When we purchased our first multifamily home in Providence, RI in 2017, we decided to take advantage of a loan product called the FHA 203k loan. This type of loan helped us complete a couple of the major renovations needed on the house. Over the couple months of the mortgage application process and then for a time after closing, we learned the pros and cons of the FHA 203k. This article will give an overview of the FHA 203k loan program, pros and cons, tips and discuss whether or not I would recommend this type of loan to buyers.
by Christian Scully
What is an FHA 203k loan?
The FHA or Federal Housing Administration is a government agency that insures loans made through FHA-approved lenders throughout the US. FHA loans offer some great benefits. FHA loans are generally easier to qualify for, providing a great option with borrowers who are lower income, have higher debt to income (DTI) ratios and/or lower credit scores. For these borrowers, the interest rates are generally lower than conventional loan products. FHA loans also allow the borrower to make as little as a 3.5% down payment.
The FHA 203k loan is a type of FHA loan that also includes funds for renovations. The borrower closes on one mortgage, that includes enough to purchase the home and additional funds to cover any repairs or improvements needed. There are two types of 203k loan: the Limited and the Standard. The Limited 203k is the easiest way to go and can provide up to $35,000 in funds for any improvement that is non-structural. Anything beyond that and the borrower would need a Standard 203k loan. Let's look at some of the advantages of using a 203k loan.
What are the advantages to using an FHA 203k loan?
By considering an FHA 203k loan for your purchase, you could potentially widen your search parameters to include homes that need renovating. In a market with low-inventory, having more potential homes to consider can help. Without having the cash on hand to complete those renovations, the FHA 203k makes it possible. Borrowers are able to borrower more than the purchase amount. The renovation funds are then placed in an escrow account (just a holding account that the lender manages), from which all contractors will be paid for their services. Even though you are getting funds for the purchase and funds for the renovations, borrowers just have one closing that takes care of it all. That eliminates the needs to seek an additional loan for renovations after purchasing a home.
Borrowers who might find typically purchase a home and delay necessary renovations due to lack of funding are able to take care of big projects immediately. If the home is a 2-4 unit multifamily and the extra units are going to be rental units, then getting them renovated and filled with tenants as fast as possible is crucial. Dealing with contractors can be challenging, and it is definitely possible to be scammed or taken advantage of. With the FHA 203k loan process, contractors are paid 50% at the start of the project and 50% when the project has been completed and inspected by a representative for the lender. That nearly guarantees that the work will actually get done and will meet FHA standards.
Quick Pros for the FHA 203k loan:
- Access funding for necessary or desired repairs, borrow funds based on the future (after repair) value of the home.
- Only pay for one closing, as opposed to seeking a second loan to pay for renovations after moving in.
- Take care of big renovation projects immediately, as opposed to waiting until you've raised funds.
- All work is inspected before payments are issued, so there is a near guarantee that the work will get completed.
- 203k loans allow you to shop homes that need repairs, opening up more options in the market.
Real Estate +
Thoughts, ideas, lessons-learned, inspiration, how-tos and more from a journey to own and invest in real estate, and helping borrowers navigate the mortgage process as a licensed loan originator.