If you’re a homeowner, you may have heard the term 203k loan used when reviewing financing options available for your home purchase. 203k loans are guaranteed by the Federal Housing Administration, or FHA, and are a bit different than your typical home mortgage loan. With a 203k loan, new homeowners are not only financing the purchase of their home but also any needed home improvements. This type of loan addresses a common problem in the housing marketing for buyers who might be discouraged from buying a property because of the potential costs to repair it.
Before you decide on which type of home loan is best for you, though, it’s important to take a deeper dive into the features and eligibility requirements of a 203k loan to see if it’s right for you.
What is a 203k loan?
Unlike traditional home loans that can only be used for the purchase of a property, 203k loans will enable you to finance two major items — the property itself and also any necessary repairs. FHA 203k loans are designed to encourage families to purchase properties, typically in communities with older homes, with the goal of renovating them to newer, more modern standards.
One of the significant benefits of a 203k loan is that homebuyers can finance their home purchase and renovations in one transaction. 203k loans are typically easier to acquire than traditional loans because the lender can track and verify all repairs as they’re made. This differs from taking out a home equity loan or another form of credit separately to fund a repair project. The added transparency into repairs means there is less risk involved, and lenders are more likely to approve 203k loans for applicants with lower credit profiles, plus they can offer more attractive interest rates.
Who is eligible for a 203k loan?
While 203k loans are available to anyone that wants to apply, they are mostly used by first-time homebuyers due to their flexible requirements and payment options. The one eligibility requirement to apply for a 203k loan is that you must live or plan on living in the home you’re financing, meet the minimum credit profile rating, and make a 3.5% payment on the loan amount. FICO scores of at least 620 are typically required to be approved for a 203k loan. However, homebuyers with lower than average credit ratings may still be approved for the loan by meeting further requirements.
What does a 203k loan cover?
When applying for a 203k loan, it’s important to note that there are two different loan formats to choose from. Depending on the extent of the repair work necessary, one type may be more applicable than the other.
Limited 203k mortgage loans, also known as 203k Streamline loans, are best suited for homeowners who only need to make cosmetic repairs like renovated kitchens and bathrooms. The types of loans are limited to costs of up to $35,000 and only allow non-structural or non-luxury items. These repairs can include appliance replacements, kitchen and bathroom repairs, flooring, painting, energy-efficient improvements and other similar repairs.
203k standard loans are formatted to be the opposite of limited 203k loans and only allow repairs on structural aspects of the property. This includes broader landscape and structural alterations and can consist of adding or removing foundations, upgrading plumbing, improving accessibility and even relocating the house.
203k loan alternatives
While 203k loans can be an excellent choice for new homebuyers, they aren’t always the best solution, and not everyone may have the ability to get approved. Thankfully, there are other alternative financing solutions available if a 203k loan isn’t the best fit, including:
Home equity loan
Home equity loans are another option some homeowners have when they’re in need of funds for home repairs. To qualify, you’ll need to have built some home equity, which is what makes up the difference of how much you still own on your home and what its current market value is. These loans are usually accessible directly through your bank or mortgage broker and can be a great option to help do repairs and build additional equity in your property down the road.
Keep in mind that these loans are based on the equity in your home, which you build up as you pay off your mortgage. This may take a few years to be a feasible option, and if you do take advantage of this type of loan, you need to be sure you can pay it back. Otherwise your house will be at risk of foreclosure.
A home equity line of credit, or a HELOC, is similar to a second mortgage but works more in the way a credit card works. A HELOC allows you to access funds that you borrow against the equity of your home. Rather than needing to receive all funds at once, though, a HELOC enables the borrower to draw funds only when needed. The benefit of a HELOC is that there are no restrictions on how you spend the money you borrow, and you can borrow against your HELOC multiple times. Your line of credit will be restored when you pay back the principal, or you can opt to pay just the interest during the draw period. Homeowners can use the funds to pay for renovations, buy a car, pay for a wedding or manage other expenses. Interest charged on a HELOC is typically lower than what you would spend on a credit card and funds cannot exceed the amount of credit issued.
Conventional loans are another alternative to 203k loans and typically offer the best mortgage rates and loan terms. The largest difference between conventional and 203k loans is that conventional loans do not provide you with the ability to finance any needed home repairs. While homeowners can certainly use a conventional loan to finance the purchase of a fixer-upper home, they will need to use a secondary financing method, like a home improvement loan, in order to pay for any repairs required.
Fannie Mae HomeStyle Loans
Homestyle loans are very similar to 203k loans in that they are both considered renovation loans with minimum down payment requirements and flexible terms. While the Federal Housing Administration insures 203k loans, HomeStyle loans are guaranteed by Fannie Mae. Where the two loans differ is in their leniency and strictness when dealing with first-time homebuyers. Fannie Mae HomeStyle mortgages, although very flexible in design, are a bit more strict when it comes to minimum credit requirements and down payment. However, both loans are great solutions if your goal is to combine the financing of both your home purchase and needed repairs.
The bottom line
FHA 203k loans offer a unique opportunity for new homebuyers to get the financing they need to find the right home for their budget, with the flexibility to customize it to their liking. 203k loans give future homebuyers more options when it comes to choosing the neighborhoods they want to live in and the means to quickly build equity as they gradually improve the value of their property. While 203k loans may not be for everyone, they are an excellent choice for those new to the housing market or with less than perfect credit, and many times are a more realistic financing option than taking out separate home repair loans.