Section 203(k) of the National Housing Act provides insurance against borrower defaults on mortgage loans issued by FHA-approved lenders so that borrowers can purchase and rehabilitate a property. The same 203(k) program can insure refinance loans used by borrowers to rehabilitate their existing home.
Why use an FHA 203(k) Loan
When borrowers buy a “fixer-upper” home, typically they have to navigate a complex process of multiple loans to acquire and make improvements to their new home. These interim loans frequently have high interest rates, short repayment terms, and a ballon payment due at the end of the repayment period. Section 203(k) loans were created to address this special situation.
The FHA 203(k)-insured mortgage loan simplifies the purchase and rehabilitation process by providing a single, long-term mortgage that covers both the purchase and rehabilitation of the borrower’s home. These loans can be both fixed and adjustable rate mortgage mortgages. FHA loans covered by the 203(k) program benefit the borrower by saving them time and money. Lenders benefit because the loan amount for purchasing and rehabilitating the property is insured before the rehab has been performed greatly reducing their risk.
More About the 203(k)-Insured Loan
In order for a home to be eligible for the 203(k) program, it must be at least a year old. The planned rehabilitation must cost at least $5000, and the value of the property must still fall within the FHA loan limits for the area where the property is located. The property’s value is determined by:
- The pre-rehabilitation value of the property plus the rehabilitation cost, or
- 110% of the appraised value of the property after rehabilitation,
whichever is less.
When an FHA 203(k)-insured loan is closed, one portion of the proceeds is used to pay the seller (or in the case of a refinance, to pay off the existing mortgage). The remaining proceeds from the loan are place into an escrow account to fund the rehabilitation as it is completed.
It should be noted that additional fees above and beyond those of typical FHA 203(b) loans may be assessed by the lender for the additional work they incur. These fees are might include a higher than usual appraisal fee, supplemental origination fees, and additional architectural document preparation and review fees.
Rehabilitation Work Covered Under 203(k)
A wide range of improvements can be covered under the Section 203(k) program. These loans can be used for everything from minor rehabilitation (as long as the cost is at least $5000) to practically rebuilding the entire property as long as the original foundation remains in tact. These loans can be used to pay for converting a property of any size to a 1, 2, 3, or 4 unit property.
Some types of improvements eligible to be covered under the program are:
- structural changes and reconstruction
- modernization of the home
- elimination of health hazards
- elimination of safety hazards
- upgrades that improve the property’s appearance
- fixing or replacing plumbing
- adding or replacing roofing, guttering, and downspouts
- adding or replacing floors and/or floor treatments
- major landscaping
- making the property accessible for a disabled person
- improvements to increase the energy efficiency of the home
Who can Apply?
As long as a borrower’s debt-to-income ratio is such that they can afford the monthly mortgage payments, they are eligible to apply.