What is an FHA 203(k) Loan?
FHA 203(k) loans allow home buyers to purchase properties and include costs for home improvement for as little as 3.5% down. They also allow homeowners to refinance existing properties and include costs for home improvement. There are two types of FHA 203(k) loans:
FHA 203(k) Standard loans are designed for major remodeling and renovation projects. There is a minimum repair cost of $5,000 and the use of a 203(k) Consultant is required.
FHA 203(k) Limited loans are designed for minor remodeling and renovation projects. Structural repairs are not allowed. No minimum repair cost is required, but total renovation costs, fees, and reserves may not exceed $75,000.
No matter which FHA 203(k) loan you are using, the following are ineligible improvements:
- New construction from the ground up
- Any work performed or materials purchased prior to closing
- Recreational or luxury improvements are not allowed, such as: installation of new swimming pools (existing swimming pools can be repaired), an exterior hot tub, spa, whirlpool bath, or sauna, barbecue pits, outdoor fireplaces or hearths, bath houses, tennis courts, satellite dishes, tree surgery (except when eliminating an endangerment to existing improvements), photo murals, gazebos
- Making additions or alterations to support commercial use or to equip or refurbish space for commercial use is not allowed
- Repair or improvements that are expected to require more than six months to complete are not allowed
- Improvements or changes made to the initial scope of work as identified in the 203(k)Consultant’s WWU and/or contractor’s bid that were not pre-approved by Diamond Residential Mortgage Corporation in advance may not be eligible for reimbursement
What Costs Can Be Financed Into FHA 203(k) Loans?
A contingency reserve will be funded to cover unforeseen repairs that are discovered during renovation. The amount of contingency will vary between 10%-20% of the bid amount. Contingency reserves are required and typically financed in the loan amount (i.e., Financed Contingency). Alternatively, you may bring funds to closing to fund the contingency reserves; however, any assets required to fund the contingency reserves must be documented and verified above the amount required for down payment and reserves (i.e., Borrower-Funded Contingency)
Hard costs (i.e., labor and materials from the contractor’s bid)
Architectural fees (FHA 203(k) Standard only)
Engineering fees (FHA 203(k) Standard only)
Consultant fees
Draw inspection fees
Title update fees
Permit costs
Feasibility Study (Diamond Residential Mortgage Corporation will not require this)
Mortgage Payment Reserves (FHA 203(k) Standard only) not to exceed twelve (12) months’ principal, interest, property taxes, and homeowner’s insurance payments, depending on the length of time the property will be uninhabitable during renovation
Other Highlights of FHA 203(k) Loans
You can use up to 110% of the property’s after-improved value to structure your loan
An Up-Front Mortgage Insurance Premium (“UFMIP”) will be financed into your loan. In addition, a monthly mortgage insurance premium will be included in your monthly payment
Your contractor’s credentials will be vetted. Any contractor hired will have to provide proof of licensing (if required), a Certificate of Liability Insurance, Worker’s Compensation (if required), any specialty certifications required (e.g., lead-based paint, mold, radon, asbestos), and a signed IRS W-9 Form
Your contractor’s bid has to meet certain requirements such as being on contractor letterhead, naming you as the client, identifying the property where the work will take place, a full description and the location of all work being performed, a labor and materials breakdown per line item, permits and their associated costs, accurate tally of all sub-totals and the grand total, start and completion dates, and number of draws needed. If the property will be uninhabitable during renovation, the contractor should indicate so and let us know how long the property will be uninhabitable. For FHA 203(k) Limited loans, the contractor must specifically state all repairs being performed are non-structural in nature
You may not be related to or have a business relationship with the contractor or any other party in the transaction. There is only one exception: you may be related to the seller
No other parties in the transaction may be related to one another or have a business relationship with one another
You may be able to perform some of the work yourself. To find out whether or not you would be allowed to perform work, contact me
Gifts are allowed on purchases and some down-payment assistance programs are allowed as well
FHA 203(k) loans may be combined with the $100 Down HUD REO program, Good Neighbor Next Door program, Energy Efficient Mortgage (“EEM”), 203(h) for Disaster Victims, Solar and Wind Technologies, and some down payment assistance programs
All permits should be pulled immediately after loan closing, work should commence within thirty (30) days’ of loan closing, and work should not cease for any thirty (30) day period. Work must be completed within nine (9) months of loan closing for Limited 203(k) loans or twelve (12) months of closing for Standard 203(k) loans
Draw Process for FHA 203(k) Loans
Below is a list of items that may be disbursed at loan closing:
FHA 203(k) Standard
- Permit costs (permits must be obtained before work commences)
- Prepaid architectural or engineering fees
- Prepaid Consultant fees
- Origination fees
- Discount points
- Materials costs for items, prepaid by the Borrower in cash or by the contractor, where a contract is established with the supplier and an order is placed with the manufacturer for delivery at a later date; and/or
- Up to 50 percent of materials costs for items, not yet paid for by the Borrower or contractor, where a contract is established with the supplier and an order is placed with the manufacturer for delivery at a later date
FHA 203(k) Limited
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Permit fees (permits obtained before work commences)
-
Prepaid Consultant fees
-
Origination fees
-
Discount points
-
Up to 50 percent of the estimated materials and labor costs before beginning construction only when the contractor is not willing or able to defer receipt of payment until completion of the work, or the payment represents the cost of materials incurred prior to construction. A statement from the contractor is sufficient to document
The remaining draw process for each loan program is as follows:
FHA 203(k) Standard
-
Up to 5 draws are allowed
-
A 10% percent holdback is required for each progress draw; the total of all holdbacks will be released in the final draw
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The 203(k) Consultant will perform an inspection prior to every draw, including the final inspection, and prepare Draw Request Form HUD-9746-A
FHA 203(k) Limited
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Remaining 50% of bid amount will be released after all work has been completed
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Final inspection will be performed by the original appraiser or an eligible 203(k)Consultant
There are many different types of renovation loans: conventional renovation loans through Fannie Mae® (“FNMA”) and Freddie Mac® (“FHLMC”), FHA renovation loans, USDA renovation loans, a VA renovation loan option, and portfolio renovation loans.
Below is a high-level overview of the renovation loans Diamond Residential Mortgage Corporation offers. For more information, explore FAQs and Blog.
Keys To Success:
- Inquire early! If you attempt to place an offer on a property that is listed for sale without a pre-qualification letter, your offer may be rejected and you may miss a window of opportunity. It is best to secure financing before you are too far into the buying process.
- Make sure your contractor is on board with the contractor qualifications, bid requirements, and draw process required for your loan type.
- If a Consultant is involved, meet together at the property with the contractor, so all parties can finalize the scope of work together.
- Provide requested paperwork quickly to meet contract deadlines. Time lost on the front end of a deal oftentimes cannot be made up on the back end of the deal to hit closing deadlines.
- Be decisive! Decide on the details of your renovation project early and resist the temptation to make changes throughout the loan process. Wavering during the process can cause delays with your closing. Feel confident in pushing forward with the decisions you make at the onset of the transaction. That’s not to say you can’t make changes along the way, but making those changes mid-stream will likely cause delays.
