FHA 203k rehab loans: what they are and how they work

An FHA rehab 203k loan lets you buy or refinance a property that’s in need of repairs and combine the funding that’s needed to purchase (or refinance) the home and pay for renovations into one loan.

Often, these loans are considered by homebuyers who are looking to purchase a fixer-upper, but they can also be used by existing homeowners to refinance and pay for a remodel. 

But they’re not without their complexities, and the reality is that for many homeowners better alternatives are available.

In this guide, we’re going to take a comprehensive look at what FHA 203k rehab loans are, who qualifies and how they work, as well as looking at the alternative options that could be a better way for you to finance renovation work on either a new or existing home. 

Specifically, we’re going to look at:

Let’s make one thing clear; the FHA 203k rehab loan used to be the go-to solution for homebuyers looking to finance both the cost of purchasing AND renovating a new home.

But today, that’s no longer the case. Both mortgage bankers and realtors will often avoid suggesting FHA 203ks to their clients as better alternatives exist.

If you’re currently considering using an FHA 203k to buy a home and renovate it, or considering refinancing into one to to pay for a remodel of your existing home, you need to be sure to explore all of your options.

Don’t rush your decision, as you could find that you’re making a mistake by going down this route.

What is an FHA 203k Rehab Loan?

An FHA 203k rehab loan allows you to finance both the cost of purchasing a property plus the cost of repairs in a single loan.

It’s a government-backed mortgage (by the Federal Housing Administration) that is essentially a construction loan and is primarily intended to encourage homeownership amongst lower-income families (or those with a lower credit score) and to support the renovation of older properties and fixer-uppers as a primary residence.

These loans can be used to refinance and pay for a remodel on an existing property or to purchase and renovate a fixer-upper. They come as either 15 or 30 year fixed-rate mortgages or adjustable-rate mortgages that require a minimum down payment of 3.5% of the combined cost of the property plus repairs.

The FHA does not lend the money on 203k loans, rather they provide financial protection to approved lenders.

How Much Can You Borrow With An FHA 203k Rehab Loan?

FHA 203k Rehab loans let you borrow based upon 96.5% of the after renovation value on a purchase, and 97.5% on a refinance, so long as this is within the local FHA loan limits.

This means that that the maximum you will be able to borrow is the lower of:

• The maximum FHA mortgage limit for the area where the property is located.
• 96.5% of the home’s after renovation value if it is a purchase, and 97.5% if it’s a refinance, including the cost of the renovation.

These loans let you borrow against what your home will be worth after work has been completed and significantly increase your renovation borrowing power compared with traditional home equity loans, lines of credit or a cash-out refinance.

You’ll also be expected to keep a contingency reserve of between 10% and 20% of the renovation bid price, just in case the project goes over budget. This contingency reserve can be financed into the loan amount or paid through personal funds.

Standard 203k Rehab Loan vs Limited 203k Mortgage

There are two types of FHA 203k rehab loans: the Standard 203k Renovation Loan (Rehab Loan) and the Limited 203k Renovation Loan (Mortgage), which used to be known as the ‘Streamline 203k.’ They each have their own requirements, allowable projects and borrowing limits.

The Limited 203k renovation loan is only suited to minor repairs and home improvements (they do not permit structural repairs and have a maximum renovation budget and cost equalling $35,000 or less), however, and this means that most homeowners who are either purchasing and renovating or refinancing and renovating will be considering the Standard 203k renovation loan. Limited 203ks don’t require a HUD consultant to be appointed.

And for the purpose of this guide, that’s what we’re referring to when we talk about an FHA 203k - a Standard 203k.

But you should be aware of the differences between these, if only so that you fully understand how these loans work and are able to properly compare to the alternatives available to you.

How Does An FHA 203k Rehab Loan Work?

In some ways, the process for taking out and using an FHA 203k rehab loan is similar to the process of buying a home with a traditional mortgage, but these loans have some distinct differences and complexities that you’ll need to know about when considering it as a way to finance a renovation.

These loans can also be used while refinancing a home you’ve already purchased, so we’ll talk about the process for either scenario.

1. Find a home to purchase or refinance your existing property: You find a home that you want to buy, but you want to make renovation repairs, or you decide that you want to renovate your existing home and borrow based on your home’s after renovation value.
2. Find an FHA 203k lender: Next, you’ll need to find an approved FHA lender and apply for a 203k loan. Your application will need to be approved based on the cost of renovations and the price to purchase (or refinance) the property, along with applicable renovation fees and contingency reserves.
3. Find a contractor/builder: You’ll need to find a general contractor who will need to prepare a detailed bid for renovations. A copy will then be provided to the lender.
4. Get an “As-Completed” Appraisal: An appraisal is performed on the property to determine the home’s current and after renovation value.
5. Lender submits documents to underwriter: The lender submits the bid, appraisal and other required information to the loan underwriter.
6. Close on your FHA 203k rehab loan: Once the loan is approved, you are able to go to settlement if you’re purchasing the home. You’ll sign closing documents at this stage.
7. Proceeds of the loan are used to purchase the home: The loan funds go to the seller of the property (or to your previous mortgage lender if refinancing) and the renovation and repair funds go into an escrow account.
8. Use loan to fund renovation: Renovation work must begin within 30 days and must be completed within six months. The lender will pay the contractor from the escrow account based upon the agreed schedule, which includes draws and inspections.

It’s important to note that steps 1-6 need to happen before you can close on the property if you’re purchasing the home.

2021 FHA 203k Rehab Loan Requirements

So what do the FHA 203k renovation loan requirements look like?

• The requirements are similar to a standard FHA loan.
• Borrowers must meet the minimum FHA credit score requirements and have a FICO score of at least 580 with a 3.5% down payment, or at least 500 with a 10% down payment. That said, many lenders require a credit score of at least 620, despite FHA requirements being lower.
• The loan amount must not be more than the FHA loan limits in your area, and cannot be greater than 96.5% of your home’s after renovation value (if you’re purchasing) or 97.75% of the after renovation value of your home if you are refinancing.
• Your debt-to-income ratio must be less than 50%, or meet Automated Underwriting System (AUS) approval. Read more about debt-to-income ratio.
• FHA loan lenders will require you to pay mortgage insurance upfront AND annually for the life of the loan, and some lenders will charge an additional supplemental origination fee.
• The property must be your primary residence.

What Are 203k Loan Rates?

FHA 203k rehab loan rates are generally slightly higher than conventional mortgage rates, but lower than rates for personal loans and sometimes even other renovation loan options.

However, it’s important to note that interest rates will vary by FHA 203k lender. Rates are generally higher than standard FHA loans because of the nature of renovation loans in general.

To get a better sense of potential interest rates for an FHA 203k rehab loan, contact lenders in your area offering this type of renovation loan.

While interest rates are an important factor in overall cost when comparing loan options for your renovation, you shouldn’t compare loans based on interest rate alone. Mortgage insurance, closing costs, interest rates, down payment, appraisal fees and more will all factor into your decision, and should be evaluated as a whole.

For example, an FHA 203k rehab loan option may have a lower interest rate than a Fannie Mae Homestyle loan option - but the required monthly mortgage insurance and upfront premium on the FHA 203k rehab loan could make it an overall more expensive option.

The Pros & Cons of an FHA 203k Rehab Loan

As with any mortgages or renovation loan, there are pros and cons of FHA 203k rehab loans:

While an FHA 203k rehab loan might sound like a great way to finance a renovation on a new or existing property, we can see that there are some drawbacks.

One of the most common reasons people choose FHA 203k rehab loans (whether they are purchasing and renovating or refinancing), is that low minimum FICO score requirement of 580+. This may be a great option for you if you’re limited by a lower FICO score.

Either way, make sure you consider all of your options to find the right solution for you.

FHA 203k Rehab Loans vs Fannie Mae Homestyle Loans

It’s important that we touch upon Fannie Mae Homestyle loans, a common alternative to 203k loans.

These both allow you to borrow money for both the purchase and rehab of a home, but there are a few notable differences that you need to know about.

Fannie Mae Homestyle loans are different in these ways:

• No requirement for an upfront Mortgage Insurance Premium (MIP).
• Lower monthly mortgage insurance (as low as 0.4% on a HomeStyle loan vs 0.8% on an FHA 203k).
• The 0.4% monthly MIP can be removed after 12 years, or sooner with proof of at least 20% equity.
• The ability to be used on second homes and investment properties.
• Higher loan amounts ($548,250 versus $431,250).
• Higher minimum FICO score requirement (620+)

Take a look at our guide on “Why are Fannie Mae Homestyle loans better than FHA 203Ks when renovating?” to learn more.

Homeowners who aren’t as limited by a low FICO score might find more benefits within a Fannie Homestyle loan (fewer fees, ability to be used on second homes and investment properties, and higher loan amounts).

That said, there are still other alternatives available that we want to introduce you to.

Introducing RenoFi Loans - A Better Alternative To An FHA 203k Rehab Loan

If you’re considering an FHA 203k rehab loan either to purchase a fixer-upper and pay for repairs or to refinance and renovate your existing home, the key thing that you need to know is that another option exists that may be better-suited to your needs.

Before jumping into an FHA 203k, we want to introduce you to RenoFi Loans, an alternative that can provide the ease of a home equity loan with the borrowing power of a construction loan and a lower interest rate.

This alternative is a new type of home renovation loan that allows you to purchase your new home with a traditional mortgage and simply add the loan to finance the renovation when you’re ready.

The main things you need to know about RenoFi Home Equity Loans are:

• You can borrow between $20k and $500k
• Terms of up to 20 years
• Ability to borrow up to 90% of your home’s after renovation value
• The full loan amount is available at closing
• You won’t need to refinance your existing mortgage

But how do RenoFi Loans compare to other home renovation loans? Below, we’ve compared them with FHA 203k rehab loans, Fannie Mae HomeStyle loans and single-close construction loans.

If it looks like a RenoFi Loan might be right for you, contact RenoFi to discuss your options and help you to get the home you want on your terms.

4 Reasons Why You Shouldn’t Use An FHA 203k Rehab Loan (& Consider A RenoFi Loan Instead)

So why should you consider a RenoFi Loan instead of an FHA 203k rehab loan to finance your renovation? Here are 4 reasons:

1. Extra Steps & Delays To Your Home Purchase

The truth is that those who are using an FHA 203k rehab loan to purchase a fixer upper are at a huge disadvantage in a competitive market because of the extra steps they have to take versus a traditional mortgage, and when you’re up against a buyer who can quickly secure a loan while you’re bogged down by the FHA 203k renovation loan process, the odds aren’t in your favor.

Keep in mind, these extra steps have to happen before you even purchase the home, so if those competing buyers are skipping all these steps with a traditional mortgage, it’s safe to say you’re already out of the game.

The alternative, and for most people the better option and a way to avoid these extra steps and delays is to purchase the property with a traditional mortgage and use a RenoFi Loan to finance the renovation after closing.

2. Big Decisions, Little Time to Think

All additional work aside, no one likes making decisions under the pressure of a ticking clock.

And when you’re buying in a competitive market, an FHA 203k rehab loan forces you to rush the process.

That means those who use these to purchase and renovate a property in a single loan have to force everything from the planning of all the specific details of your renovation project to shopping for the right contractor into a very tight timeline. When an FHA 203k rehab loan is used for a purchase, work must begin within 30 days of closing.

In comparison, when buying with a traditional mortgage and using a RenoFi Loan to renovate, you can close on the home then take your time to put together your renovation wish list, compare contractor quotes and make the right decisions that work for you long-term.

3. Higher Fees & Costs

There are typically higher fees and costs associated with an FHA 203k rehab loan than other types of financing, meaning that this usually isn’t the most affordable option.

You will need to pay FHA mortgage insurance upfront AND monthly for the life of the loan, and some lenders will charge an additional supplemental origination fee.

Additionally, you will be required to pay inspection fees, title update fees and finance a contingency reserve of between 10% and 20% of the renovation bid price in the escrow, in case the project goes over budget.

With a RenoFi Loan, you won’t need to pay for FHA mortgage insurance, inspection fees, title update fees or finance a contingency reserve.

4. Restrictions On The Type Of Improvements You Can Carry Out

FHA 203k rehab loans place a restriction on the type of improvements that you can carry out, but when using a RenoFi Loan, these restrictions don’t exist.

An FHA 203k rehab loan will not allow:

• Projects that will take longer than six months to complete
• Projects that class as luxury amenities, including adding a swimming pool, a tennis court, a barbecue area or similar
• Minor landscaping work

Learn more about how homeowners have used RenoFi Loans for backyard renovations like pools, landscaping work, patios, and more.

Using A 203k Loan To Refinance & Renovate Your Existing Home

FHA 203k rehab loans are commonly used to purchase and renovate a property in a single loan and can also be used to refinance and renovate your existing home.

If you are looking to use an FHA 203k to finance renovations on your current home, it’s important to know that the maximum loan amount available to you is:

• 97.75% of the your home’s after renovation value (also called the ‘after completed value’)

The same criteria that we outlined above relating to approved projects and timeframes apply when using this loan to refinance and renovate.

Make The Right Decision When Financing Your Renovation

Make the wrong decision on how to finance a renovation and it can be costly or significantly limit your borrowing power.

FHA 203k’s were once the go-to solution for buying (or refinancing) and renovating, newer options could offer better alternatives, depending on your financial situation. You are no longer tied in to complex financing options that require a lot of additional work.

RenoFi’s Renovation Home Equity Loan can offer the same benefits of FHA 203k rehab loans without the need to refinance, plus even lower insurance rates and fewer fees.

FAQs on FHA 203k Rehab Loans

Speak to one of our advisors and find a lender offering RenoFi Loans in your area today!