What Is An FHA 203(k) Loan?

Amy FontinellePersonal Finance Expert

Amy Fontinelle is a freelance writer, researcher and editor who brings a journalistic approach to personal finance content. Since 2004, she has worked with lenders, real estate agents, consultants, financial advisors, family offices, wealth managers, insurance companies, payment companies and leading personal finance websites. Amy also has extensive experience editing academic papers and articles by professional economists, including eight years as the production manager of an economics journal.

Mike CeteraEditor in Chief, Forbes Marketplace U.S.

Mike Cetera is the editor in chief for Forbes Marketplace U.S. Mike has written and edited articles about mortgages, savings accounts, CD rates and credit cards for more than a decade. Prior to joining Marketplace, his work appeared on Bankrate, The Points Guy and Fit Small Business. Mike earned a master’s degree in public affairs reporting from the University of Illinois and has been a journalist for more than two decades. He also has offered his expertise in numerous TV, radio and print interviews.

Amy Fontinelle,

Amy FontinellePersonal Finance Expert

Mike Cetera

Mike CeteraEditor in Chief, Forbes Marketplace U.S.

Personal Finance Expert, Editor in Chief, Forbes Marketplace U.S.

Rachel WitkowskiCorrespondent/Editor

Rachel Witkowski is an award-winning journalist whose 20-year career spans a wide range of topics in finance, government regulation and congressional reporting. Ms. Witkowski has spent the last decade in Washington, D.C., reporting for publications including The Wall Street Journal, American Banker and Bankrate. Ms. Witkowski's deep knowledge of government and policy aided a series of investigative stories that triggered congressional hearings on employee claims of discrimination at a federal agency and how indirect auto lenders were being reviewed by regulators.

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Rachel Witkowski

Rachel WitkowskiCorrespondent/Editor

Correspondent/Editor

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Updated: Dec 22, 2020, 9:30pm

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Do you want to buy a fixer-upper, but don’t have the cash to fix it up? Would a home addition give you the extra space you want without having to move, but you don’t have enough equity to get a home equity loan?

Whether you’re buying a home or refinancing one, an FHA 203(k) loan can help in situations like these. This government-backed home rehabilitation loan provides a guarantee to lenders so borrowers can get a mortgage for more than a home’s current value. You must use the extra money to repair and improve the home under an approved and carefully supervised plan.

How Does an FHA 203(k) Loan Work?

An FHA 203(k) loan works like a regular FHA loan in many ways. What’s different are the requirements related to using part of the loan to rehab your current or soon-to-be home.

You’ll need to find lenders that offer 203(k) loans. You can do this using the Department of Housing and Urban Development’s lender search tool. Check the box for “203(k) Rehabilitation Mortgage Insurance Program” at the end of the submission form. Once you’ve located the lenders you’re interested in working with, it’s a good idea to apply with several of them. This way, you’ll be able to compare loan estimates and get the best rate and lowest fees.

In addition to the usual mortgage underwriting requirements, you’ll need a two-part appraisal for a 203(k) loan. The first part shows the property’s current value, which can be based on an FHA appraisal or the net purchase price. The second part shows the property’s estimated value after the improvements you want to make with the loan.

You must use an FHA-approved appraiser, and the appraiser will need a copy of your improvement and repair plans. We’ll talk more about those plans in the next section.

When the loan closes, the lender will disburse the funds to cover the home’s purchase price or pay off the old mortgage. The renovation funds go into an escrow account. As the approved contractors you’ve lined up complete the home repairs and renovations in your plan, the lender will pay them from the escrow account. You’ll make payments on a single mortgage, and the principal will cover both the purchase price and the repairs.

The FHA limits how much you can borrow with a 203(k) loan. You can borrow a maximum of 110% of what the home will be worth after renovations. However, the loan amount can’t be more than the property’s pre-renovation value plus renovation costs, so your borrowing limit may be lower than 110%. You can finance up to $350 in loan origination costs and a percentage of borrower-paid discount points.

You also can’t borrow more than the FHA loan limit for your area. For 2020, the limit is $331,760 in most parts of the country. It reaches as high as $765,600 in high-cost areas.

Types of FHA 203(k) Loans

How much money will you need for repairs and improvements? Will any of them be structural? The answers to these two questions determine whether you’ll need a standard FHA 203(k) loan or a limited FHA 203(k) loan.

Standard 203(k) Rehabilitation Mortgage

Use a standard 203(k) loan if the home you’re financing needs at least $5,000 in repairs. You’ll have to hire an FHA-approved 203(k) consultant to inspect the property, create architectural exhibits and prepare a scope of work and cost estimate.

You can do the work yourself to save on labor costs. However, you can’t use the loan proceeds to pay yourself for your labor. The work must be completed to professional standards, so this isn’t the time to try hanging drywall after watching a few home improvement videos.

It’s a good idea to have contingency reserves in case the repairs go over budget, and you may be able to finance these reserves if doing so won’t put you over the maximum loan amount. You also may be able to finance mortgage payment reserves to pay your loan while the home is being repaired if you aren’t living in it.

Limited 203(k) Rehabilitation Mortgage

Use a limited 203(k) loan if you won’t be making any structural changes to the home. There’s no minimum repair amount for a limited 203(k) loan, but the maximum is $35,000. You don’t have to hire a 203(k) consultant, but you do have to create a work plan.

You’ll need to hire a professional contractor to prepare this plan, which includes itemized cost estimates for labor and materials. For work that the FHA calls “specialized,” you will need estimates from a licensed and bonded contractor.

You can’t use a limited 203(k) loan if the repairs will prevent you from occupying the home for more than 15 days or if the work will take more than six months to complete. You also can’t use this loan for landscaping or site improvements.

You can finance a contingency reserve fund if you want. However, it can’t be more than 20% of the repair and improvement budget.

What an FHA 203(k) Loan Can Be Used For

An FHA 203(k) loan can be used to repair and remodel these types of properties:

One- to four-unit single-family homes
An FHA-approved condo or townhome
A manufactured home, as long as you aren’t making structural changes
Mixed-use properties that are more than half residential, where the residential portion has one to four units

The home must be at least one year old, and you’ll need to live there for at least 12 months.

Here are some examples of the many repair and remodel expenses you can use the loan proceeds for, whether you’re using a standard or limited 203(k) rehab loan:

Repair or replace plumbing, heating, air conditioning or electrical
Repair or replace roofing
Make energy conservation improvements
Add or repair fences, walkways or driveways
Modernize the home
Make the home accessible for someone with disabilities

With a standard 203(k) loan, you also can make these types of changes:

Increase or decrease the number of residential units, as long as the final number is one to four units
Demolish the structure and rebuild a new home on the same foundation
Repair a damaged foundation
Add a garage
Add living space
Finish an attic or basement

Here are some examples of ineligible expenses for either type of loan:

Adding a pool
Creating an outdoor fireplace
Building a gazebo in the backyard and putting a hot tub underneath it
Constructing tennis courts in your backyard
Converting part of the property to a cannabis dispensary, or any other commercial use
Installing a satellite dish

Other costs associated with improving the property—such as permits, inspections, architectural and engineering fees and hiring a 203(k) consultant—can be included in your loan.

FHA 203(k) Qualifications

As a borrower, what qualifications do you need to get an FHA 203(k) loan? They’re the same as for a regular FHA loan:

Your credit score is at least 500 if you’re putting 10% down, or at least 580 if you’re putting 3.5% down
You’re not delinquent on federal debt (tax or otherwise)
You will live in the home you’re financing
You don’t want to borrow more than the FHA loan limit for your area
Your debt-to-income ratio isn’t higher than 43%, or 50% if you have a 580 credit score and plenty of cash reserves

FHA 203(k) Loan Advantages

Finance a home and renovations with one loan
Pay for repairs over time, not up front
Choose from a broad list of eligible repairs and improvements
Borrow up to 110% of the home’s post-renovation value
Get a lower interest rate than other financing options
Make structural, functional or cosmetic improvements
Finance up to six months of mortgage payments on a standard 203(k)
Enjoy generous credit score and down payment requirements
Get a fixed-rate or adjustable-rate mortgage

FHA 203(k) Loan Disadvantages

Borrower pays up-front and ongoing FHA mortgage insurance premiums
Long-term costs may be higher than other home improvement financing
Not for investors who want to fix and flip
Can’t borrow more than the FHA loan limit for your area
Loan requires extra paperwork and lender approvals
May be hard to find contractors with 203(k) bidding and paperwork experience
Smaller pool of lenders to choose from
Individual lenders may have higher credit score requirements
Loan approval can be slow

FHA 203(k) Rehabilitation Loan Statistics

203(k) loans closed October 2019 through September 2020 (FY 2020): 7,669
203(k) loans closed October 2018 through September 2019 (FY 2019): 2,165
Cities with the most FHA 203(k) loans in FY 2020 and FY 2019: Newark, Boston, Chicago
Region with the most FHA 203(k) loans in FY 2019 and FY 2020: East Coast
Lenders who closed the most 203(k) loans in FY 2020: LoanDepot (607), Homebridge (436), Home Point (345)
Lenders who closed the most 203(k) loans in FY 2019: Homebridge (621), LoanDepot (492), Home Point (322)