How to Apply for an FHA 203(k) Loan

An FHA 203(k) loan allows would-be homeowners who don't have a lot of cash to buy a property in need of repairs. FHA 203(k) mortgages are backed by the government and essentially finance both the purchase and repairs on a home.

These loans are intended to support homeownership among lower-income households, allowing them to improve and update older properties as their primary residences. For eligible borrowers, an FHA 203(k) loan is often the only way to finance a property needing significant repairs, but there is a lot of red tape involved. Outlined below is the process and what to expect.

Types of 203(k) Loans

There are actually two types of FHA 203(k) mortgages. The first is called "standard," and it's meant for properties that need extensive and structural repairs. The cost of the rehabilitation must be at least $5,000.

The second is called "limited." It's designed for properties that need only non-structural repairs. Your real estate agent or lender can help you make this determination. Repairs under a limited 203(k) loan are capped at $35,000.

FHA 203(k) Loan Eligibility

You'll have to meet the usual borrower requirements for a Federal Housing Administration (FHA) loan, like having a steady, verifiable income and a minimum credit score. As of 2021, you'll need to come up with a down payment of 3.5% of the home's purchase price plus repair costs if you have a credit score of at least 580. If your credit score is between 500 and 579, you'll have to put down 10%. This means that if you are buying a house with an asking price of $150,000 and need repairs of $15,000, you will need 3.5% of $165,000, or $5,775, as your down payment (or $16,500 if your credit score is between 500 and 579).

Only owner-occupants, not investors, can apply for an FHA 203(k) loan, and borrowers who qualify are required to purchase mortgage insurance. An FHA loan requires that you pay two types of mortgage insurance premiums (MIPs)—an upfront MIP and an annual MIP (which is paid monthly). Annual MIP payments are required for either 11 years or the life of the loan.

Choose an FHA-Approved Lender

The FHA doesn't actually lend borrowers money for a mortgage. Instead, you get a loan from an FHA-approved lender—a bank, a credit union, or another financial institution.

When applying for a loan through a government program, whether it's a VA loan, an FHA loan, or an FHA 203(k) loan, your choice of lenders will be somewhat limited. But because the 203(k) loan application is complex, you definitely want to work with a lender who has experience with this specialty loan product.

Create a Rehab Proposal

In addition to the usual mortgage loan application requirements, such as proof of income and credit reports, the 203(k) loan application requires the creation of a rehab proposal. The rehab proposal must describe the work to be done on the property and provide an itemized cost estimate for each repair or improvement. Architectural exhibits, such as a plot plan and proposed interior plan, are required for any structural repairs.

HUD's checklist will help guide you through the items your proposal should address. The checklist covers every area of the home that might need repairs, from gutters and driveways to flooring and windows.

If you hire contractors to do the work, in most cases, they must be licensed. If you plan to do the repairs yourself, the work must be completed to professional standards, in a timely manner, and you can't use the loan to pay yourself for your labor. You can only use the loan toward the cost of materials.

If this sounds like a bum deal, remember that borrowed money, even at a low interest rate, is not free money—it's money that you'll have to pay back, with interest. As long as you know what you're doing and can afford to spend the time on the project, you can come out ahead by doing the work yourself. Also, you may be able to use the money you save by not hiring contractors to make additional improvements to the property that you couldn't otherwise afford.

Get an Appraisal

The home you want to buy must be appraised as it would be for any loan, except that the appraiser must estimate what the value of the home will be after the repairs and improvements are made. An as-is appraisal may also be required, but sometimes the purchase price can stand in for the as-is appraisal.

203(k) Consultants

For a standard loan, borrowers are required to hire a 203(k) consultant to help them complete all the extra paperwork required, such as preparing architectural exhibits. The fee to hire such a consultant can be included in the mortgage, provided it does not exceed limits established by HUD.

For a home requiring $15,001 to $30,000 of repairs, for example, HUD does not expect the consultant to charge more than $600.

Borrowers seeking a limited loan can also choose to hire a 203(k) consultant, but the cost cannot be rolled into the loan. It is perfectly acceptable to complete all the paperwork yourself, although you'll probably want some input from your potential contractors. You can search for approved consultants on HUD's website.

The Bottom Line

The FHA 203(k) application process is a lot of work, to be sure. If it seems like too much trouble, you might be better off continuing to search for a home that's closer to move-in ready or save until you can afford a nicer place. But if you have the time, energy, and patience, the 203(k) loan is often the only way to finance the purchase of a property needing significant repairs. Otherwise, you'll need to have enough cash to pay for the property and the repairs outright.