What is 203k Renovation Home Loan and how does it work?

FHA 203k loan is designed to finance the needs of homeowners when it comes to buying an old, damaged or even “inhabitable” house. Obviously, an old house costs much less than a brand new one but the flip side of it is that this abode can eventually cost an owner much more due to massive renovations that are needed to be done.

Besides, not many lenders are willing to grant a mortgage for buying an old house and it’s totally explainable: a house often goes as collateral for a home loan. In a case the borrower fails his mortgage repayment; his home is supposed to be foreclosed by a bank and sold to compensate the lost loan.

But if the home is in a bad (or even uninhabitable) state, the lender takes increased risks that collateral doesn’t match the value of the loan. That is why FHA 203k loan often comes along with the main Mortgage loan as an additional financing for the house.

How to get a 203k loan?

Just because a 203k loan is backed by the government, it is easier to qualify for it, but one must only deal with the FHA-approved list of lenders. That is how the government stimulates people to buy older houses and renovate them. Any repairs that are required with such a house could be paid from the Renovation Loan.

Renovation Loan

But “easier” doesn’t mean easy in terms of eligibility. Below we will describe the criteria the borrower has to meet in order to qualify for the government-backed 203k loan.

What can you do with the money borrowed under the 203k loan?

Basically, a 203k loan covers all types of renovation works needed and moreover, the lender often gives about 15%-20% above the required amount just in case the final cost of all works will exceed the initial calculations (according to the contract with the Company that will do all renovation works).

money

It needs to be said that the borrower has to write up the contract with such Company before applying for a loan, and the Contract must contain the full list of works to do with the exact cost of each type of renovation.

The Renovation loan covers the following types of renovations:

  • New ceiling and new flooring. If the house requires the full floor replacement or new ceiling (including an inbuilt electric system in it), the 203k loan covers it fully.
  • New appliances. This includes the kitchen equipment (the oven, the cooking panels, etc.) the washing machine and a dryer, the refrigerator and a freezer, the heating system, and air conditioner.
  • All kinds of exterior works: changing or making new siding panels, painting or removing the plague, etc.
  • The works related to removing mold and old painting on the walls, especially the lead-based painting that was popular in older times.
  • Repair of cracked walls – inner and outer walls of the main building and its additional constructions.
  • Plumbing, replacement of the bathroom and all water systems.
  • Replacement of the porch, deck and the overall building reconstruction to make it “habitable”.

Renovation loan

Taking into account that the 203k loan includes a “contingency reserve” which is about the 20% above the main amount, the homeowner can complete all reconstruction works at the highest level of quality, without worrying about the lack of funds. It is also highly beneficial for the lender, as the value of the refurbished and renovated house increases dramatically. Therefore, in a case of the house’s foreclosure, the bank will be able to sell it quickly and get its money back.

The minimum amount of any type of FHA 203k loan is $5.000. The ceiling (the FHA mortgage limits for 2017) could be defined individually, depending on various factors (the scale of interior or exterior works, the credit score of the borrower, etc.).

Eligibility for a 203k loan

Despite the FHA-approved lenders may set slightly different criteria for a 203k loan eligibility, there is a general list of requirements that potential borrower must meet.

lenders

  1. A Borrower must provide the bank with the official document that proves he has a stable source of income. The amount of income must be enough to make monthly payments on the loan.
  2. Credit score of the borrower must be at least between the “good and excellent”.
  3. The borrower must hire a HUD consultant that helps to make the analysis of the home’s renovations scale and the approximate cost of it.
  4. The borrower must submit all required documents for the 203k loan.
  5. The property that is supposed to be bought and renovated must meet the FHA requirements, such as: a house must have a good foundation even if the whole building was torn down and other requirements (see the full list on the FHA website).

The practical benefits of getting FHA 203k loan

  • The biggest advantage and the main reason of why people prefer getting the 203k loan is that with the help of that money anyone can buy a house that costs not much (due to its bad state) and renovate it to eventually turn it into a really expensive property that borrowers would not have been able to afford if it was new.

FHA loan

  • If the Renovation loan goes as a part of the main Mortgage Loan, the down payment for it will be minimal and affordable for anyone.
  • The interest rate is very low in comparison with a standard homeowner’s loan.

Still, there are some cons of a 203k loan!

First of all, not all types of property you are going to buy will qualify for this loan and there are several strict criteria for it.

FHA loan

Second, without a professional HUD consultant, you (or a renovating company) may underestimate the volume of the works needed, so it may turn out that the money you have borrowed is not enough. Moreover, the renovation of the house may cost you times more than the building’s actual value on the market (a lot depends on the area where the house is located).

And finally, even if you need to replace just a kitchen equipment or an air-conditioning system that will cost you about 2-3 thousands of dollars, you won’t be able to borrow less than $5.000, as this is a minimum required amount of a 203k loan to borrow.