How to Get a 203k Loan in 6 Steps (And What Else to Consider As a Buyer)

What’s a 203(k) loan?

Many mortgage lenders will not finance the purchase of a home that needs significant repairs. The Section 203(k) program, by contrast, is specifically designed to provide funds to both buy and renovate, upgrade, and repair a home. This makes it ideal for homebuyers who can see the potential in properties that aren’t necessarily dream homes, 100% ready for occupancy.

A 203(k) loan is an FHA-backed rehab loan that lets you borrow money to pay for both the cost of the home and any needed repairs. It’s an excellent tool to gain large amounts of equity soon after buying the home. That’s because a home in need of repair will often sell for significantly less than it would be worth after those needed repairs are made.

For instance, a home that would be worth $300,000 in tip-top condition might sell for $250,000 as-is. With the help of a 203(k) loan for $275,000, a buyer could have enough money to purchase the home and pay for all the repairs. The result could be a home worth $300,000 that only cost the buyer $275,000. And that difference of $25,000 is home equity that now belongs to the new buyer.

The 203(k) loan also has some limitations. For instance, it’s not suited for flippers or investors who don’t plan to live in the home after the purchase. Navigating the 203(k) lending process takes longer and is more complex than other more common financing methods, so it requires patience and flexibility.

But for the right buyers, a 203(k) loan can be an effective and efficient way to finance a fixer-upper purchase.

How does a 203(k) loan work?

Here are some specifics around 203(k) loans and what buyers should know.

• Buyers can borrow enough to pay for the purchase price of the property and for repairs.
• The Limited 203(k) loan, formerly known as the FHA Streamline 203(k), is used for homes that need minor repairs. With this option, you can borrow up to $35,000 in cash for cosmetic and non-structural repairs above the amount borrowed to purchase the property.
• A Standard 203(k) is for homes that need major renovation or have structural issues. You have to borrow a minimum of $5,000 for repairs, and there’s no official limit on what proportion of the loan amount goes to renovations versus the actual purchase price of the home (though a HUD consultant will need to oversee the project and certain guidelines must be followed).
• A 203(k) loan can only be used to purchase a primary residence. That means the buyer has to live there full-time, usually for at least a year, before selling or renting it to another occupant.
• The total 203(k) loan amount can be either 110% of the home’s estimated value after repairs are done, or for the sales price of the home, plus whatever estimated repairs will cost — whichever amount is lower.
• Another cap on the loan amount is the regional FHA loan limit. The FHA sets this limit every year and varies by geography based on that area’s median sales price.
• Only lenders that have been approved by the FHA can offer 203(k) loans.
• Interest rates on 203(k) loans are as much as 1% higher than for other FHA mortgage loans.
• All work must be done by a professional, licensed, and bonded contractor. You can’t use a 203(k) loan to fund do-it-yourself repairs.
• All repairs must be planned, specified, and approved in advance.

Like borrowers who use other FHA loans, 203(k) borrowers have to pay mortgage insurance. This includes 1.75% of the loan amount paid at closing, plus additional monthly mortgage insurance payments for the lifetime of the loan.

There are two types of FHA 203(k) loans: Limited (formerly known as “streamline”)  and standard.

1. Limited 203(k) loans are for homes that need only cosmetic fixes, such as painting, carpet, bathroom remodels, or new appliances, as well as relatively minor required safety and health modifications, such as mold remediation.

2. Standard 203(k) loans can pay for more significant work, including fixing structural problems, adding water or sewer connections, or even moving the home to a new location.

All told, a 203(k) loan involves considerably more paperwork and upfront effort, as well as following strict guidelines, than other types of loans. But it can be worth it.

“I used it,” Forney says. As a “broke 25-year-old kid,” he explains, he used a 203(k) loan to buy a house that, among other problems, had a mold issue. He had the needed work done and sold it three years later for a sizable gain.

“I got the repairs done at a much lower cost than if I was paying for them secondhand from the seller, and got a much greater return from an investment perspective,” Forney says. “I love the product in that regard.”

Who is eligible for a 203(k) loan?

Any buyer who can qualify for an FHA loan can typically qualify for a 203(k) loan. These requirements include:

• You must be a U.S. citizen.
• Your credit score must be at least 500 for a down payment of 10% or higher, with 580 needed if you’re putting down less than 10%.
• You must be able to put at least 3.5% down on the home loan.
• Your debt-to-income ratio should not exceed 43%, including current debts plus future mortgage costs.

The main restrictions are related to the property, not the borrower. The key requirements are:

• The home has to be at least one year old (no new construction).
• The home can’t be too run-down if you plan to use a limited 203(k) loan — remember that $35,000 repair limit.
• The sales price and estimated repair costs combined can’t exceed the FHA loan limit for the region.
• The house must be a single-family home or condo, or a two- to four-unit multifamily property or manufactured home, although mixed-use properties with limited commercial use may be approved.
• The home must be occupied as the buyer’s primary residence for at least one year.

If you are buying a multi-unit property, you’ll need to live in one of the units. If you’re using a limited 203(k) loan, then the home has to meet minimum safety and health requirements.

Another stipulation of the limited 203(k) loan is that you have to live in the house while repairs are done. Of course, this means the home has to be suitable for habitation.

What types of repairs can you do with a 203(k) loan?

Not just any repair can be paid for with a 203(k) loan. The limited 203(k) loans are more restrictive, while the standard 203(k) loans allow more types of work to be done.

Limited 203(k) loans

Repairs that can be done using a limited 203(k) loan must meet the following parameters.

• Repairs can’t cost more than $35,000 in total.
• Changes can’t be structural, such as moving load-bearing walls.
• Adding new rooms isn’t allowed.
• Upgrades can’t be luxury extras, such as adding a pool, outdoor kitchen, or hot tub.
• Work must be completed within six months.

Here are some changes that are allowed with a limited 203(k) loan.

• Remedying health and safety hazards, such as lead-based paint (these repairs are required)
• Improving disability access
• Repairing or replacing roofs and gutters
• Replacing flooring
• Repairing or replacing decks and porches
• Finishing a basement
• Replacing appliances
• Remodeling kitchens and baths
• Improving energy efficiency
• Weatherizing
• Improving septic systems
• Interior and exterior painting
• Applying major landscaping repairs (minor landscaping repairs can’t be included)
• Improving the sewer and plumbing systems

Standard 203(k) loans

For a standard 203(k) loan, you’ll see slightly different parameters around the loan itself as well as repair requirements.

• The loan amount can’t exceed 110% of the property’s value after repairs, subject to the FHA’s local loan limits.
• A consultant from the Department of Housing and Urban Development (HUD) has to approve repairs and handle payments.
• Completed repairs must be inspected by a HUD-approved inspector.

Limitations (such as prohibitions against luxury add-ons) apply to both standard and limited 203(k) loans, but you can do almost any kind of repairs with a standard 203(k), including:

• Completing major repairs and alterations
• Moving load-bearing walls or otherwise altering the property’s basic structure
• Replacing or upgrading air conditioning and heating
• Adding a tornado shelter
• Landscaping and upgrading the site
• Moving a home
• Changing a home from single- to multi-family

With either loan, you can’t do non-permanent improvements, such as replacing furniture or installing satellite dishes.

One notable advantage of the standard loan is that you may be able to include up to six months’ worth of mortgage payments in the loan amount.

The pros and cons of a 203(k) loan

A 203(k) loan offers a unique opportunity to buy and renovate a home with a single mortgage, making it an attractive option for buyers looking to get their hands on a fixer-upper. With flexible FHA terms and the ability to finance repairs, this loan can help you save money and build equity quickly.

Let’s break down the benefits of a 203(k) loan:

While a 203(k) loan can be a great way to finance both the purchase and renovation of a home, it comes with extra steps and requirements compared to a traditional mortgage. Before deciding if it’s the right fit, consider the challenges that come with this type of loan:

If a 203(k) loan isn’t for you, you may be able to use a home equity loan or line of credit, cash-out refinance, or personal loan to pay for repairs on a home you are planning to buy or already own. Fannie Mae also has a HomeStyle Renovation mortgage that can work similarly to an FHA 203(k) loan.

Is a 203(k) loan right for you?

A 203(k) loan can be great for the right kind of buyer.

If you have extra time to spend finding a suitable home, lender, and contractors, and are detail-oriented enough to oversee the project approval and completion process, this could be a good way to finance a home purchase.

On the other hand, a 203(k) loan may not be good if you are in a hurry to move, lack the time or energy to cope with the added paperwork, or just want a home that’s ready to move into without requiring any repairs.

If motivation is the issue, it may help to understand that a 203(k) loan can be a smart financial move. “There’s a lot of friction in the process,” but “you can get a heck of an equity position if you do it right,” Forney says.

6 steps to getting a 203(k) loan

Every home, repair project, and borrower is different. But the process of getting a 203(k) loan does tend to follow some broad outlines. Here are the steps to getting a 203(k) loan.

1. Identify and get pre-approved by a 203(k)-friendly lender. Check HUD’s online search tool to find a local lender who’s done a 203(k) loan in the last year.

2. Locate a suitable property and make an offer, noting that you plan to use a 203(k) loan.

3. Depending on whether you use a limited or standard 203(k) loan, you may need to find a HUD 203(k) consultant to help plan the repairs.

4. Line up professional contractors who can provide written repair estimates.

5. Get an appraiser — the lender will order one — to determine the home’s value before and after improvements.

6. Close on the loan, take possession of the property, and start the repairs.

Part of the loan proceeds will pay the seller. The rest will go into escrow and be paid to the contractors as work is completed.

Some details will be different depending on whether you have a standard or limited 203(k) loan. For instance, a limited 203(k) borrower must occupy the home while repairs are done.

After moving in and starting work, you may still have to make updates. For instance, change orders are required when the requirements for completing a repair are different from what was originally envisioned.

Getting change orders approved by the lender can be time-consuming and frustrating. That’s one reason why it’s important to be thorough when preparing project estimates.

Ready to buy a fixer-upper?

Does a 203(k) loan sound like it would be worth the trouble? You always can make your homebuying process easier if you work with an experienced real estate professional. That’s even more relevant when doing a 203(k) loan.

“It’s a great tool when it’s used right,” Forney says. “But you have to work with an agent that knows how to work the process.”

Header Image Source: (Jonathan Borba / Unsplash)