Two men working on a home project
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Got your eye on a fixer-upper or a foreclosure home? A Federal Housing Administration home loan program can help you buy the place and give it a makeover, too.

An FHA-insured Section 203(k) loan allows borrowers to lump the cost of repairs and improvements into their mortgage.

Benefits for homebuyers and homeowners

“We’ve seen tremendous growth in the use of these loans across the country, especially in areas where the housing stock is old and needs repairs or when people are buying foreclosures and short sales,” says Stephen Adamo, former president of Weichert Financial Services and now the head of U.S. home loans at Santander Bank.

The 203(k) loan also can be a good refinance option for cash-strapped homeowners who either cannot or do not want to tap their home equity.

Limited vs. standard 203(k) mortgage

There are two types of 203(k) loans.

  • A streamlined or limited 203(k) has an easier application process, and the repairs or improvements must total $35,000 or less.
  • The standard 203(k) requires additional paperwork and applies to improvements costing more than $35,000.

Either type of 203(k) loan requires a minimum of $5,000 to be spent on rehabilitation of the home. Generally, the maximum mortgage amount is the lowest of:

  • The FHA’s maximum mortgage limit for the area.
  • A calculation involving the home’s “before” value plus improvement costs.
  • A calculation involving the home’s “after” value, including the improvement.

You apply for a Section 203(k) mortgage through an FHA-approved lender.

The rules on 203(k) loans

While 203(k) loans can be used for refinancing as well as purchase loans, they are limited to owner/occupants. Investors are not eligible.

The work must begin within 30 days of closing and be complete within six months. The borrower is allowed to be named the contractor if qualified, but cannot be paid for anything outside the cost of materials and must meet specific FHA qualifications.

If you hire a contractor, be sure to ask if they have done 203(k) program work before, says Mike Tompkins, a mortgage consultant with KS StateBank in Scottsdale, Arizona. “The contractor needs to understand the payment schedule and requirements.”

When work is complete, the borrower provides a letter, and a HUD-approved cost consultant conducts an evaluation. Consultants can be found through a lender or via the FHA website.

Roof repairs, yes. New hot tub, no

Certain types of projects may be ineligible for 203(k) financing, says John Thomas, a certified mortgage planner with Primary Residential Mortgage in Newark, Delaware.

“No major structural repairs can be undertaken with a streamlined 203(k), such as putting on a new addition or fixing a cracked foundation,” Thomas says. “But you can repair the roof, do plumbing repairs and even add an attached garage.”

Standard 203(k) loans allow almost any home improvement as long as it adds value to the home, including structural additions, finishing a basement or remodeling a kitchen. However, luxury items such as a swimming pool or a hot tub cannot be financed with a 203(k).

Qualifying for a 203(k)

Like all FHA loans, 203(k) mortgages allow you to make a down payment of as little as 3.5 percent. That’s based on the total loan amount, including both purchase and renovation costs.

You’ll need a decent credit score — at least 580, though many lenders require a score of 620 or higher.

The loans require an upfront mortgage insurance payment of 1.75 percent of the total loan amount, which can be wrapped into the financing.

Borrowers also pay a monthly mortgage insurance premium based on the loan-to-value ratio and length of the mortgage.

“Interest rates on 203(k) loans are slightly higher than other FHA loans (about 0.2 percent to 0.5 percent higher) because there’s a greater risk for the lender until the work is actually completed on the property,” Thomas says.

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