but you can’t enter into the transaction knowing you will sell the house as soon as it’s fixed up.
No. Only permanent, attached upgrades are allowed to be financed. Appliances are okay, but not furniture that does not add value to the home and can be removed.
Like all FHA loans, the 203k loan requires you to put down 3.5 percent of the total purchase price, plus repair costs and required contingency costs. For instance, a $200,000 home with $30,000 in repair and contingency costs would require a down payment of $8,050 (3.5 percent of $230,000). Keep in mind that closing costs apply and are in addition to the down payment. Closing costs for a 203k loan are typically between 3 percent to 6 percent of the purchase price.
Homeowners must live in their homes as their primary residence for 12 months before renting it out or selling.
It will likely take 60 days or more to close a 203k loan, whereas a typical FHA loan might take 30-45 days. There is more paperwork involved with a 203k, plus a lot of back and forth with your contractor to get the final bids. Don’t expect to close a 203k loan in 30 days or less.
Usually, no. You must choose licensed contractors for all work. The only exception is if you are licensed and a full-time contractor by trade. In these cases, some lenders may approve DIY work.
Yes. You can choose a 203k loan with an adjustable rate (ARM) or a fixed rate (30- or 15-year term). An adjustable rate could save you money, especially when rates are high, if you plan to sell the home soon after the first year you own it.
Yes. Along with the usual closing costs, expect an extra supplemental origination fee of about 1.5 percent of the loan amount. And, you’ll be charged a HUD consultant fee depending on the size of your project. This fee typically ranges from $400 to $1,000.
An FHA 203k loan can help you gain immediate equity in your home by financing home improvements that add value right away. However, the application process takes more time and more attention to detail when compared to a standard FHA or conventional loan.
Where to find an FHA 203k rehab loan?
It’s always wise to shop around and find the best lender. But with a 203k loan, you may not always want the lender with the lowest interest rate. It’s often better to accept a higher interest rate if it’s coming from a lender with more 203k loan experience than the lender who’s offering a lower rate.
This is a rare exception in mortgage shopping in which the lowest rate may not be in your best interest. In the world of 203k loans, contractors and lender experience is typically more of a consideration than cost. Click the link below to begin your search for the best FHA 203k loan lender for your financial needs.