FHA 203k loan qualifications

203(k) loan-graphicYou've found the ideal home, but it's not without flaws. The roof needs to be replaced, and the furnace is making a clunking noise. The homeowner is elderly and doesn't have the money to make any repairs. You've spoken with a number of lenders, but none of them can offer you a mortgage because of the property's condition. So, what are your options? A FHA 203 (k) loan is the answer.

The FHA launched the 203 (k) program in 1978 to allow homeowners to finance property repairs as part of their mortgage loan terms, in an effort to improve the quality of neighborhoods and communities across the country. It enables a home buyer to obtain an FHA-backed mortgage on a home that requires repair, allowing them to acquire their home and complete the repairs/improvements after the transaction is completed.

Since the 1930s, the Federal Housing Administration (FHA) has insured mortgages to assist Americans in realizing their dream of home ownership. It limits the fees that mortgage lenders can charge home buyers while allowing buyers to make smaller down payments.

Homes purchased through the 203 (b) program must meet FHA standards for livability and sustainability to help protect home buyers. In other words, before a home can be sold, some repairs and upgrades must be made.

FHA 203(k) loan limits

Typically, mortgage lenders will only lend up to the present appraised value of a property. Any necessary repairs or renovations must subsequently be financed or paid for in some other way by the home buyer.

However, under the 203 (k) program, a borrower can now acquire a single mortgage loan to cover both the purchase and rehabilitation of a property. In other words, the loan amount can be more than the property's existing appraised value, assuming that the included repairs will swiftly improve the market value.

Keep the following in mind when looking at FHA programs:

  • The borrower must be the owner of the purchased property or a nonprofit organization. Investors are not allowed.
  • A one to four-unit owner-occupied dwelling only.
  • Condominium units that have been approved by the FHA are permitted.

FHA 203 (k) loans is offered in two varieties:

Nice 2 story houseThe Limited 203 (k) (also known as the streamline) excludes structural changes, landscaping, and other similar expenses, and has a maximum repair limit of $35,000.

Standard 203 (k) is a full rehabilitation that allow for structural changes, additions, landscaping, architect, and engineer contracting, and the employment of a 203 (k) consultant, among other things.

For both the limited and full versions, the maximum loan amount is the maximum FHA mortgage limit for the area where the property is located.

Contractors are paid through a series of draws requested from the lender for both the FHA 203 (k) Standard/Full/Rehab and the FHA 203 (k) Streamline (max 2 for the Streamline and max 5 for the Standard/Full/Rehab).

The overall renovation does not include exterior repairs.

Appraisal guidelines, seasoning regulations, credit qualifications, and other traditional FHA requirements still apply.


Frequently asked questions about the 203(k) loan program

Q. Is there a time limit on the rehabilitation construction period?
A. Yes, the Rehabilitation Loan Agreement includes three conditions relating to the completion of work on time.

  1. The work must commence within 30 days of the agreement's execution.
  2. The work must not be suspended for more than 30 consecutive days prior to completion.
  3. The work must be performed within the time period specified in the agreement (but not more than six months); the lender should not permit a time period longer than that needed to finish the work.

Q. What happens if the borrower defaults on the agreement's terms?
A. The lender may refuse to release funds from the Rehabilitation Escrow Account in the future. The money left in the account may be used to decrease the principal balance on the mortgage. Additionally, the lender may declare the mortgage debt due and payable.

Q. Is a contingency reserve usually required by HUD/FHA to handle unforeseen cost increases?
A. In general, yes. Cost estimates for houses over 30 years old with renovation expenses over $7,500 must include a contingency reserve. The reserve must be at least ten (10) percent of the rehabilitation cost, but not more than twenty (20) percent in the event of substantial restoration. If utilities were not turned on during the inspection, a minimum of fifteen (15) percent is required.

Q. Is it possible to modify the architectural displays, including the cost estimate, once the mortgage loan is closed?
A. Yes. Prior to starting renovations, the Department of Housing and Urban Development or a direct endorsed lender must authorize the modifications.

If the modification has an effect on the dwelling's health, safety, or needs, the contingency reserve may be utilized to cover the cost of the alteration.

If, however, the borrower's health, safety, or need for the housing is not impacted and the cost of the house increases, the borrower must contribute to the contingency reserve fund to cover the cost rise.

If the modification results in a lower rehabilitation cost, the difference will be deposited in the contingency reserve fund; if it remains unused, it will be used as a mortgage prepayment after construction completion.

Q. What if the cost of rehabilitation rises over the course of the rehabilitation? Is it possible to raise the 203 (k) mortgage amount to meet the extra expenses?
A. No. This demonstrates the critical importance of carefully choosing a contractor that can correctly estimate the cost of upgrades and execute the restoration on time and on budget.

Q. Can a Section 203 (k) mortgage be an ARM?
A. Yes. Only owner-occupants are eligible for an Adjustable Rate Mortgage. An ARM is not available to investors or non-profit organizations.

Q. Is it possible to incorporate mortgage payments (PITI) into the mortgage?
A. Yes, in accordance with the Standard (k) program. Up to six months' worth of payments may be included in the mortgage if the home is deemed uninhabitable during the renovation period.

Q. Is it necessary to hire a contractor to do the work?
A. No. However, if the borrower wishes to do work or serve as a general contractor, they must be competent to do so and perform it promptly and in a workmanlike way. It is critical that the work be completed within the timeframe specified in the Rehabilitation Loan Agreement (signed at closing). A borrower who does his own labor may be compensated solely for the cost of the supplies. Savings may be used to offset cost overruns or make further improvements.

Q. Can the borrower benefit from cost reductions associated with rehabilitation?
A. No. However, the savings may be used to reduce cost overruns on other work items or utilized to enhance the property. If the cost savings are not transferred to the mortgage principal, the mortgage payments will stay unchanged, since the loan has already closed. To take advantage of the cost reductions, a Change Order must be filed and authorized by the lender.

Q. Is it possible for the borrower to provide their own job specifications and cost estimates?
A. Yes, but only for those participating in the Streamline (k) program.

Q. Is just one assessment needed to determine the property's "post-rehab" value?
A. Yes, as long as the lender is satisfied that the contract sales price is acceptable for buy transactions and that the current debt on the property is low enough to ensure the homeowner maintains a healthy equity position.

Mortgage lenders must request, and the purchaser (s) may be charged for, an as-repaired appraisal on all Section 203 (k) transactions involving HUD-owned-REO properties.

Mortgagees also have the option of obtaining an updated as-is appraisal if the M & M contractor's as-is appraisal is more than six months old.

However, if the underwriter thinks the sales price is equivalent to the as-is value, an as-is assessment is not required.

Q. Is it possible for us to reside on the property while the work is being done?
A. You may reside in the house during construction with a streamlined 203 (k) project.
You cannot reside in the home during construction with a typical 203 (k) project.

Q. How can I determine if my 203 (k) project is a "streamlined" or a "standard" one?
A. Loans for renovations under $35k with NO structural repairs are simplified. Standard: any remodeling that requires structural repairs or if the total cost of the project exceeds $35,000.

Q. How long is the work expected to take?
A. It is determined by the scope of labor needed. The average turnaround time is 30 to 45 days (from start of construction to final sales clean).

Q. How is the contractor compensated?
A. Although each transaction is unique, the industry norm is a 50% deposit at the time of closing through a two-party check made out to the buyer and contractor from escrow. After the work is finished, the lender pays the outstanding amount (and, if required by the lender, inspects).

Q. How do I go about completing my paperwork?
A. Your final completed form will be included in your closing package. When the work is completed, you will submit it to your lender for final approval along with your contractor invoice. Your documentation is complete after the bank has examined or signed off on it.