What is an FHA 203k Loan and How Does it Work?

FHA 203k loans offer more flexibility than conventional loans.

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?
• Types of 203k loans
• Refinancing
• How do they work?
• Eligible renovations
• Requirements
• Lenders
• Pros and cons
• Alternatives
• How to apply
• FAQ

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.

Types of 203K loans

There are two types of 203k loan options: Standard (or Full) 203k loans and Limited 203k loans. Both are federally insured mortgages that can be used to buy a home or make improvements to it. They do, however, cater to different types of projects based on the scope and cost of the planned renovations.

Standard 203k Loans

The Standard or Full 203k loan is designed for larger, more complex projects. This includes structural renovations, landscaping work, and any other project where the renovation costs exceed $35,000. Standard 203k loans can also be used to finance both structural repairs and functional improvements to structures. For example, if you buy a home that requires a new roof, HVAC system, or structural foundation work, the Standard 203k loan may be a good fit.

With a Standard 203k loan, the property must be appraised to find out how much it is worth after renovations are done. Working with a HUD-approved 203k consultant is also required. The FHA-approved consultant will assess the proposed work, review the contractor’s bids, monitor project progress, and sign off on loan proceeds disbursements.

Limited 203k Loans

The Limited or Streamline 203k loan is a simplified version designed for non-structural renovations. These are small remodeling projects or updates that won’t cost more than $35,000. Borrowers can use a Limited 203k loan to make a variety of improvements, such as cosmetic changes like painting, updating flooring or appliances, or even making energy-efficient upgrades.

The Limited 203k loan, unlike the Full 203k loan, does not allow for structural changes. As a result, it’s usually easier to obtain because there’s less paperwork and you don’t need to hire a 203k consultant. However, it is still critical to hire a reputable contractor who is well-versed in the 203k loan process.

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.

Refinancing with 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 refinance 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.

How does the FHA 203k loan work?

Understanding how a 203k loan works is important for people who are thinking about getting one. This type of loan has its own steps and roles that make it different from other mortgage products. Here’s what you can expect.

Application process

203k loan applications are more detailed than mortgage loan applications. Potential borrowers must have a credit score of at least 620, a debt-to-income ratio below 43%, and the intention to live in the home as a primary residence. After making sure they are eligible, applicants should look for a suitable property that needs repair or renovation.

Once a property is chosen, the borrower works on a detailed plan for fixing it up, including an estimate of how much it will cost. This plan is necessary for 203k loan applications.

Next, applicants must find a 203k-approved lender, complete the lender’s application, and provide income proof, tax returns, and renovation plans. HUD-approved consultants perform feasibility studies and property appraisals for Full 203k loans. The lender approves the loan if it meets all criteria after a thorough review.

Contractors and consultants

Contractors and consultants play important roles in the 203k loan process. Contractors give detailed bids for the work to be done, carry out the plans that have been approved, and ask for payments as project milestones are met.

Moreover, a HUD-approved consultant is needed for a Full 203k loan. The consultant looks over the proposed plans for renovation, checks out the property, does a feasibility study, and keeps an eye on the project. They make sure the proposed renovations will cost what was estimated and will increase the property’s value. Before each stage of the job is paid for, the consultant also signs off when the work is done.

For a Streamline 203k loan, you don’t need a consultant, but you do need a reliable contractor who can finish the work to your satisfaction and within the budget.

Timelines and payment schedules

Once the 203k loan closes, work must start on the house within 30 days. For a Full 203k loan, the project is supervised by the consultant and the contractor, and the work must usually be done within six months.

Contractors are paid in parts, or “draws.” For big projects, the first draw comes after the loan closes, and the rest are given as each important stage of work is finished, according to the agreement. Before each payment, the consultant must check the work.

For Streamline 203k loans, the contractor can be paid up to twice: once as a down payment and once as a final payment after the work is done to satisfaction.

By knowing about these parts of a 203k loan, potential borrowers will be better able to get through the process and make sure that the renovations go as smoothly as possible.

What can you do with a 203K loan?

The repairs and projects that can be done depend on which type of 203K loan option is chosen.

• 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

Keep in mind that the size of the proposed renovation will largely determine the type of 203k loan that is best for your needs. The Full 203k loan would be the best option for major structural repairs or extensive renovation projects. For simpler, non-structural improvements, the Streamline 203k loan may be the best option.

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.

During the loan application process, the scope of work will be decided. It must be in line with the rules set by the Federal Housing Administration (FHA) to be legal and eligible. Which one you choose will depend on the types of repairs your fixer-upper needs.

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.

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 home loan. The FHA 203k loan requirements are flexible, which makes qualifying easier than a typical renovation loan.

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.

Maximum loan amount

Using an FHA 203, 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.

Occupancy and citizenship requirements

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.

Furthermore, all FHA loans are available to U.S. citizens and lawful permanent residents. Lenders will verify citizenship status at the time of application.

Where can I get an FHA 203k loan?

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 you’re working with an FHA-approved lender that underwrites 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.

FHA 203k loan: Pros and cons

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 home 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.

Alternatives to an FHA 203k loan

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 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.

Freddie Mac CHOICERenovation and CHOICEReno eXPress loan

Like the HomeStyle renovation loan, both of these programs let you finance the cost of buying and fixing up your home up to the maximum conforming loan amounts. But the CHOICEReno eXPress loan makes it easier to qualify if the cost of your renovations is less than 10% or 15% of your home’s value, depending on where you live. Both Fannie Mae and Freddie Mac’s renovation programs allow for as little as a 3% down payment.

Cash-out refinance

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.

How to get an FHA 203k loan

Applying for a 203k loan is a multi-step process that involves a bit more paperwork and time than a standard loan application due to the additional requirements related to the renovation plans. Here’s a detailed look at the steps involved:

1. 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 installing a new bathroom. These types of updates are all eligible uses for this remodel loan.

2. Determine Your Eligibility

Make sure you meet the eligibility criteria for a 203k loan. This typically includes having a credit score of at least 620 and a debt-to-income ratio of less than 43%. The property must also meet eligibility criteria: it must be a one-to-four unit dwelling that is at least one year old.

3. Find a suitable property and plan your renovations

Search for a property that you’d like to buy and renovate. Make a detailed plan of the improvements you wish to make, including cost estimates. For a Full 203k loan, your plan must involve at least $5,000 worth of renovations, while a Streamline 203k loan must not exceed $35,000 in renovation costs.

4. Choose your contractors

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.

The 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 who 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.

5. 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 a re-approval with the lender. Again, make sure your contractor knows all this!

6. Choose a 203k-approved lender and provide documentation

Not every lender offers 203k loans, so it’s important to find a lender who is familiar with the specifics of the 203k loan process. You can find a list of approved lenders on the Department of Housing and Urban Development (HUD) website.

You will need to provide a range of documentation to support your application. This may include pay stubs, W-2s, tax returns, details about your debts, and a written proposal for your planned renovations.

7. Property appraisal and feasibility study

For a Full 203k loan, the lender will arrange for a HUD-approved consultant to visit the property. The consultant will perform a feasibility study and review your proposed improvements to ensure they increase the property’s value and meet HUD’s Minimum Property Standards and local code requirements. For a Streamline 203k, a consultant isn’t needed, but the property will still need to be appraised.

8. Closing the loan

Once the loan is approved, you’ll proceed to closing, where you’ll sign all of the loan documents. The renovation funds from your loan will be put into an escrow account to be released as work is completed.

9. Overseeing renovation work

Renovation work must start within 30 days of closing your loan. For a Full 203k loan, you’ll work with your consultant to oversee progress.

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.

10. 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.

Plus, you may be able to refinance out of the FHA loan and the mortgage insurance premium (MIP) that comes with it.

FHA 203k rehab loan FAQ

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.