The Rehabbers’ Guide to 203(k) Loans

Tight-fisted lenders have made home equity loans harder to come by. So what’s a fixer-upper to do? Meet the 203(k) loan.

Lenders' weak stomach for extending credit doesn't have to sour your upgrade dreams.

The old but new again FHA 203(k) loan rolls remodeling and mortgage costs together, whether you’re buying or refinancing an existing home loan to pay for upgrades.

First, Some 203(k) Basics:

• 15- or 30-year term option
• ARM or fixed-rate option
• 3.5% down payment for loans of $625,500 or under and 5% for loans above $625,500; other FHA loan qualifications apply
• Interest rate a tad higher than market
• Higher fees compared with equity or other FHA loans, for such things as title checks, architectural plan reviews, appraisal, and FHA inspections 
• No balloon payment
• Loan amount = projected value post-rehab, including the cost of the work
• FHA loans take longer to close than conventional mortgages
• More paperwork than a straight mortgage loan

Now, 13 Rules for What You Can and Can't Do with a 203(k):

1. You can buy a fixer-upper so awful it wouldn’t qualify for a regular home loan. Whether buying or refinancing, all that needed work might keep your home from qualifying for a regular bank loan. Banks don’t finance homes in ill repair because they’re too hard to resell if they have to take the house back via foreclosure.

2. You can DIY with a 203(k) if you can show you know how to DIY. You can do the work yourself, or act as your own general contractor, if you can prove you’ve got the chops, and can get the job done on time (the maximum timeframe is six months). Of course there’s a catch: When you DIY, you can only use the 203(k) proceeds for supplies. You can’t pay yourself to do the work on your own house.

3. You can use a mini 203(k) for mini-sized projects. If you’re just doing your kitchen, bathroom, or another project that costs $35,000 or less, there’s a streamlined version of the 203(k) designed just for limited-size projects.  

4. You can’t use it to buy a new-construction home. The house you’re fixing up has to be at least a year old.

5. You can’t use it to buy and install a new toilet, even one of those fancy Totos. You have to spend at least $5,000 on your renovation to use the 203(k) program. And the whole mortgage, including those remodeling costs, has to be under the FHA mortgage limit for the area where you live. 

6. You can expect the lender to be up in your grill about how and when the home improvements get done. An inspector will be dispatched to your home multiple times to check in on the progress, which is why rule #7 is so important.

7. You have to keep your contractor from going on a long vacation to Europe.

• Your contractor has to start work within 30 days of the loan closing.
• He can’t stop working on the project for more than 30 days.
• He has to get the whole job done within six months.

Doing it yourself? The same timelines apply. So no long vacations for you until the work gets done.

Related: 5 Essential Questions to Ask Before Hiring a Contractor

8. You can use the loan to make your mortgage payments if you can’t live in the house until the work is done. This is one sweet provision of the 203(k) program because it means you don’t have to make a mortgage payment on the home you’re remodeling and pay to live somewhere else while the work is going on.

You can use the 203(k) loan to pay for up to six months of principle, interest, taxes, and insurance payments when your property is going to be uninhabitable because of the renovation work.

9. You can use it to make energy-efficiency upgrades like installing a new furnace, windows, or attic insulation. You can get a 203(k) loan to pay for 100% of the cost of energy-efficiency improvements. You don’t have to get those improvements appraised, but they do have to be cost-effective, meaning they’ll pay for themselves over their useful life. The HUD inspector will make the call.

10. You can rip the house down if you plan to build something in its place. As long as you keep the foundation of the home, you’re good to go. 

11. You can have a little shop downstairs. It’s kosher to use a 203(k) loan to remodel a home that includes some commercial space, as long as you use the money only for projects in the residential part of your home and the amount of commercial space doesn’t exceed these limits:

• 25% for one-story building
• 49% for two-story
• 33% for three-story building

12. You can use a 203(k) for a condo unit, but . . . your condo building must have FHA approval — which is tough to get these days — or meet VA, Fannie Mae, or Freddie Mac guidelines. Also, your building can have no more than four units, though there can be multiple buildings in the association.

13. You can’t break these rules or the lender can take its money back. Like immediately. Your lender can also refuse to advance you any more money or apply any money left in the escrow account to reduce what you owe on the mortgage.