Have you found a home that you love, but it’s in bad shape? The 203k loan may be a perfect way to purchase a home that is a little rough around the edges.
The FHA 203k rehab loan has become a popular loan choice in today’s market where many homes need a little, or a lot, of TLC.
The 203k loan allows a buyer to finance the purchase price of the house and the cost of needed or wanted repairs – all with one loan. No scrambling around before closing trying to repair the home so the bank will lend on it. No pounding the pavement looking for a 2nd mortgage to finance repairs. No living with a leaky roof for five years while you save up the money to fix it. A 203k loan can take care of these repairs and more with one loan transaction.
Two Types of 203k Loans
It’s important to note that there are two sub-types of 203k loans: the full 203k, and the Streamline 203k.
In this article we will focus mainly on the Streamline 203k loan, since it is the most popular type, and will suit most homeowners who are looking to buy a fixer-upper. Additionally, many more lenders offer the Streamline 203k program.
Here are some basic differences between the 203k sub-types:
- No structural changes allowed
- Maximum $35,000 can be financed for repairs
- Structural changes are allowed. In fact, the home can be leveled and rebuilt. (If a home is demolished, a portion of the existing foundation system must remain in place.)
- No maximum repair limit as long as the entire loan is below FHA’s maximum loan amount for the region.
Streamline 203k Program Overview
This loan is perfect for someone who already qualifies for an FHA loan, but ends up finding a house that won’t qualify for FHA financing as-is. The 203k loan helps the borrower open up one loan to pay for the purchase price of the home, plus the cost of repairs. Buyers end up with one fixed-rate FHA loan, and a home that’s in much better shape than when they found it.
The most important aspect of the Streamline 203k is the amount of money you can finance for repairs, which maxes out at $35,000.
However, be careful that your bid does not go much above $30,500. This is because there are extra “soft costs” – inspection fees, extra origination fees, and contingencies – that eat up about $4,000 to $5,000 of your allowed amount. See our 203k Fees section below and download the 203k Worksheet that shows these “soft costs.”
The 203k loan sets up an escrow account for the repair costs. This allows the loan to close before construction has begun. This is important because most sellers won’t allow construction to be done prior to the sale closing. Nor is it a good idea for buyers to sink money into a home that isn’t theirs yet. This is often a temptation because many homes are in need of repairs in order to obtain financing.
The 203k loan establishes an escrow account which holds the money so that the contractor can be paid ½ of the repair costs up front, and ½ when all the work is complete. This ensures that the contract has enough money to start, but doesn’t bail on the project prior to completion.
The repair costs are determined by a finalized, set-in-stone bid prior to closing of the loan. For repairs totaling more than $15,000, a 203k inspector makes sure the work is complete to FHA standards when all the work is complete. If the total cost of your repairs is less than $15,000, you won’t need to have the completed work inspected.
The home being purchased must be at least 1 year old. This makes sense, because, normally homes less than a year old don’t need significant rehabilitation. In addition, the home must be purchased as the buyer’s owner-occupied residence, just like with any FHA loan.
Besides having a repair escrow account, the 203k loan works a lot like a standard FHA purchase loan. Most people who qualify for standard FHA can qualify for a Streamline 203k loan.
Why Do a 203k? Is it Worth the Hassle?
The 203k loan can give the buyer an advantage to come out on top as far as equity. Many homes in need of repair are discounted more than those repairs actually cost. The reason is that the number of buyers who want to take on a fixer-upper is significantly lower than the amount of buyers who want a move-in ready home. Also, most types of financing are not available for these homes. The seller either needs a 203k buyer, or a cash buyer. Sellers have to reduce their price significantly to attract these buyers.
The lower price means that often, the buyer can purchase the house, pay for repairs, and have instant equity. Each home and situation is different, but with some help from your real estate agent and contractor, you can determine the future value of the home compared to the total cost to acquire and repair the home.
Streamline 203k List of Allowable and Non-allowable Repairs
Many buyers are surprised at what the 203k allows them to do. This loan can be used solely for cosmetic purposes, not just when a home is in severe disrepair. You can remodel a kitchen or bathroom, adding amenities like granite countertops and high end appliances. The repairs don’t even need to be necessary to make the home eligible for FHA financing. In other words, if a home has a functional kitchen, but it’s outdated, the buyer could use a 203k loan to remodel cabinets and countertops, upgrade appliances, and the like, with a 203k loan.
Keep in mind that repairs can’t be structural when using the Streamline 203k. This means foundations, load-bearing walls, etc. may not be altered.
If the property you are looking at need structural repairs to qualify for financing, you will need to use a full 203k instead of a Streamline 203k, or find a different property.
Acceptable Streamline 203k Repairs:
- HVAC, Plumbing & Electrical
- Disabled person’s access improvements
- Lead-based paint stabilization
- Mold abatement/termite repairs
- Asbestos removal (must be done by a licensed asbestos expert)
- Basement finishing/remodeling (non-structural only)
- Septic system/well repair
- Flooring (not including sub floor which is considered structural)
- Kitchen/bathroom remodels
- Appliance purchase and install
203k Non-Allowable Repairs
There are some amenities that FHA deems as “luxury” items or items not permanently affixed to the home, which are not allowed:
- Barbecue pits
- Exterior hot tubs, saunas, spas
- Outdoor fireplaces (although indoor fireplaces are allowed)
- Swimming pools
- Satellite dishes
- Tennis courts
- Alterations to improve commercial use of the property
The 203k Loan Process
Here’s a breakdown of the general 203k loan process:
- The buyer finds a home that they like, but it’s in disrepair.
- The buyer talks to their loan professional about the FHA 203k. Although they were pre-approved for regular FHA or conventional financing, they most likely need to be re-approved for a 203k loan. The loan professional issues another pre-approval based on the estimated purchase price and repair costs, plus other 203k-related fees.
- The buyer will find a general contractor to work up a detailed bid of all repairs. When the bid is complete, the buyer and lender receive a copy.
- An appraisal is ordered, which will reflect the future appraised value of the home. The final bid is used by the appraiser to determine determines what the home will be worth once all work is complete.
- The lender submits the bid, appraisal, and all borrower income, credit, and asset documentation to underwriting.
- The underwriter issues an approval, usually with conditions needed from the buyer and the contractor.
- Once all conditions are received, the buyer signs final loan documents. The lender funds the loan. Part of the loan funds are put into an escrow account, which holds the money for the repairs.
- 50% of the repair costs are issued to the contractor up front. The other 50% will be paid to the contractor when all work is complete.
- The contractor has six months to complete the work.
- When the work is complete, the remaining repair costs are issued to the contractor.
- The escrow account is closed out. The buyer has a home that is 100% complete, and one loan with one interest rate that covered the original purchase price and all repair costs.
Who Can Qualify for a 203k?
Generally, most people who qualify for a standard FHA loan can qualify for a 203k loan, provided the 203k loan amount isn’t significantly higher than the buyer’s original pre-approval. The lender may charge a higher interest rate or higher fees for the 203k loan, so make sure with your loan professional that you still qualify.
203k Breakdown of Costs
Here are some extra fees you can expect to pay with a 203k loan:
- 203k Inspection fees: 2 inspections at $150 each. These ensure that the work is being done to FHA standards.
- 203k Title update fee: $150. This fee protects the title in case the builder puts any liens on the property for disputed pay regarding the construction work on the home. If any liens are placed on the home, this fee insures the FHA loan will remain in first position on title.
- 203k Supplemental Origination Fee: 1.5% of the rehab costs, or $350, whichever is greater. This fee is charged for the extra work involved in setting up and managing the escrow account.
- 203k Contingency Reserve: This is usually 10% of the final repair bid, but can be as high as 20%. This is held in the 203k escrow account in the case of cost overruns on the project.
For a sample breakdown of all fees, see the HUD-92700 section below.
What If I Exceed the Repair Cost Limit?
If it appears you will exceed about $30,500 in repairs, see if any of your repairs qualify for the Energy Efficient Mortgage (EEM) program. If so, your lender may allow you to exceed the 203k limit in the amount of the EEM eligible costs, provided they are under the EEM limit, typically $8000.
If your repairs do not qualify for EEM and your bid is over the 203k limit, you will have to remove repair items from your bid. You are not allowed to bring cash in at closing to pay for additional bid items out-of-pocket.
There is no minimum repair cost for a Streamline 203k. However, it may not be cost-effective to pay the extra 203k fees for just a few hundred dollars’ worth of repairs.
203k and Condos
Typically, 203k loans are for single family homes, but they are allowed for condominiums as well. For condos, the work is allowed on the interior only, and no more than 4 other units in the condo complex can be undergoing 203k repairs at the same time.
203k Construction Period
The contractor must certify that work will begin within 30 days of loan closing and must be completed within 6 months. Since the Streamline 203k is for non-structural repairs, the contractor may need to certify that the borrowers will not be displaced for more than 30 days during the repair period.
Maximum Mortgage Amount
The maximum mortgage amount is the same for 203k as for standard FHA loans. Check HUD’s website for the maximum amount for your county.
In addition to this limitation, the 203k loan amount must not exceed:
- The purchase price plus rehab costs, less the 3.5% down payment
- Or, 110% of the expected market value once all work is complete, less the 3.5% down payment
For instance, let’s say a home is worth $100,000 before repairs and the borrower wishes to finance in $20,000 in rehab costs including fees. The maximum base loan amount before upfront mortgage insurance is:
- $120,000 – 3.5% down payment= $115,800
If the appraisal states the home will only be worth $105,000 after all repairs are done, the maximum loan amount is based on 110% of the future appraised value:
- $115,500 (110% of $105,000) – 3.5% down payment = $111,457
The HUD-92700 “203k Worksheet”
As part of the 203k process, you will need to sign the FHA 203k Worksheet, also called the HUD-92700. This form is a breakdown of all loan costs, 203k fees, purchase price, repair bid amount, final loan amount, etc. Your lender will provide you with this form.
What is the Down Payment Requirement on a 203k?
The down payment is the same as a standard FHA. You must put down 3.5% of the total purchase price plus repair costs.
What are the Requirements for the 203k Bid?
One of the most challenging aspects of a 203k loan is getting the contractor to work up a proper bid. Many contractors have never supplied a repair bid for the purposes of 203k financing, so they are often surprised at the requirements. Before getting a bid for 203k work, make sure your contractor is willing to work and re-work the bid until it’s perfect. If you contractor seems wary, find another contractor. An incomplete bid can kill your 203k transaction.
A bid may not change nor can repair costs increase after loan closing. Make sure your contractor has supplied a solid bid and has not underbid the project in any way. It’s better to overestimate the bid. Any money not used for repairs is applied back to your loan principle after the work is complete.
Here’s a list of items generally needed on the bid:
- Contractor’s name, address, phone number, and current license number
- Buyer’s name
- Property address where the work is to be done
- Permit costs, if any
- Bid to state that work will begin within 30 days of loan closing and all work will be done within 6 months of closing
- Contractor’s acknowledgement that he/she will receive 50% of the repair funds at loan closing and the other 50% when all work is complete
- Statement that the buyer will not be displaced from the home for more than 30 days
- Labor and materials must be broken out to separate line items on the bid
- Tax must be broken out on the bid
- The final bid amount must match the amount on the 203k Owner/Contractor agreement.
- Buyer and Contractor signature and date
It’s best to have just 1 or 2 contractors on the job, because you’ll need separate bids for each contractor. Getting all required documentation from multiple contractors can prove very time consuming.
However, you will need additional contractors for electrical/plumbing/mold remediation if the general contractor is not specifically licensed in these areas. For instance, a general contractor who only has a contractor’s license cannot do even minor electrical work on a 203k project.
Download our Bid Checklist Spreadsheet PDF Sample and Editable Spreadsheet to help you and your contractor(s) to understand the exact bid requirements and other documents needed. This spreadsheet is especially helpful if you have multiple contractors on your project.
What Items do I Need from the Contractor?
In addition to a correct bid, here are some things your contractor may need to provide. Your lender may require more or less documentation depending on their guidelines.
- Current license
- Liability insurance, errors and omissions insurance, and a bond
- Contractor’s resume showing work experience
- Workman’s comp insurance if the contractor has employees or hires sub-contractors
- Written business references stating the contractor is in good report with past clients
- Contractor’s portion of the 203k Homeowner/Contractor agreement
Additional 203k forms
In addition to the bid, you’ll need to acknowledge and sign these forms:
- HUD-92700 203k Worksheet (provided by the lender)
- FHA 203k Homeowner/Contractor Agreement (must match bid dollar amounts and one is needed from each contractor)
- Self Help Agreement (if doing work yourself and are qualified)
- 203k Borrower’s Acknowledgement (provided by the lender
For editable versions of these documents, and more downloadable forms, see our Downloadable Mortgage Forms page.
Can I Refinance and Repair My Home with a 203k?
Yes. The 203k refinance works just like the purchase program. Instead of the purchase price being on the 203k worksheet, the “purchase price” will essentially be the cost to pay off the existing loan. Generally, the repair costs are added to the amount of the existing loan balance to determine the total new loan amount. However, the new loan amount can’t exceed 110% of the future appraised value.
No cash may go to the borrower with a 203k refinance. All funds must go to the contractor doing the work and the current lender to pay off the existing mortgage.
The 203k appraisal
The appraiser will need the final repair bid to determine the future appraised value of the home. Be sure you have decided on all repairs, and all those repairs are in the bid. If you change your mind about repairs after the appraisal is complete, it may result in delays due to appraisal re-writes (and upset appraisers).
Can I do the FHA 203k Work Myself?
In some cases, this is allowed. Lenders might require documentation that you are qualified to do the work, and can do it in a timely manner. Usually this means that you are licensed as a contractor or in a similar profession, since it’s tough to otherwise document that you’ve had enough experience to do the job.
If you can prove you’re qualified, you can only finance the cost of the materials, and you will still need to provide a detailed bid for materials you plan to purchase.
The 203k Consultant
A 203k consultant is not required for a Streamline 203k. If you need a full 203k loan, you will hire a HUD-approved consultant.
Streamline 203k loan: The Right Fit for Many Buyers
Even though the 203k involves a few more leaps and hurdles than the standard FHA loan, it can be a great tool to buy a home that has potential. Don’t be scared away by the rules and requirements, because your lending professional should know the ins and outs of the 203k loan.
To be on the safe side, ask your loan officer how many 203k loan he or she has done in the past year, and how many the processing staff has done. Experience on the part of the lender can save a lot of time and headache for the borrower. Find a loan officer who has done 2 or 3 of them in the past year, at least.
With a little help from your lender, and knowing what to expect, you can purchase a home and fix it up per your needs and wants. In a few short months you could be in your fixed-up and touched-up dream home.
Tim Lucas (NMLS #118763), Contributor/Editor
Tim Lucas is a mortgage writer with over 11 years of experience as a loan originator, processor, and team manager. Get a live rate quote for your home purchase or refinance at MyMortgageInsider. Visit Tim on Google+ and Twitter.