What is an FHA 203 (k) loan?
An FHA 203 (k) loan is a type of government-insured mortgage that allows the borrower to take out a loan for two purposes – buying a home and renovating a home. An FHA 203 (k) loan is for the rehabilitation or repair of a home that will become the principal residence of the mortgagee. An FHA 203 (k) is also known as an FHA construction loan.
Understanding an FHA 203 (k) loan
The FHA 203 (k) loan encourages low- and moderate-income families to buy homes that are in urgent need of repair – especially homes located in former communities. The program allows an individual to buy a home and renovate it under a fixed or variable rate mortgage. The amount borrowed includes the purchase price of the house and the cost of the renovation, including materials and labor.
The loan can also cover the financing of temporary housing (if necessary), which could take the form of rent for the period of rehabilitation of the house. The double-acting loan eliminates the need for a borrower to make two separate mortgage and home improvement loan applications, which may not be approved by the bank or may have a higher combined cost.
Normally, lenders are unwilling to offer a mortgage for a property in need of major repairs due to their security and habitability standards. FHA 203 (k) loans, which are supported by the government, reassure lending institutions because the cost of home improvement is included in the mortgage package. The renovation costs are placed in an escrow account and disbursed as payment to the contractors as the work is completed. The complete renovation of the house should not take more than six months, as stated in the FHA guide for a 203 (k) loan.
An FHA 203 (k) loan allows low-income people to afford to buy a home, especially one that needs to be repaired.
Types of loans 203 (k)
There are two types of 203 (k) loans – streamline 203 (k) and standard 203 (k). The loan only applies to individuals and families who intend to make the property their primary residence. This means that real estate investors and pinball machines are not eligible. The work carried out must be entrusted to an approved handyman and must not be carried out by the mortgagor.
Rationalization 201 (k): minimal repairs
A house that does not require a lot of work would generally be paid for using the 203 (k) rationalization. This option does not include structural work on the house, such as adding new rooms or landscaping, and the house must be habitable throughout the renovation period. Repairs as part of the 203 (k) rationalization are capped at $ 35,000.
Standard 2020 (k): Extensive work
Standard 203 (k) includes all major repairs and structural work that must be done at home with no capped repair costs. The minimum amount that can be borrowed is $ 5,000.
Some of the repairs covered by an FHA 203 (k) loan include plumbing, flooring, painting, heating and cooling systems, renovating the bathroom and kitchen, improving standards of health and safety, improving the landscape, setting up access tools for people with disabilities, adding energy conservation systems and replacing windows and doors.
Renovations considered extravagant or luxurious (such as swimming pools or improvements that would not be a permanent part of the property) are not covered by an FHA 203 (k) loan.
How do lenders use an FHA 203 (k) loan?
The Federal Housing Administration (FHA) was created during the Great Depression, which experienced a high rate of foreclosures and defaults. The FHA has urged banks to provide home loans to people with low and middle incomes, people with low credit scores, or first-time home buyers with no credit history. This helped stimulate the economy, as people who would not normally be approved for a loan were issued mortgages. The FHA loan was created to insure these types of mortgages, so that in the event the borrower defaults, the FHA would step in to cover the payments, thereby minimizing the risk of default faced by the lender.
High-income people generally prefer to buy in newer and more developed areas of a city. The FHA introduced loan 203 (k) specifically to encourage low-income earners who do not qualify for a standard mortgage to choose to live in and improve on run-down neighborhoods.
Get an FHA 203 (k) loan
It is important to note that the FHA is not a lender; he is a mortgage insurer. You get an FHA 203 (k) loan by applying through your bank, credit union or other lender. Not all lenders offer these loans. To find an approved lender, check out the HUD approved lender search.
Nor is it a home insurer or a warranty provider. Home buyers should always take out home insurance and guarantees for their home and property.
Pros and Cons of an FHA 203 (k) Loan
As with other FHA loans, a person can make a down payment of only 3.5%. As the loan is insured by the FHA, lenders can offer lower interest rates for a 203 (k) loan compared to what borrowers can quote elsewhere. Interest rates vary for each borrower based on their credit history. Although the FHA allows individuals with credit scores as low as 580 to request a 203 (k), some lenders may require a higher score of 620 to 640 to issue one. This is still below the 720 score required for a standard mortgage.
However, the FHA 203 (k) loan is not free. An initial mortgage insurance premium must be paid monthly by the borrower. Additional set-up costs may also be charged by the credit institution. In addition to the financial costs to the borrower, the rigorous paperwork required and the long time it takes to hear from the FHA and the lender are factors to consider when applying for this program. Overall, a person with a low credit score who wants to own a home that needs to be repaired and upgraded may realize that the FHA 203 (k) has great advantages that outweigh its costs.