203(k) Refinance: A Home Improvement Loan With No Home Equity
If you want to improve your home, but have little or no home equity, look at the FHA 203(k) refinance program. This unique mortgage lets you add financing for major home additions and improvements to your refinance loan amount.
The program comes in both a Standard and a Limited version.
The chief advantage of the 203(k) refinance is that you don’t need tons of home equity to wrap your remodeling costs into your new loan.
Why Relocate When You Can Renovate?
Imagine that you have a home which is well-located but is also too small, too old or both.
You love your neighborhood, and you don’t want the cost or hassle of moving. You decide to stay in place and upgrade.
You might pay for your improvements with a traditional cash-out refinance. Or, you could get a second loan or a home equity line of credit (HELOC).
The Problem With Traditional Home Improvement Loans
While these options can make sense for some projects, you can only fund a big project if you have considerable home equity to support the new loan.
For example, if you have a $200,000 home with a $180,000 mortgage balance, you wouldn’t be able to get any additional cash. Most lenders limit cash-out refinancing or home equity lending to 90 percent of your home’s value — or less.
The Solution To Standard Home Improvement Loans
The way around the equity limitation problem is to choose an FHA 203(k) refinance mortgage.
With such financing, says HUD, “the value of the property is determined by either
(1) the value of the property before rehabilitation plus the cost of rehabilitation, or
(2) 110 percent of the appraised value of the property after rehabilitation, whichever is less.”
In plain language, HUD is saying that you can borrow more than the current value of the property.
Determining Your 203(k) Loan Amount
Here’s how, assuming you’d like to add $50,000 in improvements:
Under the first standard, “the value of the property before rehabilitation plus the cost of rehabilitation,” we have a $200,000 home plus $50,000 in improvements, So, lenders examine the loan as though the property has a value of $250,000.
With the second standard, you can get financing based on “110 percent of the appraised value of the property after rehabilitation.” If the property is worth $250,000 after the desired upgrades, 110 percent of that is $275,000.
What You Can’t Do With A 203(k) Refinance
There are several limitations here.
First, HUD will only allow a 203(k) refinance mortgage for the lesser of the two loan amount calculations — $250,000 in this case.
Second, FHA lenders will not approve a 203(k) mortgage for more than the FHA mortgage loan limit for your community.
The second “limitation” should not affect most applicants. limits are set according to area home prices. Chances are that your refinance amount will fall well within limits.
Third, the improvements must cost at least $5,000 to qualify for the 203(k) program.
How The Standard 203(k) Refinance Program Works
With a typical home equity loan or cash-out refinance, you get cash at closing. With a 203(k) refinance, the process is different.
Typically, some money will be disbursed at closing to pay off your existing mortgage. The rest of the money will be retained by the lender, and then released in a series of “draws” as the renovation work is completed.
With a Standard 203(k) loan, you must work with a HUD-approved construction consultant. The consultant inspects the work as each stage is completed, and then helps you complete a “draw request” to the lender. The lender then issues a check made payable to the borrower and the contractor.
203(k) Limited Program
The Limited program (formerly known as the Streamline K) is for home refinances that don’t need to include extensive renovations. For projects that can be completed for less than $35,000, the Limited 203(k) is a good choice.
Examples of eligible projects include:
- Minor kitchen remodeling with no structural repairs
- Interior and exterior painting
- Appliance repair or replacement
- Replacement windows and doors
- Roof, gutter and downspouts repair or replacement
- Basement finishing or remodeling without structural repair
Limited loans don’t require the use of a consultant. Typically, half of the construction proceeds are disbursed to the contractor upfront; the rest are paid when the work has been completed.
203(k) Refinance Advantages
There are several distinct benefits associated with the 203(k) program.
First, with the 203(k) you can borrow more than the current value of the house, a huge plus.
Second, the money is in hand as each step in the process is completed.
Third, by working with a HUD-certified consultant (when choosing the full Standard 203(k) program) you have a professional on your side to assure that everything is done correctly.
Fourth, the property does not have to meet minimum property standards at closing. The logic is that the home will be improved through the use of the 203(k) refinance program.
Fifth, checks issued under the program are made payable to both the borrower and the contractor. This means the homeowner has leverage, because the contractor can’t get a check unless the borrower is satisfied with the work.
203(k) Refinance Drawbacks
While there are many attractions to the 203(k) programs there are also cons.
To use the program, you have to work with a HUD-approved contractor. This may eliminate the builder you were hoping to use.
While fees and costs can be rolled into the loan amount, they are still expenses. Because a 203(k) loan is more complex than a standard mortgage you can expect to pay additional lender fees.
For more information and details, speak with a lender who has done 203(k) refinance loans. Also, speak with local 203(k) consultants and ask about their experiences.
What Are Today’s 203(k) Renovation Loan Rates?
Mortgage rates are low for every loan type at the moment, and 203(k) loans are no exception.
Check today’s rates and see how cheaply you can borrow to renovate your home.