In this article:
The Process: From applying to walking into your newly remodeled home, the steps you take to get it done.
Eligibility: What you can do with a 203k Â rehab loan, and what you can't.
Pros and cons: Incredible benefits, and some downsides, too.
Buying a home that needs some TLC can be a good choice. Imperfect homes 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.
But thereâ€™s a reason not as many people want to buy a fixer. It does take more work, planning, and time compared to buying your standard â€śturn-keyâ€ť home.
Up for the challenge? Then rewards await. Here are your first steps.Click to see your 203k loan eligibility (Oct 20th, 2017)
An FHA 203k loan, (sometimes called a Rehab Loan or FHA Construction loan) allows you to finance not one, but two major items 1) the house itself, and; 2) needed/wanted repairs. Because the lender tracks and verifies repairs, it is willing to approve a loan on a home it wouldnâ€™t otherwise consider.
The loan addresses a common problem when buying a fixer home: lenders often don't approve loans for homes in need of major repairs.
A home must meet certain safety and livability standards. Some home buyers are handy enough to buy the house and fix it up themselves. But, if the home is too run down, you canâ€™t get a loan in the first place.
The 203k lets you buy and fix up a house in one transaction, allowing the lender to approve the loan despite its initial condition.
The process is like that of regular home buying, with some modifications:
Apply â†’Â Get Approved â†’ Find A Contractor â†’Â Get Bids â†’Â Close the loan â†’ Complete Repairs â†’ Move in
Receiving a final approval involves lining up contractors and receiving bids, and some additional â€śhoopsâ€ť to jump through. Donâ€™t get stressed at this process, though. The 203k lender will drive the process and guide you through. Youâ€™re not on your own!
Choose your projects: The first step is deciding which repairs you want to do (see â€śWhat Kind of Repairs Can I Do?â€ť below). The lender will require any safety or health hazards to be addressed first â€“ things like mold, broken windows, lead-based paint, and missing handrails.
From there, choose which cosmetic items you want to take care of. For instance, say you want to replace appliances, add granite in the kitchen, and gut the bathroom. Those are all acceptable projects for the loan.
Choose your contractors: Once youâ€™ve got your project list together, find contractors. The contractors must be licensed and insured, and typically have to be in full-time business. No buddies who do construction on the side, and you typically canâ€™t do the work yourself unless youâ€™re a contractor by profession.
Best results will come from super-experienced and professional remodeling firms that have done at least one 203k renovation in the past. Remember: your entire project can be held up by one contractor that is unwilling to complete the necessary forms. You might even go so far as to write the 203k paperwork requirements into the contractor agreement.Click to see your 203k loan eligibility (Oct 20th, 2017)
Get your bids: Once your contractor is â€śon boardâ€ť with helping you complete your loan, get official bids. Make sure the bids arenâ€™t â€śguessesâ€ť. They must be completely accurate. The reason is that 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 everything 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 â€śfinal approvalâ€ť.
Close the loan: You will sign final documents, and the house is officially yours.
The contractor starts work: Once the loan is finalized, the contractors can complete the work. Depending on the extent of the repairs, you may be able to move in at the same time.
For bigger projects, arrange to live somewhere else until work is complete. You can finance up to six months of payments for the new mortgage to allow room in your budget to do so.
Move In And Enjoy: The work is complete, and youâ€™re the owner of a beautiful new home. Youâ€™ve probably built a ton of equity in a short time, and you didnâ€™t have to engage in a bidding war to buy your ideal home.Click to see your 203k loan eligibility (Oct 20th, 2017)
A 203k is a sub-type of the popular FHA loan, which is built from the ground up to help those who might not otherwise qualify for a mortgage. FHAâ€™s flexibility makes 203k qualification drastically easier than for a typical construction loan.
FICO: FHA allows credit scores down to 580, although some lenders might require a score of 620-640 to qualify for a 203k. Still, thatâ€™s much lower than the 720+ you would probably need for a conventional construction loan.
Down Payment: FHA requires just a 3.5% down payment, based on the purchase price + total project cost. For instance:
You can receive 100% of your down payment requirement via a gift from family or approved non-profit organization.
Debt Payments and Income: Lenders will examine your debt-to-income ratio. This is the comparison of your income and debt payments. Typically, less than 43% of your income should go toward your proposed house payment plus all other debts.
Thatâ€™s $430 in payments per $1,000 of before-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 shouldnâ€™t exceed $2,150 per month.
Loan amount: You can borrow up to 110% of the propertyâ€™s proposed future value, or the home price plus repair costs, whichever is less. These loans are also subject to your regionâ€™s FHA loan limits.
Occupancy: You must plan to live in the property you are buying. If you plan to fix and flip, the 203k loan isn't for you.
Citizenship: All FHA loans are available to U.S. citizens and lawful permanent residents. Lenders will verify citizenship status at time of application.Click to see your 203k loan eligibility (Oct 20th, 2017)
There are two types of 203k loans. Which one you choose depends on the extent of the repair work.
This option allows you to do relatively minor repair work. Things like kitchens and bathrooms.
The stated limit to costs is $35,000. However, an FHA 203k loan requires a â€śbufferâ€ť 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 â€śrealâ€ť maximum repair job can cost around $31,000.
Most non-structural, non-luxury items are acceptable:
In short, you canâ€™t do anything structural (move load-bearing walls, add rooms) or change the footprint of the home.
So why choose the streamline 203kÂ option? Because more lenders offer it than the full 203k. And, itâ€™s a much simpler process than the standard option.Click to see your 203k loan eligibility (Oct 20th, 2017)
With this option, you can do just about anything you want to the home, except non-permanent changes or adding luxury amenities.
Read MoreÂ â†’ Should You Choose A Standard Or Streamline 203k?
Mortgage rates are somewhat higher for FHA 203k loans. Expect to receive a rate about 0.75% to 1.00% higher than for a standard FHA loan. Still, base FHA rates are some of the lowest on the market, so 203k rates are competitive.
You'll pay standard FHA mortgage insurance, which is typically 1.75% of the full loan amount upfront (rolled into the loan) and 0.85% yearly (broken into 12 equal monthly payments). On a $250,000 loan, that's $4,375 upfront and $177 per month.Click to see your 203k loan eligibility (Oct 20th, 2017)
Here are the steps you'll complete when buying a fixer-upper with an FHA 203k loan. It's a little different from a "regular" loan, because you'll be submitting your list of improvements, and the loan doesn't completely fund until the improvements are complete.
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 (or its agent) releases escrowed fundsÂ to the contractor as work is completed.
Once your contractor completes the work, you own a renovated house that may already be worth more than you paid for it. That's a sound investment as well as a home customized to your needs.
Most people use this loan to buy a home, but it can be used to refinance, too.
As long as you have at least $5,000 in improvements to do, you can use this refi option. Your maximum refinance loan amount (subject to FHA loan limits) is the lowest of these three calculations:
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.
The lender orders an appraisal that shows two values: the "as-is" or current property value, and the other provides the "improved value."
Your maximum loan amount is the lowest of:
You do not need an FHA currently to use an FHA 203k refinance.
The buy-and-rehab strategyÂ can give home buyers instant equity, and a lot of it.
Homes in need of repair or updating can be had on the cheap, and the fixesÂ may not be very expensive at all.
For instance, a house potentially worthÂ $250,000 may sell for just two hundred thousand, when it needs only twenty thousand dollars in repairs.Â That leaves $30,000 in potential equity for a buyer with the initiative and drive to manage the fixes.
According to real estate data website Realtytrac, the median home price in a "distressed" sale was 42% lower than the price nettedÂ inÂ non-distressed situations. That's a big discount.
The problem comes, however, when the buyer goes toÂ finance the home purchase.
Most mortgage programs require homes to be in near-top shape before the loan is approved.
Thatâ€™s where theÂ FHA 203k rehab loanÂ comes in.
The Federal Housing Administrationâ€™s (FHA) 203k loan allows buyers to finance theÂ homeÂ andÂ up to $35,000 in repairs with one loan.
It's possible to haveÂ lower payments and higher equity in your home the moment you move in, compared to your friends and neighbors. Itâ€™s time to take a closer look at the FHA 203k program.
As you would expect, there are some plusses and minuses with the loan.
The benefits are undeniable: gain a ton of instant equity, experience less competition for the home, and gain valuable experience remodeling a home.
But with every reward comes the preliminary work. The 203k loan is no exception.
As stated above, you will have to secure reputable contractors, and be uber-diligent about having them complete paperwork. Donâ€™t be surprised if the lender requires you to send a bid back to the contractor two or three times for missing information.
You will also have to decide on the upgradesÂ that are within your budget. That can be exciting, but also stressful. Youâ€™ll have to make decisions quickly to ensure the loan approval stays on track.
The loan process will take more time than a standard loan. You are increasing paperwork requirements by 2-3 times compared to a standard loan. Go into the process expecting and embracing that fact. Donâ€™t think that youâ€™ll be the exception that closes the loan in fifteen days. Set realistic expectations with the seller!
Are you ready to tackle these relatively minor inconveniences to reap the benefits? Then a 203k loan is probably the right loan for you.
Itâ€™s always wise to shop around and find the best lender. This is a rare exception where you might take a higher rate from a lender that does these all the time, rather than a low rate from an inexperienced lender.
In the world of 203k loans, contractors and lender experience is typically more of a consideration than cost.
Complete a short form at this link, and check your eligibility for a 203k loan from a lender in our network. Youâ€™ll receive a rate quote, eligibility check, and further advice on whether the loan is right for you.Click to see today's rates (Oct 20th, 2017)
The following are real-life success stories of 203k loan users, with reporting by Lee Nelson, who has appeared on Realtor.com, MyMortgageInsider.com, and more.
In his early 20s, a young college graduate working at a bank came to Elizabeth Larsenâ€™s loan office to talk about buying a home.
â€śI had known this manâ€™s Realtor for a long time,â€ť says Larsen, mortgage loan originator at NFM Lending, Palatine, Ill. â€śThe young man wanted a fixer upper. He decided he couldÂ buy cheapÂ and make it worth more.â€ť
The three-bedroom property in Aurora, Ill, that the buyerÂ chose had some issues, including two bathrooms that needed updating and an unfinished basement.
One year after he took out the rehab loan, the new homeowner came back to Larsen. Because his home had increased in value, he wanted to refinance to a conventional loan.
This buyer had put plenty ofÂ time and effort shopping around to get the right remodelers. The good work they did helped him make money from his renovation.
â€śHe now doesnâ€™t have to payÂ FHAâ€™s mortgage insuranceÂ with the new loan," she said. "He saved money, too, because the interest rates had gone down."
Often, you can gain instant equity by remodeling -- if you choose projects that add more home value than they cost.
"He also wanted a total debt consolidation and put his student loans into the refinance,â€ť LarsenÂ added.
â€śSo, his only debt now is his mortgage. It helps when people take your advice. He was able to come in with all this equity after using the rehab loan.â€ť
Realtor Alexa Rosario works almost exclusively with first-time homebuyers.
â€śI just closed on an FHA 203(k) loan recently, and absolutely love the program for a few reasons,â€ť says Rosario, agent with Happy Homes Network of Keller Williams Realty in Plantation, Fla.
â€śHere in South Florida, the average price range is $250,000. Some first-time homebuyers canâ€™t afford to purchase above that, especially if they are single.â€ť
The restrictive guidelines placed on homeowners associations by most lenders make it hard to finance condos inÂ Florida. And there is a lot of competition from investors for lower-priced single-family homes and townhouses.
But her recent clients, a newlywed couple who had recently graduated from college, were able to go under contract for aÂ bargainÂ $130,000 townhouse that needed a lot of work,Â said Rosario.
â€śWe had a contractor go out and give us an estimate for the repairs. The repairs were going to cost about $40,000.
I knew that there were similar, updated properties that were selling for $180,000, so I was confident that we could make it work,â€ť she says.
The rehab loan went through for $170,000, and the buyers put 3.5 percent down. The appraisal, closing and repairs loan went without a hitch.
â€śThe buyers moved into the home as if it were brand new and beautifully updated,â€ť Rosario says. â€śItâ€™s a great program, and I highly recommend it.â€ťClick to see your 203k loan eligibility (Oct 20th, 2017)
The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.
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2017 Conforming, FHA, & VA Loan Limits
Mortgage loan limits for every U.S. county, as published by Fannie Mae & Freddie Mac, the Federal Housing Administration (FHA), and the Department of Veterans Affairs (VA)