FHA 203k Rehab Loan Requirements: Everything You Need To Know Up-Front

Certified Mortgage Advisor
NMLS 1701021
Published 
May 14, 2020

Everything you need to know about FHA 203k

So we're going to talk through FHA 203K loan requirements. So you can get a better understanding of this rehab alone.

Overview

First of all, let's talk through an overview of FHA 203k it's like an FHA loan, but it's for rehab properties, meaning that it needs a little bit of work to be done.

Fixer uppers

So this loan is for fixer-uppers. If they need a little bit of work if you're that house could be on HGTV and it can be flipped into a dream home. It's probably right for the 203k.

Standard 203k

So something that we need to know, there are two flavors of the 203k. Two different versions. There's the standard, and then there's the limited. So let's first talk about standards. The standard doesn't have a loan limit. It just goes up to the FHA loan limit, which varies by county.

Normally this is going to hover in the mid $300,000 range.

Limited 203k

A limited 203k has a 35,000 maximum. So what are the differences standard is going to require a little bit more documentation. It's going to be a little bit longer of a process because you have a loan limit. That can be a lot higher. It goes all the way up to around the mid 300,000 and higher if you're in a high purchase price area.

We're limited to a 203k is only going to allow you to have $35,000 as a max. So what we're mainly going to be talking about here is the standard 203k. That's what most people are going to go through, unless they're familiar with two or three Ks, you probably won't be using or taking advantage of the limited as much because there are some restrictions to it.

580 Credit Score: 3.5% down

So credit score is just like a normal FHA loan. If you have a 580 credit score and higher, you're going to be looking at a three and a half percent down payment. So that's based on the purchase place plus repairs. So if you have a purchase price of 100,000 and repairs of 50,000, you need three and a half percent of $150,000 as your down payment.

500 score: 10% down

If you have a 580 score down to a 579 score down to a 500 score. You need to put 10% down. This is the exact same standard for a regular FHA loan.

Finance home and repairs in a loan

So the benefit of the 203k is that you get to finance the home purchase. Plus the repairs are all wrapped together in one loan. Normally, if somebody was looking at doing repairs on their own, they need to purchase the home and then finance repairs themselves, either with cash home equity line or some other personal funds, both the 203k you can say, I want to purchase the property and get the repairs all wrapped into one loan, one payment, one closing.

So why would we do this? Normally because you can't purchase a home that is in need of repair, banks want to make sure that when they lend you money, the asset that they are securing that mortgage with, it's, what's called the collateral of that loan. They want to make sure that. You ever go into default that they can resell that property for a good value.

So when you purchase a home, they want it, they don't want to see it to have a ton of repairs needed. Even on FHA loans, things like broken glass, chipping paint anything that's a tripping hazard FHA will not let you lend money on a home. So at two or three K allows you to get a home that is in need of a new kitchen of a new bathroom and new paint removing all safety issues at two or three K allows you to purchase a home that might be foreclosed or needs work done to it.

What can you fix

Here's what you can fix with the 203k.

1. Hazards

Anything health and safety FHA is wildly concerned about. They are so much about health and safety. So anything broken windows, missing handrails, lead-based paint, mold. These all needed to be taken care of with a 203k. Those are not optional. These are things that are health and safety concerns by the FHA. Those have to be taken care of if you're doing a 203k.

2. Cosmetic

So this is mainly why you'd be using a 203k. Obviously, you want to take care of health and safety stuff, but that's boring. What you really want to be doing is fixing up the cosmetic things. This is where you can get a lot of value from a 203k.

House Flip

This is where you can do a flip. because you can buy a home that's ugly, that no one wants to move into living in it for a little bit, fix it up, add some cosmetic things like replace appliances, get a new bathroom update countertops, then sell the property in a year or two or maybe more for a higher value.

Repairs

Here's the list of repairs:

•  .

• Modernization and implementation to the homes function, and these were straight from FHA guidelines.

• Elimination of health and safety hazards.

• Changes that improve appearance and eliminate obsolescence. So this is something like seventies shag carpet, and gross, outdated cabinetry reconnect.

• Replacing plumbing, installing a well and or a septic system.

• Adding or replacing roofing gutters and downspouts adding or replacing floors and floor treatments.

• Major landscape work in site improvements.

• Enhancing accessibility for a disabled person.

• Making energy conservation improvements.

Flexibility with what you want to fix

So you can see, you can do a ton of stuff with the the203k standard. If you're looking at limited, you have to make sure that you're not working on any foundational issues, and normally things like plumbing. Can't be fixed on a limited FHA 203k. That's what I'm going to the standard one. You're going to have a lot more freedom to do what you want. You're going to have a higher loan amount and more flexibility with what you want to fix.

Work to be done

How does it get decided how much money you get to use? You don't just get to go to the lender and say, I want to purchase the property. Then I want to spend this much money, and then they give you a pile of cash. It just does not work that way. We're dealing with banks, we're dealing with lenders, they have restrictions and guidelines, and they're going to check the work along the way.

How much you can borrow?

So they have a formula for how you get to decide how much money is going to be put into the values. So here's how they've decided how much you can borrow. You can borrow either up to 110% of the property's future. Okay, this is going to be determined by an appraiser, not by you by an appraiser. So if the appraiser says this home is going to be worth $200,000, you bought it for a hundred, you put 50,000 in repairs, and they say after that, it's going to be worth a hundred, let's say $200,000. They'll let you borrow 110%, which is $220,000. So that's the max that you can borrow. Okay. Or purchase price plus repair costs, whichever is less.

So it really comes down to whichever is less. So that example, I just gave them 110% if you said a hundred thousand dollars purchase price, $50,000 of repairs, you can't say, oh 110% of our future value is 220,000.

In more repairs, they won't let you do that. You have to put in your repairs first, and then if it's lower than that, they're going to take the lower amount. So in this example, they would use $150,000 as of the max value that you would draw a loan from.

Required: licensed contractor

Also, this is entirely required. Everybody I've talked to that does a 203k once to do the work themselves. They think that they're going, the bank's going to give them $30,000 and they get to play with it. It just does not work that way. It has to be a licensed contractor with a full-time business that's insured. So you might be able to get away with doing the work here on your own. If you can prove that you are a licensed contractor and you have a full business as a contractor, but if you just do contracting work on the side, even if you have a license it's going to be difficult to have a lender, allow you to do the work on your own because FHA guidelines say only 10% of the work can be sweat equity.

So what ends up happening with the 203k is you're going to have to partner with a contractor and you're going to tell the contractor, Hey, this is exactly what we want to do. Your contractor is then going to submit bids to you and to your lender. And they need to itemize every single thing that you want to be fixed.

It needs approval from the lender

The lender is going to be the one to approve or deny those repairs and help you calculate how much your total loan is going to be. So the contractor is going to make accurate bids for the work and send it to the appraiser for the projected value. The contractor and the appraiser are going to work together to figure out what's the after repair value and then how much of a maximum loan can you borrow from.

Expectations

First of all, I have to be complete. FHA 203k's are a bit of a nightmare. They sounded great on a YouTube video, right? Because if you look up two or three K videos, you're going to see people talking about how no money down, go and flip a home and make $50,000 tomorrow. All these crazy promises just don't really work out in the real world.

They are long and they're complex

If you're looking at closing this, I would expect 60 to 90 days to close this loan. Normally alone, close in 20 to 30 days, maybe 45 days expect 60 to 90 days for this loan to close. Write out your contract, have your realtor write out a contract for 60 to 90 days. They're just long.

Be ready with the paperwork

They involve a lot of paperwork in the lenders that do 203ks. Normally are a little bit slower. The lenders that are fast and get things done quickly, normally do that because they work on very clean loans. They don't work on rehab loans, just take time because you're going to be going back and forth with the contractor and bids and an appraiser and the lender. And you all need to be working together to get on the same page about what's happening with the loan.

Still needs to through the regular loan process

Not only that, but you have to go through the regular loan process. You're going to have to work with your lender to talk about quotes, send in documents, make sure that you go through underwriting, and get approved.

Work must begin within 30 days of closing

That's a requirement that you have there and then the work must be completed and re-inspected within six months. So you have your licensed contractor at most 30 days after the loan closes, they need to start the work and complete it within six months. And the lender is going to have an inspector come out and make sure the work is completed.

They need to make sure that this money that they gave to a contractor actually got finished and actually got done properly.

Rates is going to be higher that the traditional FHA loan

Also, you need to expect that rates are going to be higher than a traditional FHA loan. I would expect anywhere from one to two percentage points higher. So if on an FHA loan, you're getting a normal, let's say 4%. I would expect on a 203k you're probably going to be looking closer to a five and a half percent. Now that's not all bad. You got money to rehab a property. That's a pretty good rate for what you're using it for. And most of the time, what you're going to do with the 203k is you're going to refinance out of it into something like an FHA streamline or a conventional loan in the future.

203k is a bridge for Conventional loan

You just use the 203k as a rehab loan kind of short term. The 203k is more like a bridge than it is a 30-year loan. If you have a 203k loan for 30 years, you probably need to readjust your strategy. You're gonna have a two to three K let the value kind of season and meaning, stay in the property for a year or two, then refinance into something like a conventional loan or you might've well, just sell the property and make cash off.

Alternatives

Fannie Mae and Freddie Mac have their own rehab programs. One's called Homestyle. But you could also use something like a Cash Out or HELOC. This is only if you currently own a home. So let's say you own a home right now. You could pull out equity from your home to use as repair costs on an investment property. That's absolutely something that you could do.

If you want to rent it out

Something else to keep in mind is that 203k is a home that you need to live in. It's not something that you can use as an investment property necessarily. You actually have to move into the property after repairs are completed. And then like with most FHA loans, you want to stay in there for about a year. If you're, if you are going to rent it out, so stand there for a year to make sure you don't commit occupancy fraud, and then you can rent it out and use it as an investment.

Example

A house potentially worth $250,000, may sell for just 200,000 when it only needs $20,000 in repairs. So that leaves $30,000 in potential equity for a buyer, with the initiative and drive to manage the face.

Initiative and Drive

I think it really comes down to these two things initiative and drive. It's a great point to bring up when we're talking about 203ks, they're going to take work. They're going to be stressful. If this is your first home purchase, maybe you want to do a lot of research before you go into it. Get a lot of advice, make sure you're walking through everything as diligently as possible. Because when people see homes on the market that are in disrepair, most of the time, they don't want to purchase them. The only people purchasing them are people who have cash, or people who are doing rehab loans, most of the time.

Most people won't move-in ready homes. So if you're willing to put up with the struggle that comes with a fixer-upper, then great, a 203k might be great for you. It's probably going to be an advantage. If you have some home repair or contractor background, if you're just a handy person, then you won't necessarily be able to do the work. But you'll understand what's going on. Then after some of those bigger repairs are done, you can still do a little bit of minor work on the home after the loan closes.

Flow of the process

So to wrap it all up, let's talk about the flow of the process because it can be a little confusing. So here's eight steps to close on a 203k.

1. Apply

So the first thing is we're going to apply. They're going to apply with a lender and the lender that does 203k loans. Make sure you check that out upfront. Not all lenders do 203k loans.

2. Get under contracts

After you applied and got pre-qualified. You want to get under contract. So you're talking with a realtor. You found a home that you like that you want to do a 203k on, and then you get under contract for the home.

3. Get a contractor

After that, you're going to find a contractor. So call around interview some contractors and then find ones who could help you with a 203k. It's going to be bonus points. If they've done two or three cases before because they're familiar with the process.

4. Get bids

Then that talk with your contractor about what work you want to be done, and then get bids, itemized bids for every single thing in there. What walls are getting painted and what's happening to the kitchen. What's happening to the bathrooms what's getting done outside. What landscaping work is happening. You need to get that bid itemized, broken down, and detailed sent to the lender and the appraiser.

5. Finalize Loan Processing

Next, you want to finalize the loan processing. So your lender is going to reach out and say, Hey, we need things like pay stubs, W2's tax returns your driver's license, bank statements. They're gonna need all that stuff to process your loan like a normal FHA loan.

6. Close loan

After that, the loan is going to close.

7. Complete repairs

The contractor's going to complete repairs.

8. Move in

Then you can finally move in.

Will take a lot of work

You can probably tell 203ks are a bit involved. You want to work with a lender who's experienced with 203ks so you can navigate the process well. Overall, they're not a terrible loan, but they just take work. They're not going to be this golden dream that you're going to see a lot of people pitch. Because it's super fun to talk about 203Ks and all the potential of making money, but it does take work and you need to know that going in. You need to know what is happening.

Do your research

Don't let this be the article you read, go watch videos as well. Talk to lenders, talk to realtors, talk to contractors, get their opinion on what's going to work best, and then come up with a game plan that works for you and your family moving forward.

Talk with a loan officer
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