So you want to buy a fixer-upper
Buying a home that needs some TLC can be a good choice.
Fixer-uppers come with less competition from other buyers, and you can build tens of thousands of dollars in additional equity in a short time by making relatively minor improvements.
But there’s a reason not as many people want to buy a fixer-upper. It does take more work, planning, and time compared to buying your standard “turn-key” home.
Up for the challenge? Then rewards await. Here are your first steps.
What is an FHA 203k loan?
An FHA 203k loan (sometimes called a Rehab Loan or FHA Construction Loan) allows you to finance not one, but two major items:
- The house itself
- Needed repairs and modernizations
This loan addresses a common problem when buying a fixer home: Lenders often won’t approve loans for homes in need of major repairs.
Because the lender tracks and verifies repairs when using a 203k loan, it is willing to approve a loan on a home it wouldn’t otherwise consider.
That said, for a lender to approve financing, the home must already meet certain safety and livability standards. This will be determined primarily by the FHA home appraisal.
If the home is too run down, you won’t be able to use an FHA 203k rehab loan.
This loan program can be a good option for borrowers on a tighter budget and first-time home buyers who want to buy an older or run-down home and repair it, rather than buying a more expensive turn-key home.
How does the 203k loan program work?
The process for an FHA 203k loan is like that of regular home buying, with some modifications:
- Apply with a 203k-approved lender
- Get approved for the loan
- Choose a contractor
- Get bids (estimates for the repairs)
- Close the loan
- Complete repairs
- Move in
Receiving a final approval involves lining up contractors and receiving bids, and some additional hoops to jump through.
Don’t get stressed at this process, though. The 203k lender will drive the approval process and guide you through. You’re not on your own!
Choose your projects
The first step is deciding which home improvements or modernizations you want to do (see qualifying repairs below).
The lender will require any safety or health hazards to be addressed first — repairs like mold, broken windows, derelict roofing, lead-based paint, and missing handrails.
From there, choose which cosmetic improvements you want to take care of.
For instance, say you want to replace appliances, add granite in the kitchen, and gut the bathroom. Those are all qualifying projects for this remodel loan.
Choose your contractors
Once you’ve got your project list together, find contractors.
The contractors must be licensed and insured, and typically have to be in full-time business. You can’t use buddies who do construction on the side, and you typically can’t do the work yourself unless you’re a contractor by profession.
Best results will come from super-experienced and professional remodeling firms that have done at least one 203k renovation in the past.
Remember: Your entire project can be held up by one contractor that is unwilling to complete the necessary forms.
You might even go so far as to write the 203k paperwork requirements into the contractor agreement.
Get your bids
Once your contractor is on board with helping you complete your loan, get official bids. Make sure the bids aren’t guesses. They must be completely accurate.
The reason is that the lender will submit final bids to the appraiser, who builds the value of the work into the future value of the property, upon which your loan is based.
Changing bid dollar amounts later could incur additional appraisal costs and trigger re-approval with the lender. Again, make sure your contractor knows all this!
Submit everything to the lender
By this point, the lender will have your income, asset, and credit report information. Once it has all the required bid paperwork, your loan can go to final approval.
Close the loan
You will sign final mortgage documents, and the house is officially yours.
Contractor starts work
Once the loan is finalized, the contractors can start the home improvements. Depending on the extent of the repairs, you may be able to move in at the same time.
For bigger projects, arrange to live somewhere else until work is complete. You can finance up to six months of mortgage payments into your loan amount to allow room in your budget to do so.
Move in and enjoy
The work is complete, and you’re the owner of a beautiful new home.
You’ve probably built a ton of home equity in a short time, and you didn’t have to engage in a bidding war to buy your ideal home.
FHA 203k loan requirements for 2022
A 203k is a subtype of the popular FHA loan, which is meant to help those who might not otherwise qualify for a mortgage.
FHA’s flexibility makes qualifying for a 203k loan drastically easier than for a typical renovation loan.
203k credit score requirements
FHA allows credit scores as low as 580, although some lenders might require a score of 620-640 to qualify for a 203k loan.
Still, that’s much lower than the 720 or higher you would probably need for a conventional construction loan.
Minimum down payment
FHA requires just a 3.5% down payment, based on the purchase price and total project cost. For instance:
- Home price: $200,000
- Total project cost: $25,000
- Down payment: $7,875 (3.5% of $225,000)
You can receive 100% of your down payment requirement via a gift from family or an approved non-profit organization.
Income and debt requirements
Lenders will examine your debt-to-income ratio, too. This is the comparison of your monthly income and debt payments.
Typically, less than 43% of your income should go toward your proposed mortgage payment plus all other debts.
That’s $430 in payments per $1,000 of pre-tax income.
For example, if your income is $5,000 per month, your future house payment plus auto loan payments, student loan payments, and credit card bills shouldn’t exceed $2,150 per month.
Using an FHA 203k loan, you can borrow up to 110% of the property’s proposed future value, or the home price plus renovation costs, whichever is less.
But keep in mind that your total loan amount can’t be higher than your region’s FHA loan limits.
You must plan to live in the property you are buying. If you plan to fix and flip as an investment property, the 203k loan isn’t for you.
All FHA loans are available to U.S. citizens and lawful permanent residents. Lenders will verify citizenship status at the time of application.