Often associated with fixer-upper houses, the 203(k) loan is one of the many financing options available to someone buying a property. Knowing whether or not it is right for a property purchase means appreciating how such a loan can be used.
What is the 203(k) Loan?
Per HomeBridge Financial Services, the 203(k) Loan is a “rehab loan” or “renovation loan” that allows those who own a home to “finance both the purchase or refinance along with the renovation of a home through a single mortgage.” It’s overseen by the Federal Housing Administration (FHA), and the loan is backed by the federal government. Since it’s a renovation loan, it gets used for homes that need repair from damage or general maintenance and restoration as a result of age and wear and tear. The Mortgage Reports tells readers that the loan “is available to both buyers and refinancing households, and combines the traditional “home improvement” loan with a standard FHA mortgage, allowing homeowners to borrow their renovation costs.”
So, the properties that a purchaser is considering that might not be up to the purchaser’s standards may be fixed through the 203(k) loan.
FHA’s website says that “Section 203(k) offers a solution that helps both borrowers and lenders, insuring a single, long term, fixed or adjustable rate loan that covers both the acquisition and rehabilitation of a property. Section 203(k) insured loans save borrowers time and money. They also protect the lender by allowing them to have the loan insured even before the condition and value of the property may offer adequate security.”
How Can the 203(k) Loan Be Used?
203(k) loans give the borrower the money toward the home, plus the additional money to repair and renovate the areas that need attention.
From the HUD website, repairs made under the term “rehabilitation” for the 203(k) “may range from relatively minor (though exceeding $5000 in cost) to virtual reconstruction: a home that has been demolished or will be razed as part of rehabilitation is eligible, for example, provided that the existing foundation system remains in place.” These loans can be used to renovate only a portion of a residential property that has other (non-residential) uses, and may be used to turn a single-family home into a multi-family home, making the property ideal for rental.
Per HUD, the list of “Eligible Activities” is as follows:
- structural alterations and reconstruction
- modernization and improvements to the home’s function
- elimination of health and safety hazards
- changes that improve appearance and eliminate obsolescence
- reconditioning or replacing plumbing; installing a well and/or septic system
- adding or replacing roofing, gutters, and downspouts
- adding or replacing floors and/or floor treatments
- major landscape work and site improvements
- enhancing accessibility for a disabled person
- making energy conservation improvements
Legalwiz gives a list of the kinds of properties that may be used:
- Existing homes that are at least one year old.
- Condos—if they have been FHA approved for financing for owner occupied. The loan will cover only the portion of the rehab that is not already taken care of by the existing HOA.
- Single family, duplexes, triplexes and quadruplexes. In addition, you can rehab a single family into a multifamily (up to 4 units) or downsize a multifamily (make a quadruplex into a duplex or triplex for example).
- Mixed-use properties such as a combination of residential and commercial as long as only the residential portion is the only part bring renovated under the loan. Please note that there are limitations depending on the % of other use vs. residential and the number of floors that the building has.
- Tear-downs as long as the original foundation remains.
- An existing home that is being moved to a new foundation.
What Are the Requirements for Such a Loan?
According to The Balance, the restoration of the home must be completed within six months, and the funding for the project gets put in escrow.
You must borrow at least $5,000, and there are maximum limits set by the FHA that vary by location. For most people buying a single-family home that is not extravagant, you’ll fall into these limits. For smaller projects, the Streamlined FHA 203(k) allows you to borrow less (with an easier process). You can borrow enough to finance 110% of the home’s projected value after improvement. Appraisers will review your plans and take the forecasted value of your home into account.
What Should Readers Know About Such a Loan?
The Balance also lists several “basics” that borrowers should know. Among those is the question of where the borrower wants to live. If they don’t wish to be dwelling in the property as it undergoes renovation, then requesters will want to consider the procurement of funds for housing. The article says that extra money may be borrowed to “cover rent or your existing mortgage for up to six months.” It also says that the project should be completed within six months, and that funds are put in escrow.
In a blog titled “Why Are 203k Loans So Terrible?”, home loan servicer Amerifirst dispels misunderstandings about the 203(k) Loan. For the amount of time it takes to close the loan, it does address collective customer complaints—citing that there’s a difference between a Streamlined 203(k) Loan for smaller renovation efforts as opposed to the Full 203(k) Loan. It also notes that the loan should not take “significantly longer” than others to close, implying that the familiarity of lenders with the 203(k) Loan may expedite the closing process.
From their website, HUD requires that properties receiving funds through the 203(k) Loan “meet certain basic energy efficiency and structural standards.”
The 203(k) Loan and Multi-Family Houses
In a separate blog article, AmeriFirst speaks to a relationship between the use of the 203(k) Loan and multi-family homes. If one wishes to purchase a multi-family home (like a duplex or a triplex, for instance) and intends to use the 203(k) for repairs or remodeling, the purchaser may do so. Use of such a loan in this capacity requires that the purchaser use the home as their primary residence, and that the property can have up to four units, so that three other occupants may help pay for the mortgage through their rent.
This blog offers the “Required FHA 203(k) Improvements,” which include the following:
- Additions to existing structure
- Rehabilitation of existing structure (weather-stripping, caulking, insulation, etc.)
- Replacement systems (heating, ventilating, and air conditioning systems)
- Smoke detectors
Separately, it offers “Eligible FHA 203(k) Improvements” that include the following:
- Elimination of health and safety hazards
- Structural alterations and reconstruction
- Changes for improved functions and modernization
- Changes for aesthetic appeal
- Reconditioning or replacement of plumbing, heating, air conditioning, and electrical systems
- Installation of well and/or septic system
- Roofing, gutters and downspouts
- Flooring, tiling and carpeting
- Energy conservation improvements
- Major landscape work and site improvement
- Improvements for accessibility to the handicapped
But just like the former AmeriFirst blog, other outlets of real estate information mention an association of difficulty for the 203(k) Loan. Smarter Landlording’s contributing writer calls the loan ”troublesome” and “complex,” with the writer telling the story of her use of the 203(k) Loan to purchase a multi-family home, saying that the loan’s requirements for testing for lead-based paint, mortgage-payment reserves, and payment processes weren’t understood by her in the beginning. She also corroborated the claim of more-than-usual paperwork for the loan (recommending access to a copy machine, a scanner, fax machine, and printer) and stated that at one point in her renovation process, she “had the lender, the investors, the contractor, and the inspector all in disagreement over one issue.” The writer specifically said that she wouldn’t use the loan again, but that she didn’t regret her decision as it ultimately resulted in a positive experience.
If readers are looking to avoid a similar outcome, knowing about such issues in advance—and how to avoid them—may be critical to getting the best possible experience out of the 203(k) Loan. Asking direct, targeting questions before pursuing the loan as well as knowing the full extent of what the construction might require helps put together a more comprehensive plan for the 203(k)’s use.
Others offer a more positive assessment of using the 203(k) Loan in such a way. Writing for Annie Mac Home Mortgage, Jeff Onofrio says the loan is “absolutely great” and that the loan allowed him to get a $600,000 repair cost for a four-unit property (saying the amount available for borrowing goes up as the number of units increases for a multi-family home. He also reminds readers that the loan is not for investors, and stresses that the three months of reserves are necessary for a three or four-unit property, and that the rental payments must be able to sustain the mortgage on its own.
The FHA 203(k) Loan can be used to improve dramatically the conditions of a property, be it through small repairs or full-scale renovations.
There are many requirements for the loan than range from how much money can be requested (with a minimum or maximum limit set, depending on the property). The loan can be used to renovate a multi-family home, which gives the chance for renters to pay off the loan so long as the one financing the loan is willing to consider the property their primary residence for at least one year.