Guide To FHA Home Loans: FHA 203(k) Construction & Remodeling Mortgage

FHA 203(k) Mortgage Lets You Wrap Renovation Costs Into Your Purchase Mortgage

Buying or refinancing a home with an FHA 203(k) mortgage offers a few advantages if your property isn’t already perfect. That’s because you can add renovation costs into your purchase or refinance loan.

Choose the FHA 203(k) mortgage for larger projects — buying a fixer-upper or refinancing your home while also funding major renovations.

Another option is FHA’s “Title 1” loan, which allows you to finance your smaller project. It isn’t tied to a refinance or home purchase. For either of these loans, you need to work with an FHA-approved mortgage lender.

How The FHA 203(k) Loan Works

Financing home improvements with FHA can be better than getting a home equity loan for your improvements. That’s because home equity loans require home equity, and this product does not. It allows you to add the construction costs to your loan, and uses the “improved” value of the property to calculate your loan-to-value ratio.

FHA 203(k) Loan: Benefits And Downsides

Conventional Vs. FHA: What's Better For You?

You can use the 203(k) mortgage to finance your home purchase and add improvements at the same time. Or you can get a 203(k) refinance and include your improvements in that loan.

The improvement refinance is kind of like a cash-out refinance, but you don’t need equity, and you don’t incur the risk-based surcharges that you pay with cash-out refinancing.

You can choose the standard 203(k), which works for renovations costing more than $35,000, or the Limited program for smaller projects. The standard program requires that you work with an approved 203(k) consultant to work out the costs of the upgrades.

Eligibility

FHA eligibility is not especially rigorous. But if you are eligible you’ll still need to meet FHA’s underwriting standards to get loan approval.

To apply, you must:

• Finance a house that is at least one year old;
• Borrow a total amount that is less than the FHA’s maximum loan amount for your area; and
• Have at least $5,000 for rehabilitation or renovation costs.

Your proposed improvements must also meet eligibility guidelines. Luxury items won’t qualify, so your bathroom fireplace and outdoor hot tub may not cut it. But here are some projects that can be financed with a 203(k) loan:

• Structural changes or rebuilding
• Modernizing and improving function
• Eliminating health and safety hazards
• Improving / updating your home’s appearance
• Reconditioning or replacing plumbing systems
• Installing a well and/or septic system
• Adding or replacing roofing, downspouts, or gutters
• Adding or replacing flooring
• Making site improvements or adding landscaping
• Making the home accessible for disabled
• Green renovation or energy conservation projects

These projects are especially useful for bringing an old home up to code.

Buying A Fixer-Upper

Here are the steps you’ll complete when buying a fixer-upper with an FHA 203(k) 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.

• Find a lender approved to do 203(k) loans. Get several mortgage quotes so you can be confident that you’re getting a good deal.
• Apply for your home loan and get a pre-approval letter.
• Find a property. Make sure that your offer contains language indicating that you need a 203(k) loan in order to complete the purchase. Note that your maximum loan amount calculation s different for purchases. Check out HUD’s Maximum Mortgage Worksheet for more information.
• Find an FHA 203(k) consultant, if your improvement costs will exceed $35,000. This person will arrange for a detailed proposal from licensed contractors. It will contain the scope of the work to be done and a detailed cost estimate.
• Find a contractor to write an estimate of work needed and materials required. You aren’t allowed to do the work yourself unless you are a professional builder.
• The lender, after giving you the okay, will get your home appraised (with and without improvements).

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 funds to the contractor as work is completed.

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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.

How Much Can You Refinance?

The minimum cost for improvements is $5,000. Your maximum refinance loan amount (subject to FHA loan limits) is the lowest of these three calculations:

• Your current mortgage(s) on the property plus rehabilitation and certain closing costs;
• The current property value plus rehabilitation costs; or
• 110 percent of the improved value multiplied by FHA’s 97.75 percent maximum loan-to-value ratio. (This is 96.5 percent for purchases.)

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 203(k) Is Today's Home Improvement Loan

The lender orders two appraisals. One determines the “as-is” or current property value, and the other provides the “improved value.” Imagine that you owe $300,000 on a property worth $310,000. You need $50,000 for improvements, your closing costs are $5,000, and the improved value of the property would be $350,000. Your loan amount would be the lowest of:

• $300,000 + $50,000 + $5,000 = $355,000
• $305,000 + $50,000 = $355,000
• $350,000 x 1.10 x 0.9775 = $3716,338

So in this case, your maximum loan amount is $355,000. Your FHA mortgage will pay off your old loan and include extra to cover your closing costs and $50,000 in renovations.

The Limited (Formerly Streamline) 203(k)

FHA’s Limited 203(k) program lets you wrap up to $35,000 in renovation expenses into your mortgage to repair, improve, or upgrade your house. You don’t have to work with a consultant.

You will, instead, work with your contractor to file a “work plan” with your application.

The FHA Streamline Refinance Program: Let's Review

Don’t Want to Refinance? Consider An FHA Title 1 Loan

If you like your current mortgage (maybe your current loan has no mortgage insurance, or you’ve got an untouchable low rate), or you don’t need a huge loan for your home improvement, an FHA Title 1 loan may be your best bet.

You can borrow up to $25,000 for as long as 20 years on approved improvements. Some of the advantages of Title 1 Loans are:

• Low closing costs (because your loan amount is lower)
• Easy processing
• If your loan is less than $7,500, all you need is a signature—there is no lien recorded against your home
• You can do the work yourself if you are qualified
• Manufactured homes are eligible for Title 1 loans (a max of $17,500 for 15 years)

Keep in mind that FHA 203(k) loans are funded by lenders, not by HUD. Private lenders set interest rates and loan fees. So, compare quotes from several competing mortgage lenders to find the best mortgage rates, just as you would for any other home loan.

What Are Today’s Mortgage Rates?

Mortgage rates today are amazingly low. They had been trending up, and then they fell back down. To get your best rate, contact several lenders and compare. Choose the one with the best deal for you.