FHA 203(k) Loan Program Pros and Cons
Using one FHA home loan instead of two separate loans simplifies the financing process and saves you money and time. The program can be used for significant home improvement projects or a total tear-down, making it highly attractive if you are looking to buy or refinance a fixer-upper.
The FHA 203(k) Program offers borrowers multiple advantages including financing major home renovations with one mortgage, requiring a low down payment or equity contribution, financing based on the post-renovation property value and an attractive interest rate. Program disadvantages include the additional cost of FHA mortgage insurance premium, loan limits and extra closing costs.
We review the full list of the pros and cons for an FHA 203(k) loan below. Borrowers should understand both the positives and negatives of an FHA 203(k) loan to determine if it is the right program for them.
FHA 203(k) Loan Program Pros
Finance a Home Purchase or Refinance Plus Significant Home Improvements with a Single Loan
The FHA 203(k) Program enables you to finance the purchase of a home or refinance plus the cost of significant home improvements with a single loan as opposed to arranging a mortgage plus a second construction loan to finance the renovations. Using a single home loan instead of two separate loans streamlines the financing process and saves you money and time. Additionally, most construction loans are not long-term and need to be refinanced when the home improvement project is completed, which increases costs for the borrower. The FHA 203(k) Program offers borrowers a single, simple and more cost-effective solution for financing major home improvements, repairs or remodeling.
Attractive Interest Rate
The interest rate on FHA 203(k) loans is usually lower than the interest rate for other home improvement mortgage programs. The mortgage rate for an FHA 203(k) loan is lower because borrowers are required to pay mortgage insurance premium and the program is backed by the government, which provide additional protection for the lender in the event the borrower defaults on the loan. The lower interest rate reduces your monthly mortgage payment and potentially saves you thousands of dollars in interest over the life of the loan. Borrowers should compare lenders to find the FHA 203(k) loan with the lowest mortgage rate and closing costs.
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Low Down Payment / High Loan-to-Value (LTV) Ratio
In the case of a home purchase, the FHA 203(k) Loan Program only requires that borrowers make a down payment of 3% of the property purchase price, which is significantly lower than the 10% - 20% required by other standard mortgage or construction loan programs. In the case of a refinance, the program only requires that borrowers have 2.25% equity in the property which implies a loan-to-value (LTV) ratio of 97.75%. Requiring a low down payment or equity position in a property makes the FHA 203(k) Program an attractive home improvement financing option for borrowers who struggle to save money to buy a home or who have limited home equity.
Financing Based on Post-Improvement Property Value
In many cases lenders do not provide a mortgage based on the value of the property after the home improvements have been completed which means that borrowers qualify for a smaller mortgage and are required to arrange a separate loan to finance the home renovation project. Only after the project has been completed can borrowers refinance their mortgage and separate loan based on the higher, post-improvement property value. The FHA 203(k) Program, however, allows you to arrange a mortgage based on the post-improvement property value. For the purpose of qualifying for an FHA 203(k) loan, the property value is defined as the pre-renovation property value plus the estimated cost of improvements or 110% of the appraised post-renovation property value, which is less. Using the higher post-renovation property value enables borrowers to qualify for a larger mortgage and also eliminates the need to arrange a separate construction loan.
No Restrictions on Mortgage Type
The FHA 203(k) Program can be used for both home purchase loans and refinances. Although the program is typically used to buy homes that require significant repairs or renovations it is also useful for borrowers who are seeking to refinance their existing mortgage and implement a major home improvement project at the same time. Borrowers with high loan balances and limited equity in their homes may find it challenging to qualify for a construction loan, home equity line of credit (HELOC) or home equity loan to finance a home improvement project. Borrowers in this situation, however, can use a FHA 203(k) loan to both refinance their existing mortgage and finance their home renovation.
FHA 203(k) Loan Program Cons
Up-Front and Ongoing FHA Mortgage Insurance Premium (MIP)
FHA 203(k) Program participants are required to pay an up-front and ongoing monthly FHA mortgage insurance premium (MIP). FHA MIP pays for insurance that protects lenders in the event that borrowers default on their mortgage. Although it can be added to the mortgage amount, the upfront MIP increases your closing costs while the ongoing monthly fee increases your total monthly housing expense. The upfront FHA MIP for most loans is 1.75% of the mortgage amount while the ongoing fee depends on the loan amount, loan-to-value (LTV) ratio and mortgage term. The FHA MIP is discounted if the home meets certain energy efficiency requirements, which is particularly relevant for FHA 203(k) Program participants who are looking to finance energy efficiency home improvement projects. MIP is an extra cost that borrowers do not pay with standard mortgage programs although most programs require borrowers to pay monthly private mortgage insurance (PMI), which is similar to the ongoing MIP, if your loan-to-value (LTV) ratio exceeds 80%. Before selecting an FHA loan, borrowers should understand how MIP impacts their upfront and ongoing mortgage costs.
FHA Loan Limits
Your FHA 203(k) mortgage amount cannot exceed the FHA loan limit for the county in which the property is located. FHA loan limits vary by county and by the number of units in the property being financed. In the contiguous U.S., FHA loan limits for a single unit property such as a home or condominium range from $472,030 to $1,089,300 for high cost areas and the limit for a four unit property ranges from $907,900 to $2,095,200. In Alaska, Hawaii, Guam and the U.S. Virgin Islands loan limits range from $1,633,950 for a single unit property to $3,142,800 for a four unit property. Home buyers who live in higher cost counties may find that the FHA 203(k) loan limits restrict their housing options. The limits are less of a factor for borrowers looking to buy more affordable homes.
Extra Documentation and Closing Costs
The FHA 203(k) Program requires borrowers to submit to the lender architectural, design or engineering plans for the home improvement project. Preparing these plans can be costly and time consuming. Additionally, due to the additional work required to review and process an FHA 203(K) loan, most lenders charge a supplemental origination fee which is an extra closing cost borrowers are required to pay. Some appraisers may also charge higher fees because they are required to appraise the property both before and after the home improvement project is completed. Borrowers should understand any additional lender or third party closing costs before selecting a lender.
More FREEandCLEAR Resources
FHA 203(k) Loan Guide
Review our comprehensive overview of the FHA 203(k) Home Loan Program including borrower qualification requirements and other important program information such as property eligibility, home improvement project guidelines and FHA loan limits.
FHA Mortgage Rates
FHA 203(k) loans are provided by traditional lenders such as banks, mortgage banks, mortgage brokers and credit unions. Use our FHA rate table to find lenders that offer the FHA 203(k) Loan Program and to review updated FHA mortgage rates and fees for lenders in your area. Comparing rates from multiple lenders is the best way to save money on your mortgage.
Fixer-Upper and Home Improvement Mortgage Program Summary
Review and compare key program features and eligibility requirements for multiple fixer-upper and home improvement mortgage programs so that you can select the financing option that is right for you.
Sources
"203(K) Rehab Mortgage Insurance." Federal Housing Administration. U.S. Department of Housing and Urban Development, 2020. Web.