For many borrowers, an FHA 203(k) loan is the best way to get a mortgage. The reason being is that the government insures these loans, making them far easier to obtain. An FHA 203(k) loan allows borrowers to either purchase a home or renovate a home.
Therefore, an FHA loan 203(k) is often compared to a construction loan. The loan is excellent for people with low credit scores and low down payment savings. Alternatively, some people refer to these loans as a purchase plus improvements mortgage.
How does an FHA 203(k) loan work?
The loan encourages low- to middle-income families to purchase homes that aren’t in the most excellent condition. These houses are often in older communities and need urgent repairs. The loan enables individuals to purchase a home and renovate the home via an adjustable-rate mortgage or a fixed mortgage.
In most circumstances, lenders are unwilling to provide a mortgage for homes in poor condition. Of course, these homes are often not on par with standard living conditions. However, because the government backs FHA 203(k) loans, lenders are far more confident about giving mortgages on homes needing repairs.
What are the various types of 203(k) loans?
There are two types of 203(k) loans — the limited 203(k) and the standard 203(k). Note that these loan options only apply to borrowers looking to make the home their primary residence. In turn, house flippers and real estate developers will not qualify for either loan.
- Limited 203(k) – This type of loan is perfect if borrowers need minor work on the home. For example, the loan does cover structural work, which may include adding new rooms or landscaping. However, the home must also be livable during the entire construction process. As a result, the maximum borrowing amount is $35,000.
- Standard 203(k) – This type of loan is ideal for borrowers needing extensive repairs. The minimum borrowing amount on a standard 203(k) is $5,000, and there is no cap on repair costs. This loan will cover various repairs including plumbing, heating, air conditioning, kitchen remodeling, and flooring work. However, the loan doesn’t cover extravagant repairs such as swimming pools, etc.
How can I qualify for a FHA 203(k) loan?
You can get an FHA 203(k) loan via a bank or a credit union. Either way, these loans are accessible for many borrowers. Not all lenders will offer FHA 203(k) loans, but many do. It’s important to note that borrowers still need to obtain home insurance on the property when they use this loan. Here are some requirements for an FHA 203(k) loan:
- Credit score – Borrowers tend to require a credit score of at least 500 to qualify for an FHA 203(k) loan, but some lenders may ask for a higher credit score
- Down payment – Lenders will want a minimum down payment of 3.5% on an FHA 203(k) loan. Of course, the larger the down payment, the better! If your credit score is between 579 and 500, you will have to place a 10% down payment.
- Loan limits – The FHA 203(k) loan does have a limit, depending on your location. As a result, you will have to research the loan limits in your county. Your desired home might be too expensive for an FHA 203(k) loan.
Here are some other requirements:
- You will need to live in the home that you decide to finance
- Your debt-to-income ratio cannot be higher than 50% if you have a credit score of 580 and lots of cash reserves
- You cannot be a delinquent on federal tax
Pros and cons of FHA 203(k) loans
As with any loan, borrowers need to assess various pros and cons before they sign any documents. Here are some of them:
Pros of getting an FHA 203(k) loan
- You don’t need a high credit score – Lenders don’t require a solid credit score when applying for an FHA 203(k) loan. Therefore, these loans are an option for anyone with financial troubles or first-time buyers. As a result, you can get an FHA 203(k) loan with credit scores lower than 620. In contrast, many conventional lenders will require a 620 credit score as the absolute minimum.
- You don’t need a large down payment – Some loans require a large down payment, but an FHA 203(k) loan isn’t necessarily one of those. A considerable benefit of an FHA 203(k) loan is the ability to obtain assistance from close friends, families, and employers when making your down payment. Many conventional lenders don’t allow borrowers to receive contributions to their down payment.
- Various housing options – Borrowers can apply for an FHA 203(k) loan on multiple types of housing such as single-family homes or duplex homes. In contrast, many conventional lenders are strict about the houses you can apply your loan towards.
- You can get cheaper monthly mortgage insurance with low credit scores – Monthly mortgage insurance can be a massive annoyance to many borrowers. It can add up and present unwanted monthly costs going forward. However, when you obtain an FHA 203(k) loan, you can get cheaper monthly mortgage insurance costs (even with low credit scores).
Cons of getting an FHA 203(k) loan
- Lower loan limits – The Federal Housing Administration sets its loan limits every year. Therefore, this could impact how much you can buy with FHA 203(k) loans, particularly in expensive areas. Generally speaking, these loan limits are 65% of an area’s conforming loan limits.
- You’re limited to primary residences only – You can only get this type of loan to buy a house you’re going to live in. So, if you’re looking for a vacation home or property investment, you will have to obtain a conventional loan instead.
- You can’t do the work yourself – What if you’re a builder or an expert at repairing houses? Unfortunately, when you obtain an FHA 203(k) loan, the loan doesn’t allow you to do the repair work yourself.
- Loan approval can be very slow – If you’re looking to move fast and get a mortgage as soon as possible, you might want to reconsider getting an FHA 203(k) loan. These loans can sometimes take up to six months to obtain, a time frame that may not work for many borrowers.
An FHA 203(k) loan is an excellent option for homebuyers looking to hire others to work on their homes. It’s also a terrific option for anyone with low credit scores, first-time buyers, and borrowers who can’t commit to large down payments. However, there are many pros and cons of an FHA 203(k) loan to consider.
As with any type of mortgage, it’s essential to talk with your lender to determine if this is the best option for you. You could always find an FHA 203(k) loan consultant to guide you through the process.