Homeowners

FHA Loans for Home Renovations: A Guide for Homebuyers

Maybe you fell in love with the worst house on the best block or a stunning, century-old home in need of a lot of work. Or you’re finding that you can only afford a fixer-upper.

If you're considering purchasing a home that needs pricey repairs or updating, a Federal Housing Administration (FHA) 203(k) loan for home renovations might be a solution.

These loans allow you to finance both the purchase and renovation costs in the same loan.

"The FHA 203(k) is an amazing product to use and it's underused," said Dusty Lloyd, a loan officer for New American Funding based in Dana Point, Calif.

What are FHA loans for home renovations?

FHA 203(k) loans are designed to help homebuyers with lower credit scores and smaller down payments. The mortgages are backed by the Federal Housing Administration.

There are two types of FHA renovation loans: the Standard 203(k) and the Limited 203(k).

The Standard 203(k) is intended for major home renovations, while the Limited 203(k) is better for smaller repairs and improvements.

The benefit of these loans is that they simplify the process. Both the home purchase and the renovations are funded under one mortgage. This means you won't have to worry about securing separate loans for the renovation.

"You can do it all in one loan and the benefit is that you [may] only have to put 3.5% for a down payment," said Lloyd. The exact amount of the down payment will depend on your credit score and other criteria lenders will consider.

What can you renovate with an FHA 203(k)?

One of the greatest advantages of FHA loans for home renovations is the wide range of eligible improvements.

You can use it to fix health and safety issues, make structural alterations, or upgrade your home's energy efficiency. For example, you can use the loan for repairs to plumbing, roofing, heating, or electrical systems. You can also upgrade a kitchen, add a new garage, or make the property more accessible for those with disabilities.

It's important to keep in mind that the renovations must improve the home's functionality and meet FHA's Minimum Property Requirements (MPR).

This means you can't renovate for purely aesthetic purposes. The rehab must enhance things like safety, livability, or energy efficiency.

How does the FHA 203(k) work?

Once you've been approved for an FHA 203(k) loan, the funds are divided into two parts. A portion goes toward paying for the home purchase price, while the remaining funds are placed in an escrow account.

The money in the escrow is released to the contractor as the renovation work is completed. The loan is then paid off over time, like a typical mortgage.

This process ensures that both the buyer and the lender are protected.

The lender is guaranteed that the home will meet certain standards before it's finished, while the buyer can secure a home in need of renovations.

"You have two options: finance [the renovations] or spend weekends asking your buddies to fix it,” said Lloyd. “And we all know how that goes."

Who is eligible for FHA renovation loans?

FHA loans are accessible to many homebuyers, even repeat homebuyers and those with less-than-perfect credit.

To be eligible for a 203(k) loan, you need to meet the general FHA requirements. Your debt-to-income ratio can be no higher than 57%. And you will need a credit score of at least 580 to qualify for a 3.5% down payment.

However, if your score is lower, you might still qualify with a higher down payment. The minimum score to use the loan is 500, although some lenders may require higher credit scores.

The home must also be at least one year old. And the renovations should align with FHA's guidelines.

What are the limitations of FHA renovation loans?

While FHA 203(k) loans offer benefits, they also come with limitations. For example, the loan amount is capped based on the home's location and the estimated cost of renovations.

Also, finding the right contractor who meets FHA's requirements can sometimes be challenging. Plus, closing with an FHA 203(k) loan may take longer than if you used a traditional mortgage.

Additionally, the renovation process can take longer than expected, which might disrupt your plans for moving into the home sooner.

Despite these hurdles, FHA renovation loans may help you find the home you always wanted.

"Always look for the worst house on the best block. You can make it look prettier, you can add on, but you can't change where it is,” said Lloyd. “That's how you get your dream home, by focusing on the location, not just the condition.”

Dusty Lloyd NMLS # 247106