If you are thinking of making home renovations, you need capital to make those changes happen. If you don’t have the cash sitting around in your bank accounts, you may consider a mortgage. The most common loan homeowners go for first is the home equity line of credit. While the HELOC does have its benefits, it gives you a second mortgage that you have to concern yourself with for the next 15 – 30 years.
Another option that many homeowners overlook is the FHA 203K refinance. Even if you don’t have an FHA loan now, you may qualify for this flexible loan program.
What is the FHA 203K Loan?
The FHA 203K loan is actually two loans wrapped into one. You can refinance your current outstanding balance on your mortgage, plus get money for your home renovations. Once you close on the loan, you only have one loan to worry about, which means only paying one interest rate and writing one check each month.
In order to qualify for the 203K loan, you’ll have to give the lender a list of the renovations you want to make. The lender will then work alongside you and your chosen contractor to determine which changes are required, which are optional, and which can be done within the budget constraints of the loan’s parameters.
There are two different FHA 203K refinance loans you can get – the full 203K and the streamline 203K.
The Full FHA 203K Loan
The full 203K loan allows you to make a variety of changes to your home. The changes can be cosmetic or structural – there are very few restrictions on what you cannot do with this loan. The full 203K is for those homeowners that want to make extensive changes to the home, even to the point that they can’t live in the home while the changes are completed.
There isn’t a specific dollar amount loan limit for this loan. Instead, the lender bases your loan amount on the value of the home now, plus the value that the renovations will add to the home. You may be able to borrow up to 110% of the home’s as-improved value for the renovations.
The Streamline 203K Loan
The streamline 203K loan is for those renovations that are ‘cosmetic.’ This loan does have a maximum loan amount of $35,000. The changes you make on the home also cannot be structural. Any structural changes, no matter the loan amount, must go through the full 203K loan process.
You still have to run the intended repairs by your lender. They have the final say in what repairs you do and don’t do. For example, if the appraiser finds issues that won’t pass FHA guidelines, those repairs will be required first. Once those repairs are complete, any money left over can be used for the renovations you want to make.
It’s important to note that you can only do small renovations with the streamline 203K loan. They include:
- Repair or replacement of the roof
- Repair or replacement of the HVAC, plumbing, or electrical systems
- New flooring
- Painting the interior or exterior of the home
- Basement waterproofing
- The replacement of windows and doors
- Well or septic replacement
- Any cosmetic or non-structural changes
Qualifying for the FHA 203K Loan
Since the FHA backs the loan, you have the luxury of flexible guidelines. Even though you may be borrowing more than the home is worth, you can get approved with the following guidelines:
- At least a 620 credit score; if you have a credit score between 580 and 619, you may get approved if you have compensating factors
- At least 3.5% equity in the home
- A housing ratio no higher than 31%
- A total debt ratio no higher than 43%
- Stable employment and income
- Proof that you will occupy the property as your primary residence
With both the full and streamline 203K loan, you’ll pay FHA mortgage insurance. In fact, you’ll pay it twice – once at the onset of the loan and again annually (but the lender charges it monthly). The FHA charges 1.75% of the loan amount upfront and then another 0.85% of the outstanding loan amount on an annual basis. You will pay the mortgage insurance for the life of the loan; you can’t eliminate it once you owe less than 80% of the home’s value.
The Largest Difference
The largest difference with the FHA 203K loan versus any other home renovation loan is the role the lender plays in the process. The lender will help you choose a contractor (they must work well with the lender), prioritize the renovations, and disburse the funds to the contractors.
In fact, the lender or the loan consultant (which is required on a full 203K loan) will hold onto the funds and disburse them according to the contract. The lender and the contractor agree on a disbursement schedule before the loan closes. The lender or their agent then checks the progress of the renovations and approves them prior to disbursing the funds.
The FHA 203K loan offers a great way to refinance your home and get your home renovations done. If you use the full 203K loan, there are very few restrictions on the work you can do to your home. Make sure you work with a reliable FHA lender that has experience with 203K loans for the best results.