The FHA 203k loan is a particular loan product that allows a buyer to purchase and renovate a home with a very small down payment. It is very similar to the FHA loan in which a buyer can purchase with a minimum down payment of 3.5% plus closing costs. The loan is ideal for a buyer that is willing to renovate a property that has several minor issues that need to be fixed. It also works very well during negotiations if the buyer finds issues during a home inspection that the seller does not want to repair– they can ask the seller for a reduction in the sales price and perform the repairs themselves after settlement.
Although the 203k loan can be used to perform major renovations (up to and including a complete gut rehab or building a new home on an existing foundation), we generally do not recommend this for inexperienced buyers that do not have construction experience.
There are two types of 203k products (at the time of this writing): Standard and Streamline. Some of the main points of each include:
Standard:
- $35,000 minimum repair cost
- FHA consultant needed
- Draw schedule may be much different than the Streamline product and the contractor may need to front more money for the project
Streamline:
- $35,000 or less in repairs
- No FHA consultant needed
- No minimum repair cost
- Typically 2-3 draws
Similarities between both:
- The interest rate for a 203k is generally higher than a standard FHA loan because of the extra risk involved for the lender.
- Although a lender may only require the buyer to have 3-6 months of reserve funds, it is our strong opinion that you should have much more (12+ months in most cases) set aside in the event that your rehab goes over budget. Most rehab projects do not finish on time or on schedule.
- The 203k loan can’t be used on a property that is less than one year old – but CAN be used for any 1-4 unit property that you’ll be occupying as your primary residence.
Potential downsides:
- The greatest risk in a 203k loan is the contractor. The contractor must not only have great workmanship but they also need to have good budgeting skills because they will be fronting money for your project. If your contractor runs out of money in the middle of a project and you don’t have enough funds to cover the difference of what is needed, you have a big problem and can be stuck paying a mortgage on an incomplete house that you are unable to sell or rent.
- If your rehab uncovers repairs or structural issues that you didn’t forecast in the beginning, you have to come up with the money yourself if it exceeds your construction budget and contingency funds. It’s very important to plan for this in the beginning and it’s always worth paying extra for inspections up front (structural engineers, plumbing line scopes, home inspections, etc.) to prevent yourself from missing any major issues.
For Standard 203k loans, an FHA consultant is required to approve your scope of budget and scope of work for the project. The FHA consultant acts as a representative of the bank and they come with their own opinions and suggestions about the work that needs to be done with the property and the potential cost. In some cases, the FHA consultant may require you to do much more work than you originally intended to– and this can make or break a transaction.
It is very important to work with an FHA consultant that is recommended by someone you trust and to review your scope of work with them before they come out to physically inspect the project.
Written by: Rodney Ross
Edited by: Lia Martin
March 31, 2022