For many borrowers, an FHA 203(k) loan is the best way to get a mortgage. That’s because the government insures these loans, making them far easier to obtain. An FHA 203(k) loan allows borrowers to get a loan for one of the following reasons:
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- Home purchase
- Home renovation
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Therefore, an FHA loan 203(k) is often compared to a construction loan. The loan is excellent for people with low credit scores and low down payment savings. You can find lenders offering FHA 203(k) loans via the lender search tool. Alternatively, some people refer to these loans as a purchase plus improvements mortgage.
How Does an FHA 203(k) Loan Work?
The loan encourages low- to middle-income families to purchase homes that aren’t in the most excellent condition. These houses are often in older communities and need urgent repairs. The loan enables individuals to purchase a home and renovate the home via an adjustable-rate mortgage or a fixed mortgage.
In most circumstances, lenders are unwilling to provide a mortgage for homes in poor condition. Of course, these homes are often unlivable and provide terrible living conditions. However, because the government backs FHA 203(k) loans, lenders are far more confident about giving mortgages on homes needing repairs.
What Are the Various Types of 203(k) Loans?
There are two types of 203(k) loans — the standard 203(k) and the limited 203(k). Note that these loan options only apply to borrowers looking to make the home their primary residence. In turn, house flippers and real estate developers will not qualify for either loan.
Limited 203(k)
Limited 203(k) loans are perfect if borrowers need minor work on the home. For example, the loan does cover structural work, which may include adding new rooms or landscaping. However, the home must also be liveable during the entire construction process. As a result, the maximum borrowing amount is $35,000.
Standard 203(k)
Standard 213(k) loans are ideal for borrowers needing extensive repairs. The minimum borrowing amount on a standard 203(k) is $5,000, and there is no cap on repair costs. This loan will cover various repair costs including plumbing, heating, air conditioning, kitchen remodeling, and flooring work. However, the loan doesn’t cover extravagant repairs such as swimming pools, etc.
You should speak with an FHA 203k loan consultant to find the best option for you.
How to Qualify for a 203k Loan from the FHA
You can get an FHA 203(k) loan via a bank or a credit union. Either way, these loans are accessible for many borrowers. Not all lenders will offer FHA 203(k) loans, but many will. It’s important to note that borrowers still need to obtain home insurance on the property when they use this loan. Here are some requirements for an FHA 203(k) loan:
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- Credit score – Borrowers tend to require a credit score of at least 500 to qualify for an FHA 203(k) loan, but some lenders may ask for a higher credit score
- Down Payment – Lenders will want a minimum downpayment of 3.5 percent on an FHA 203(k) loan. Of course, the larger the down payment, the better! If your credit score is between 579 and 500, you’ll have to place a 10 percent down payment.
- Loan limits – The FHA does have loan limits depending on your location. As a result, you’ll have to research the loan limits in your county. Your desired home might be too expensive for an FHA 203(k) loan.
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Here are some other requirements:
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- You’ll need to live in the home that you decide to finance
- Your debt-to-income ratio can’t be higher than 50% if you have a credit score of 580 and lots of cash reserves
- You can’t be a delinquent on federal tax
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Pros and Cons of FHA 203(k) Loans
As with any loan, borrowers need to assess various pros and cons before they sign any documents. Here are some of them:
Pros of Getting an FHA 203(k) Loan
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- You don’t need a high credit score – Lenders don’t require a solid credit score when applying for an FHA 203(k) loan. Therefore, these loans are an option for anyone with financial troubles or first-time buyers. As a result, you can get an FHA 203(k) loan with credit scores lower than 620. In contrast, many conventional lenders will require a 620 credit score as the absolute minimum.
- You don’t need a large down payment – loans require a large down payment, but an FHA 203(k) loan isn’t necessarily one of those. A considerable benefit of an FHA 203(k) loan is the ability to obtain assistance from close friends, families, and employers when making your down payment. Many conventional lenders don’t allow borrowers to receive contributions to their downpayment.
- Various housing options – Borrowers can apply for an FHA loan on multiple types of housing. These include single-family homes. You can even get an fha 203k loan for a duplex. In contrast, many conventional lenders are strict about the houses you can apply your loan towards.
- You can get cheaper monthly mortgage insurance with low credit scores – Monthly mortgage insurance can be a massive annoyance to many borrowers. It can add up and present unwanted monthly costs going forward. However, when you obtain an FHA loan, you can get cheaper monthly mortgage insurance costs (even with low credit scores).
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Cons of Getting an FHA 203(k) Loan
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- Lower loan limits – The FHA sets its loan limits every year. Therefore, this could impact how much you can buy with FHA loans, particularly in expensive areas. Generally speaking, FHA loan limits are 65 percent of an area’s conforming loan limits.
- You’re limited to primary residences only – You can only get an FHA loan to buy a house you’re going to live in. So, if you’re looking for a vacation home or property investment, you’ll have to obtain a conventional loan instead.
- You can’t do the work yourself – What if you’re a builder or an expert at repairing houses? Unfortunately, when you obtain an FHA 203(k) loan, the loan doesn’t allow you to do the work yourself.
- Loan approval can be very slow – If you’re looking to move fast and get a mortgage asap, you might not enjoy trying to get an FHA 203(k) loan. These loans can sometimes take up to six months to obtain, an awkward time frame for many borrowers.
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Final Thoughts
An FHA 203(k) loan is an excellent option for homebuyers looking to hire others to work on their homes. It’s also a terrific option for anyone with low credit scores, first-time buyers, and borrowers who can’t commit to large down payments. However, there are many pros and cons of an FHA 203k loan to consider.
As with any type of mortgage, it’s essential to talk with your lender to determine whether it’s the best option for you. You could always find an FHA 203k loan consultant to guide you through the process.
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