What is a 203k Loan and How Does It Work?

Written by Banks Editorial Team
3 min. read
Written by Banks Editorial Team
3 min. read

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An FHA 203(k) loan is a mortgage product backed by the Federal Housing Administration that you can use to purchase a home and pay for renovations. It lumps the purchase price and home improvement costs into a single mortgage, and you make one monthly payment instead of two.

Home Renovation Loans

 
Learn how the RenoFi ReFi cash-out refinance home renovation loan allows you access up to 80% of your home’s projected value after renovation.

What is an FHA 203k Loan?

These rehab loans are geared towards prospective homeowners looking to purchase a fixer-upper and make upgrades without paying out of pocket. If you already own your home, you can also use an FHA 203(k) loan to refinance your existing mortgage and fund much-needed renovations. 

You can choose from the following FHA203(k) loan options: 

  • Standard 203(k) Loan: This loan product can be used to pay for renovations and structural repairs that cost more than $5,000 and $35,000, respectively. Before the project starts, the homeowner is required to bring a consultant from the Department of Housing and Urban Development (HUD) on board to monitor the project. 
  • Streamline 203(k) Loan: This loan can be used to cover renovations of up to $35,000, and the funds cannot be used to pay for structural repairs. 

Be mindful that these loans can be used for various home improvement projects. Still, luxury upgrades, like outdoor fireplaces, BBQ pits, satellite dishes, hot tubs and swimming pools are not allowable expenses. 

How Does an FHA 203k Loan Work?

FHA 203(k) loans are available as 15- or 30- year fixed-rate or adjustable-rate mortgages through FHA-approved lenders. The qualification criteria for these government-backed products are more lenient than what you’ll find with most renovation home loans. Plus, you’re allowed to use a portion of the loan proceeds to cover labor and materials associated with home improvement projects. 

When the loan closes, you’ll have 30 days to start the project. Furthermore, all work must be finished within six months, and payments are remitted to the contractor(s) from an escrow account established at closing. 

Do You Qualify for an FHA 203k Loan?

Review the eligibility requirements before deciding if an FHA 203(k) loan could work for you.

Credit Score

You may be eligible for a loan with a score as low as 500. However, most lenders prefer borrowers with a score of 580 or better. 

Down Payments

The minimum down payment is 3.5 percent if you have a score of at least 580. But you’ll need 10 percent down if your score is between 500 and 579. 

Debt and Income

There are two debt-to-income (DTI) ratios to consider: 

  • Front-end DTI: It is the percentage of your gross monthly income spent on housing costs and should not exceed 31 percent. So, if your gross earnings are $7,000 per month, your monthly mortgage payment should be no more than $2,170.
  • Back-end DTI: It is the percentage of your gross monthly income spent on minimum monthly debt payments, including your mortgage. Lenders typically want to see this number at or below 43 percent. For example, if your monthly gross earnings are $6,500, the total amount spent on your outstanding debt obligations and mortgage should not exceed $2,795.

If you have good or excellent credit, the lender could approve your application with a higher DTI. 

Loan Amounts

The FHA loan limit is $420,680 in most areas. However, it goes up to $970,800 in cities with a higher cost of living. 

Home Renovation Loans

 
Learn how the RenoFi ReFi cash-out refinance home renovation loan allows you access up to 80% of your home’s projected value after renovation.

Residency and Citizenship Status

These loans are offered to U.S. citizens and non-U.S. citizens who are permanent legal residents with valid Social Security numbers who can provide proof of eligibility to work in the U.S. 

Occupancy Requirements 

You must be purchasing or refinancing your primary residence to qualify for an FHA 203(k) loan. Second homes and investment properties are ineligible. 

Advantages and Disadvantages of FHA 203k Loans

FHA 203(k) loans have their share of benefits and drawbacks to consider. 

Pros of FHA 203k Loans

  • You could get approved for a loan with a competitive interest rate, even if you have less than perfect credit. 
  • The minimum down payment requirement is relatively low. 
  • You’ll streamline the repayment process with a single loan product. 
  • You can cover temporary housing costs during the renovation.

Cons of FHA 203k Loans

  • You’ll pay a mortgage insurance premium upfront, along with monthly mortgage insurance premiums over the life of the loan. 
  • You’re prohibited from using these loan products to buy and upgrade investment properties. 
  • The timeline for renovations is limited to six months, and you may have to hire a HUD consultant to oversee the project. 
  • There are restrictions on the types of home improvements you can complete.

RenoFi as an Alternative to FHA 203k Loans

Perhaps an FHA 203(k) seems like a good fit for your financial situation. Before you find an FHA-approved lender and begin the application process, consider a RenoFi Loan to fund the purchase of your next home and the renovations or to refinance and improve your current home. 

You can get a fixed or variable rate loan from a credit union in the RenoFi network for up to 95 percent of your home’s after-renovation value. Loan amounts range from $20,000 to $500,000 with repayment terms of up to 20 years. 

Even better, you’ll get the loan proceeds at closing, and there are no required draws or inspections. Plus, you’ll generally pay lower closing costs, have more time to complete your projects, and there are no restrictions on the types of improvements you can make to your home. 

View your potential borrowing power today by using RenoFi’s loan calculator. It only takes a few seconds to explore loan options, and there’s no credit check to get started. 

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All data provided by the Home Mortgage Disclosure Act, at cfpb.gov updated Dec, 19
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