People who are willing to buy a fixer-upper and put some time and money into the property are often rewarded with a better home that is worth more. With 203k loans, home buyers can take advantage of funding backed by the Federal Housing Administration (FHA) to make fixer-upper properties easier to afford and upgrade.
203k Loan Basics
Many home buyers are aware of FHA loans, which are loans guaranteed by the government that allow lenders to offer certain applicants a better chance at qualifying for a home. A 203k loan is a type of FHA loan, in that it permits borrowers to use their mortgage loans to buy homes and make repairs or upgrades after they have closed on the purchase. For a standard FHA loan, buyers are required to obtain an appraisal, so that they know they are not paying far more than the home is worth. By comparison, 203k loans allow buyers to borrow more than the home is worth, so that they can pay for the improvements.
Getting a loan guaranteed by the FHA is often easier than obtaining a traditional loan, since the requirements are more generous considering income, debt, and credit. Although people can get an FHA loan with a credit score in the 500s, 203k loans demand a credit score of 620-640 or higher. The maximum debt-to-income ratio, including the future mortgage payment, must not exceed 43 percent of a person’s gross income. This is higher than the standard 36 percent for most traditional loans. Applicants can gain approval for 203k loans with a down payment as low as 3.5 percent, although it may depend on their credit scores. The FHA caps the closing costs that the buyer can be charged, which helps to limit the out-of-pocket expenses a borrower has to pay at closing.
When to Consider 203k Loans
Buying a fixer-upper and financing the vast majority of the work is not for everyone. It requires the ability to locate contractors for improvements, obtain bids, and determine how accurate those bids will be for the work needed. In some cases, it may take weeks or even months for the home to be ready to occupy, after the sale of the property is complete. However, buyers who have the time and the interest could use a 203k loan to customize the property in a way that will increase the home’s overall value, and make a home that is more pleasant to live in.
There are a couple of ways that 203k loans allow borrowers to determine how much money they will need in order to make the appropriate repairs and upgrades to the property. Buyers may be able to borrow up to 110 percent of the home’s estimated future value. They could also borrow the cost of buying the home plus the improvements they want to make, whichever is lower. As a result, buyers must be prepared to research the details fully, so that they know how much their projects will cost to finish.
Although buyers are given a fair bit of leeway to determine which kinds of upgrades they need to do, they must follow certain guidelines. People are allowed to make improvements that will make the home habitable and improve its value, but the upgrades must be permanent. As such, adding or renovating a bathroom may be allowed, but minor, temporary landscaping changes may not. These loans are also considered inappropriate for so-called “luxury” upgrades, like installing a swimming pool.
Buying a home to fix it up takes ambition, energy, time, and a good source of funding. For buyers who have the qualifications and the initiative to take on a project like this, 203k loans may prove to be a practical choice.