What is an FHA 203(k) Construction mortgage loan?
203(k) construction loans, also called 203(k) rehab loans or FHA Section 203(k) Construction Loans, are a type of mortgage loan optimized for home improvement and refurbishment.
If you need to do major repairs to your home or wish to purchase a new home that will require major renovations before becoming livable, a 203(k) Construction Loan may be the right choice to help you finance your home repair needs.
203(k) construction Loans are different from most home loan types in that they don’t necessarily need to be taken out at the time of a home purchase.
203(k) loans can either be taken out when repairing an existing home, or they can be borrowed when a home is purchased as if it’s a mortgage loan.
There are nuances of taking either route, which we will cover soon, but overall, 203(k) loans are very flexible as long as you will be spending the borrowed funds on home improvement.
Once you are approved for a 203(k) loan, you can borrow up to $625,500 in the most expensive markets.
However, the specifics of maximum and minimum borrowing guidelines depend on what type of 203(k) loan you will be utilizing.
Here are the FHA Loan Limits for San Diego San Diego County:
- 1 Unit Property - $612,950
- 2 Unit Property - $784,700
- 3 Unit Property - $948,500
- 4 Unit Property - $1,178,750
Although these are the typical FHA loan limits, how much money you can get through a 203(k) loan depends on several factors.
If you want to know the specifics, then check out our post that goes into further detail about the loan limits for 203(k) loans.
Types of 203(k) Loans
While 203(k) construction loans are a loan category of their own, there are two distinct types of loan which fall under the umbrella of 203(k) loans, each with their own specific guidelines.
Streamlined 203(k) Loans
The first type of 203(k) loan, called “streamlined” 203(k) loans, help homeowners and purchasers quickly find financing for less extensive projects.
As the name suggests, streamlined 203(k) loans require relatively little paper work and can be quickly processed.
However, the maximum borrowing limit is $35,000, making these types of loans ideal for smaller and less expensive projects.
While the projects that can be financed with a streamlined 203(k) loan must be less expensive by definition, that doesn’t mean that this type of loan can’t help you make major improvements on your home.
Here are a few types of projects which can be financed quickly and easily with a streamlined 203(k):
- Accessibility improvements related to disability and mobility.
- Roof repair and replacement where no major structural work is needed.
- HVAC repair or replacement depending on the type of system your home uses.
- Exterior projects like patio or porch installation or repair.
Minor remodeling that doesn’t require major structural work.
If you need a loan to cover home repairs up to $35,000, the streamlined 203(k) is one of your most convenient options on the market.
Standard 203(k) Loans
Whereas streamlined 203(k) loans are specifically targeted at smaller projects, standard 203(k)’s can cover just about any home repair, especially big repairs.
Standard 203(k) loans require a lot more paperwork than the streamlined version and can be harder to manage from an organizational standpoint.
However, the tradeoff for more paperwork is that standard 203(k) loans can finance projects up to $625,000, with maximum borrowing amounts changing from state to state and leaning higher where property values are high, as is the case with San Diego real estate at $612,950.
This higher borrowing limit makes much more extensive projects possible.
The standard 203(k) is very flexible and can be used for most kinds of home repair and remodeling.
However, the FHS notes a few instances when a standard 203(k) is required, due to the more extensive nature and unexpected costs associated with larger remodeling projects.
Here are the home repair scenarios where the FHA requires a standard as compared to a streamlined 203(k) loan:
- Relocation and repair of load-bearing walls.
- Large home additions, including the addition of new rooms.
- Extensive property landscaping expected to exceed $35,000 in costs.
- Any extensive structural repairs to a property.
- Any large scale projects with budgets exceeding $35,000.
If you have your heart set on a real “fixer-upper,” or need a large loan to make your current home livable, a standard 203(k) loan is your best choice.
203(k) Loan Eligibility Standards
If you are itching to make some major home repairs, a 203(k) loan could be the perfect option to finance your project.
However, you will need to qualify for this loan first.
And for some borrowers, it’s easy to be “over-qualified” for a 203(k) loan.
Since 203(k) loans are backed by and financed through the Fair Housing Administration, there are some very specific loan requirements that all borrowers need to meet.
Namely, FHA-backed loans are intended for lower income buyers, and you will be required to prove your income level and meet FHA standards for your area before getting approved for a loan.
Additionally, FHA loans are only approved for U.S. citizens with documentation.
From a credit score perspective, the news is much better for eligibility.
There aren’t any official lower limits for 203(k) loans, but most brokers will only accept borrowers with a credit score of 580 or better.
As long as you don’t have too many major credit issues in your past, that’s a very reasonable and achievable number.
As for eligible property types, the 203(k) is again very flexible.
203(k) funds can be used for almost all types of single family homes, as well as multi-unit dwellings of four units or less.
They can also be used to remodel complexes with more than four units, as long as the end dwelling is converted into a four-unit complex or less.
If you meet the eligibility requirements above, you will need to have 3.5% of your home’s purchase price available as a down payment.
Where property is more expensive, which is true for San Diego homes, this may seem like a prohibitive amount, but it’s less than the down payment for a conventional mortgage.
What You Can Do With a 203(k) Loan
Funds from 203(k) loans can be spent on a number of projects as long as home-improvement is the goal, but there are still a few guidelines that borrowers need to follow.
The FHA specifies three broad areas where 203(k) funds can be spent:
1) To purchase a home on a plot of land, then repair it.
This is one of the most common uses for 203(k) loans, and one of the most convenient.
203(k) loans can be taken out at the same time that you take out a loan for a home purchase, and are bundled along with your home mortgage loan to decrease fees and make repayment more manageable.
2) To purchase a home on a plot of land, move it to another plot, and then repair it.
If you have fallen in love with a house but hate its location, the 203(k) loan can be a great tool to help you finance home relocation and subsequent repairs.
This process can get very expensive.
A standard 203(k) loan would be required to finance the larger costs.
3) To refinance an existing home, then repair it.
As noted above, 203(k) loans can be used to make repairs and renovations on a home that you already own, provided you qualify for the loan type and have repairs that justify a loan.
Not every project will get approved for 203(k) financing, but it’s worth it to apply if you are eligible and have a project which needs funding.
What You CAN’T Do With a 203(k) Loan
Despite being a very flexible loan type, there are some things which the FHA does not allow borrowers to spend funds from 203(k) loans on.
Here are a couple things that you can’t do with a 203(k) loan.
1) No “Cash-Out” Refinancing
If you borrow 203(k) loans to make home repairs, all of the funds you spend must be directed exclusively at home repair and improvement.
That means you can't use this as an easy way to complete a “cash-out” refinancing of your home and walk away with money.
Every dollar from a 203(k) loan must be spent on home repair and improvements.
2) No Repairs of Dwellings Larger Than Four Units
This was covered in the “eligibility” section already, but it bears repeating.
FHA 203(k) loans are only for single family dwelling or complexes of four units or less.
Any other type of dwelling, and you can’t spend 203(k) funds to make repairs.
The only exception is if you are remodeling a larger complex into a four unit dwelling.
If you think you have a project that could qualify for 203(k) financing, the best thing you can do is pick up the phone and talk to real mortgage professional who can address any of your concerns.
Give me a call, and I’ll happily answer any questions you have about 203(k) loans.
We can talk about your eligibility, alternatives if you are not eligible, and next steps if you are.
If you have more questions about the 203(k) loan before you call me, then check out our question and answer post, our pros and cons of 203(k) loans post, or read about why a 203(k) loan would be right for you.
Of course, I would love to hear your thoughts.
Leave a comment below - or, call or text me at (760) 297-4539.
Your 203(k) Insider,