How does an FHA 203(k) loan work?

Man and woman sitting together at their dining room table, looking over their options for a 203(k) loanImage: Man and woman sitting together at their dining room table, looking over their options for a 203(k) loan

In a Nutshell

An FHA 203(k) loan lets you borrow money to purchase or refinance a home and fix it up. These loans can come with a down payment as low as 3.5%.
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The FHA 203(k) program allows you to take out a mortgage to purchase or refinance a property and use loan funds for approved renovation or repairs. In this article, we’ll go over how the FHA 203(k) loan program works and who it might work well for.

How does the FHA 203(k) loan work?

FHA 203(k) loans are intended to help you buy and rehabilitate a home you’ll use as your primary residence. You can also use a 203(k) loan to refinance your current mortgage while also borrowing money for a renovation or repair.

These loans are made by private lenders and insured by the Federal Housing Administration. They offer fixed- or adjustable-rate loans with a down payment as low as 3.5%.

The amount you can borrow with an FHA 203(k) loan is equal to the value of the property as-is plus the cost of the repairs or 110% of the expected value of the home post-rehabilitation — even if the cost of the project would be more than that. You may also finance a contingency reserve, which is money set aside in case costs run over budget.

Once the loan closes, a portion of the money will go to buying the home or paying off the existing mortgage. The rest will go into an escrow account and will be paid out as work progresses. You’ll pay an upfront mortgage insurance premium at closing, and you’ll also be responsible for an annual mortgage insurance premium as you pay back the loan.

You can use the FHA 203(k) loan with single-family homes, or homes with between two and four units. Condos and townhouses may also qualify. FHA 203(k) loans come in two main varieties — standard and the limited.

FHA 203(k) standard loan

The standard FHA 203(k) loan is for fairly extensive rehabilitation or renovation projects. The minimum cost of the renovation is $5,000. You’ll need to bring in an approved 203(k) consultant to supervise the project. This is usually a licensed contractor who’ll inspect the property, write up a work plan and prepare a cost estimate for the work. If you’re doing any sort of structural renovation or planning to spend a good deal of money, the standard 203(k) loan is the option for you.

FHA 203(k) limited loan

The limited FHA 203(k) loan is for smaller projects and has fewer requirements. The maximum amount you can spend on your renovation plan with this loan is $35,000 in most cases, though the repair costs limit can go up to $50,000 in certain parts of the country. There’s no minimum amount you must spend on repairs, and you won’t need to bring in an FHA 203(k) consultant, though you can if you wish. If your home needs only minor home improvements or if you don’t want to commit to a major project, the limited 203(k) loan may be a good choice.

How do I qualify for an FHA 203(k) loan?

Qualifying for an FHA 203(k) loan is essentially the same as for other FHA loans. Eligibility requirements include the following:

  • Credit scores — FHA loan rules require credit scores of at least 500 to be eligible. Additional lender standards may also apply.
  • Down payment — FHA guidelines state a down payment of at least 3.5% is required if you have a credit score of 580 or higher. With a credit score between 500 and 579, you’ll need to put 10% down. Additional lender standards may apply.
  • Residency — When taking out an FHA 203(k) loan, you promise that you’ll live in the home within 60 days — and remain living there for at least one year.
  • Finances — You generally can’t get an FHA loan if you’ve had a foreclosure in the previous three years. You also must not have had a bankruptcy in the previous two years. But you may be able to get an exception if there were certain circumstances, such as a serious illness or death of one of the borrowers.

What can I use an FHA 203(k) loan for?

You must generally use an FHA 203(k) loan for renovations that make the home safer, more livable or more structurally sound. Luxury items or things that won’t be a permanent part of the home — such as swimming pools, barbecue pits, a tennis court, gazebo or satellite dish — aren’t allowed.

Here are some common projects people complete with the standard FHA 203(k) loan.

  • Making structural repairs
  • Building an addition
  • Finishing a basement or attic
  • Building a garage
  • Installing or fixing a well or septic system, or connecting to public utilities
  • Repairing or replacing HVAC or plumbing
  • Making the home accessible for people with disabilities
  • Landscaping
  • Adding or fixing a deck, patio or porch

Projects using an FHA 203(k) limited loan are generally smaller in scope. Some projects listed above may also work with a limited loan. Here are some other projects people may work on with this loan.

  • Replacing roofing, siding, downspouts or gutters
  • Building or fixing a fence or driveway
  • Installing smoke detectors
  • Remediating lead-based paint

Energy-efficient FHA 203(k) features

When taking out an FHA 203(k) loan, you may also choose to take part in the FHA’s Energy Efficient Mortgage program. This program allows you to borrow money for energy-efficient upgrades to the home as you buy it or refinance the mortgage. Any projects you do must be cost-effective, meaning the improvements cost less than the amount of savings you’ll reap in energy bills.

To take part, you’ll need to have a qualified energy rater complete a home energy assessment that identifies areas where you can make the home more energy efficient. Projects could include the following:

  • Installing solar panels
  • Adding insulation
  • Replacing doors or windows
  • Replacing an HVAC system
  • Fixing or replacing the chimney

In most cases, you’ll be able to add the cost of completing the energy-efficient upgrades to your loan amount. But be aware there are caps associated with the total cost of the upgrades, such as a 5% cap of the value of the home after you finish the work.

When might an FHA 203(k) work for me?

If you’re buying a fixer-upper, an FHA 203(k) loan can be a good way to finance your new home purchase and the cost of the renovation. The same goes if you live in a fixer-upper already — refinancing with a 203(k) loan can help you pay for the improvements. FHA loans, including the 203(k), have easier qualification requirements than other types of mortgages while still offering a low down payment. This can make them cheaper and easier to get if you have lower credit scores.

You’ll want to make sure that the projects you have in mind are approved under FHA 203(k) guidelines — it may be a good idea to contact a 203(k) consultant before you commit. If you only want luxury upgrades, this loan likely won’t work for you.

Another thing to keep in mind is the total cost and value of the home. After the renovation is finished, the value of the home must fall within the FHA’s mortgage limits for the area in which you live. This limit in 2022 is listed at $420,680 in most parts of the country, though can be as high as $970,800 in high-cost areas.

Learn more about the FHA mortgage limit in your county.

Alternatives to an FHA 203(k) loan

An FHA 203(k) loan isn’t the only potential option for homeowners looking for a renovation loan. Before committing to the FHA 203(k), you may want to explore a few other options for financing your projects.

  • Fannie Mae HomeStyle Renovation: Available for new purchases and refinances, this loan program allows a down payment as low as 3%. Credit scores of 620 are required.
  • Freddie Mac CHOICERenovation: This conventional loan program offers a down payment option as low as 3%. The CHOICERenovation also has an “eXPress” option for smaller projects.
  • USDA Rehabilitation and Repair Loans: These loans are available with no down payment, with the loan amount up to 100% of the expected value of the home after the renovation. To qualify, you must fall below income limits and live in a rural area.
  • Home equity loans: Home equity loans use your home as collateral, with the amount you can borrow determined by how much equity you have in your property. Equity is the difference between what you owe on your mortgage and what your home is worth.
  • Personal loans: If you’re considering a personal loan, it’ll be important to compare rates and terms with the other loan options you have to make the best choice in terms of affordability over the lifetime of the loan.

About the author: Andrew Dunn is a veteran journalist with more than a decade of experience as a reporter and editor at North Carolina news organizations, including the Charlotte Observer and the StarNews in Wilmington. In those roles,… Read more.