The FHA 203(k) loan is a unique product that allows would-be homeowners who don't have a lot of cash to buy a property in need of repairs. But when you combine the red tape of government agencies with the additional financial risks associated with average people (people who aren't experienced with home rehabs) buying a property in poor condition, the 203(k) loan can be one of the most challenging mortgages to get approved for. Outlined below is the process and what to expect.

Key Takeaways

  • An FHA 203(k) allows a homeowner to finance repairs and is one of the only loans offering such a capability.
  • There are two types of 203(k) loans, a regular and streamlined. Regular 203(k) loans are for properties that need structural repairs, while a streamlined loan only needs non-structural repairs.
  • 203(k) loans are not very common, so many lenders either won't know how to process them or won't want to deal with the extra paperwork and hassle involved.
  • 203(k) loans require a rehab proposal that describes the work to be done on the property and provides an itemized cost estimate for each repair or improvement.

Have Enough Cash

As of 2020, you only have to come up with a down payment of 3.5% of the home's purchase 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%. So if you were buying a house with an asking price of $150,000 and needed repairs of $15,000, you would need 3.5% of $165,000, or $5,775, as your down payment.

Be a Solid Loan Candidate

Of course, you'll also have to meet the usual borrower requirements for a Federal Housing Administration (FHA) loan, like having a steady, verifiable income and a good credit score.

But otherwise, as long as you can make the monthly payments on the property you want to purchase, there are no further special requirements to qualify for this loan. Just remember that it's for owner-occupants only, not investors.

Pick a 203(k) Loan

Before you apply, determine which type of loan you'll need. There are actually two types of FHA 203(k) mortgages: the first is called "regular," and it's meant for properties that need structural repairs.

The second is called "streamlined" or "modified." It's designed for properties that need only non-structural repairs. Your real estate agent or lender can help you make this determination. Of course, if you don't know the difference between structural and non-structural repairs, a rehab project might be too much to take on.

Choose a Lender

When applying for a government-subsidized mortgage, whether it's a VA loan, FHA loan, green mortgage, or FHA 203(k) loan, your choice of lenders will be somewhat limited. FHA 203(k) loans in particular are not very common, so many lenders either won't know how to process them or won't want to deal with the extra paperwork and hassle involved. Since the loan application process for 203(k) loans is complex, you definitely want to work with a lender who has experience with this specialty loan product.

Not all lenders are approved to handle 203(k) loans. The FHA must grant lenders permission to offer them. To find an approved lender, see the approved lender search tool on the Department of Housing and Urban Development (HUD) website. Make sure to check the box at the end of the page to limit your search to lenders who have done 203(k) loans in the last 12 months.

Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).

Create Your Rehab Proposal

In addition to the usual mortgage loan application requirements, such as proof of income, proof of assets, 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.

You don't have to hire professionals to do the repairs, but the FHA says that the work must be completed to professional standards and in a timely manner. Also, if you plan to do the repairs yourself, you can't use the loan to pay yourself for your labor. You can only use the loan toward the cost of materials if you'll be doing the work yourself.

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. So 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.

Even if you are going to do the work yourself, your proposal must still include the cost of labor. Why? Because if something goes wrong and you have to hire professionals, the FHA wants you to have the money to hire them.

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 once 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.

Hire Help

Some people choose to hire a specialist called a 203(k) consultant to help them complete all the extra paperwork required for this type of loan, 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 example, for a home requiring $15,000 to $30,000 of repairs, HUD does not expect the consultant to charge more than $600. However, it is perfectly acceptable to complete all the paperwork yourself, although you'll probably want some input from your potential contractors.

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 continuing to 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.