How FHA 203(k) loans work

FHA 203(k) loans are for properties that need upgrades and repairs

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FHA home loans are known for having relatively low credit score and down payment requirements, but many people don't realize there is more than one type of these loans. While the most common — the FHA 203(b) loan — is meant for typical purchases and refinances, consumers can also use an FHA 203(k) loan for properties that need upgrades or rehabilitation.

FHA 203(k) loans are just as easy to qualify for as traditional FHA loans, and they let homeowners access cash they can use for home repairs. If you're curious about the terms and conditions of FHA 203(k) loans, how applicants can use the funds for repairs and other fine print that applies, read on for an overview of how these loans work.


Key insights

FHA 203(k) loans are available to applicants with credit scores as low as 580 with a 3.5% down payment, and those with credit scores as low as 500 can qualify if they put 10% down.

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Where the Standard FHA 203(k) loan is for homes that need extensive upgrades and repairs, the Limited 203(k) mortgage is for properties that need less than $35,000 in updates.

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With both types of FHA 203(k) loans, home repairs must be completed by qualified contractors. With Standard FHA 203(k) loans, repairs must also be approved by a HUD-approved consultant chosen by the lender.

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What is an FHA 203(k) loan?

FHA 203(k) loans are a type of mortgage backed by the government and offered through traditional lenders. Homes must be at least one year old to qualify for this type of FHA financing, and loans can be used for a purchase or the refinance of a property someone already owns.

Because FHA 203(k) loans are for properties that need updates and repairs, applicants can use additional funds built into the home loan for rehabilitation. These home loans can also be used for a range of different property types, including single-family homes, homes with two to four units, townhomes, HUD-owned properties and manufactured homes titled as real estate.

Note that there are two main types of FHA 203(k) loans — the Standard 203(k) loan and the Limited 203(k) mortgage.

Standard 203(k) loan

The Standard 203(k) program is the most commonly used since it can include enough funding to pay for major renovations, structural repairs to damaged properties and expensive energy-efficient upgrades. In fact, these loans don't list a maximum amount of money consumers can borrow for rehabilitation. That said, the total value of the home still has to fall within FHA mortgage limits based on the area where the property resides.

Costs required for rehabilitation and repairs must be at least $5,000 for this type of FHA 203(k) loan. Note that repairs with this type of loan must be completed by eligible contractors and approved by a HUD-approved consultant chosen by the lender.

Limited 203(k) mortgage

The Limited 203(k) mortgage is geared toward properties that need fewer renovations and upgrades. This is because borrowers with this loan type can only finance up to $35,000 in rehabilitation costs. These loans also come with no minimum on how much you can borrow for updates and repairs.

Because of the borrowing limit for renovations with this loan, it's best for homes that need non-structural improvements like minor kitchen remodels, fresh paint, new flooring or a new HVAC system.

While repairs and updates made with this type of loan need to be made by qualified contractors, they don't need to be inspected by a HUD-approved consultant after the fact.

FHA 203(k) loan eligibility and requirements

FHA 203(k) loans don't have any income caps that limit who can qualify. However, FHA mortgage limits do set a cap on how much individuals can borrow. In 2024, FHA loan limits for a one-unit property are set at $498,257 throughout most of the country and $1,149,825 in areas of the United States with a high cost of living.

FHA 203(k) loans also have other loan-to-value limits that apply. With purchase transactions that use the Standard 203(k) loan, for example, the FHA will only insure the lesser of either the as-is property value plus the cost of financeable repair and improvement costs,  financeable mortgage fees, financeable contingency reserves, and financeable mortgage payment reserves or 110 percent of the after-improved value. With condominiums, a lesser amount of 100 percent of the after-improved value applies.

Low credit score requirements make these loans easier to qualify for than a conventional mortgage. Applicants with a credit score of at least 580 can qualify with a down payment of 3.5%, whereas those with credit scores as low as 500 can qualify with a down payment of at least 10%.

FHA 203(k) loans require homeowners to occupy the property as their primary residence, meaning these loans cannot be used for investment properties. Homeownership counseling isn't a requirement for this type of loan.

What can an FHA 203(k) loan be used for?

Eligible improvements that help a property qualify for an FHA 203(k) loan vary but may include energy-efficient updates, structural improvements, the addition of a garage, new appliances, the installation of a new roof or gutters or improvements to accessibility for persons with disabilities.

According to Jim Bopp of Planet Home Lending, the array of use cases for these FHA loans make them a good choice for people who want to improve an imperfect home in the perfect location or to increase home value through major renovations, kitchen upgrades, a new bathroom or appliances or updates to current mechanical systems.

"You can even use it to add space for a growing family, whether that’s more kids or a parent moving in," Bopp said. "Seniors can use 203(k) to adapt their homes to make it easier to age in place."

In areas where homeowner’s insurance premiums are rising due to natural disasters, Bopp added that homeowners can use an FHA 203(k) loan to improve their home’s defenses against storms, earthquakes or floods.

That said, there are also some improvements you can't use funds from these loans for. Specifically, Bopp said you cannot use FHA 203(k) loans for investment properties since lenders require you to occupy the home as a primary residence. An exception can come into play if you're buying a home with multiple units and you plan to live in one of them.

Other uses of loan funds that are prohibited include renovations aimed at adding luxury features like swimming pools, hot tubs, saunas or extravagant landscaping, he said.

Pros and cons of an FHA 203(k) loan

Before you opt for this type of home loan, you should know about the main advantages and disadvantages. Consider the following before you apply for a FHA 203(k) loan to purchase a home that needs rehabilitation.

Pros

  • Afford the repairs you need for a home you truly want: The fact you can wrap the cost of rehabilitation into these loans is a major advantage. "Imagine finding a home with perfect bones but in need of some TLC," Bopp said. "That's where a 203(k) loan steps in, combining the purchase price with renovation costs into one manageable loan.”
  • Convenience and price: "Juggling separate loans for purchasing and renovating can be a hassle and expensive," said Bopp. "The 203(k) loan simplifies this by wrapping everything into a single loan, typically at a lower interest rate than financing improvements via a home equity loan, a credit card or a personal loan."
  • Potential to build equity: Whether it's modernizing the kitchen, adding an energy-efficient HVAC system, or expanding the living space, upgrades may increase your home equity. This is especially true if you locked in a property with a competitive purchase price.
  • Low down payment and credit requirements: FHA loans are known for their easy credit requirements and down payment requirements as low as 3.5% of the purchase price. This makes these loans easier to qualify for than many alternative home loans.

Cons

  • Lenders may be limited: Because these home loans aren't used as often as FHA 203(b) loans, some lenders aren't as versed in how they work. "This isn't your standard mortgage, and it takes a lender with a certain level of expertise and experience to navigate these waters smoothly," said Bopp.
  • FHA loan limits apply: FHA 203(k) loans are subject to FHA loan limits, so they won't work for luxury properties.
  • Consultants need to approve work: With Standard FH 203(k) loans, repairs must be approved by a HUD-approved consultant chosen by the lender.

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    FAQ

    What is the maximum amount that can be borrowed with an FHA 203(k) loan?

    FHA loan limits apply with these loans. In 2024, limits for a one-unit property are set at $498,257 throughout most of the country and $1,149,825 in high-cost-of-living parts of the U.S.

    Are there any restrictions on the types of renovations that can be financed with this loan?

    According to the U.S. Department of Housing and Urban Development, FHA 203(k) loans cannot be used for home improvements for commercial use or luxury items. The latter can include upgrades like tennis courts, hot tubs, swimming pools or gazebos.

    Can an FHA 203(k) loan be used to purchase a fixer-upper as an investment property?

    You can only use a FHA 203(k) loan for a primary residence, so these loans do not work for investment properties.

    Bottom line

    FHA 203(k) loans let homeowners wrap the cost of certain home renovations into their mortgage without having to give up the benefits that come with this government-backed loan program. These home loans are known for their less stringent credit and low down payment requirements, which make it easier for more consumers to stop renting and get into a home that suits their needs.

    That said, this mortgage program does have some additional hoops to jump through, including a requirement to meet with a HUD-approved consultant who's chosen by the mortgage lender if you're planning renovations that will cost more than $35,000. This consultant will create a list of upgrades you may need to do, and they'll provide you with a cost estimate for those updates. With the Standard FHA 203(k) loan, the consultant must approve the updates and renovations for all your loan funds to be released to you.


    Article sources
    ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
    1. U.S. Department of Housing and Urban Development, "Let FHA Loans Help You." Accessed March 5, 2024.
    2. Federal Deposit Insurance Corporation, "203(k) Rehabilitation Mortgage Insurance." Accessed March 5, 2024.
    3. U.S. Department of Housing and Urban Development, "203(k) Rehabilitation Mortgage Insurance Program Types." Accessed March 5, 2024.
    4. U.S. Department of Housing and Urban Development, "Buying a House That Needs Rehabilitation or Renovating Your Home?." Accessed March 5, 2024.
    5. U.S. Department of Housing and Urban Development, "Maximum Mortgage Limits." Accessed March 5, 2024.
    6. U.S. Department of Housing and Urban Development, "The Section 203(k) Loan Program." Accessed March 5, 2024.
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