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Buying a new home usually means you face a few upgrade costs, but those taking on a true fixer-upper might consider a 203(k) loan, also known as a mortgage rehab loan. Accessible because of provisions by the U.S. Federal Housing Administration (FHA), this mortgage loan combines financing for the home’s purchase price with the cost of remodeling or repairing it–all in a single loan.

How does the 203(k) loan work?

As defined by Section 203(k) of Housing and Urban Development’s code, the 203(k) loan allows the homebuyer to borrow enough funds to cover both the cost of the home and the price of repairs, including the cost of labor and material for those repairs, in one loan. Certain 203(k) loans may also be expanded to include funding for up to six months of mortgage payments.

The FHA does not directly lend these funds, but rather provides financial protection to lenders that do. The 203(k) loan can either be a 15- or 30-year fixed-rate mortgage or an adjustable-rate mortgage (ARM). The amount the homeowner can borrow depends on qualifications like credit and income, and the lender will also assess a down payment based on the total amount.

With the 203(k) loan, the maximum loan amount that can be borrowed is capped at 110 percent of the home’s projected value, as determined by an appraiser. Additionally, lenders require the borrower to pay mortgage insurance.

Interest rates could be slightly higher than those associated with a conventional mortgage. However, they might be significantly lower than interest rates on loans taken out to cover repairs. There are two types of 203(k) loans available:

Limited 203(k): This loan is intended for smaller renovation and upgrade projects that are valued at less than $35,000. There is no minimum cost requirement, although you can’t fund structural repairs with a Limited 203(k).

Standard 203(k): The Standard 203(k) loan is intended for more extensive repairs with a total price tag greater than $35,000. The minimum loan amount for this type is $5,000. Structural changes, like additions or full home renovations, are permitted. The homebuyer must obtain architectural exhibits and meet building codes.

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Who qualifies for a 203(k) loan?

The homebuyer must meet specific borrowing criteria from FHA, and requirements vary among lenders. Many programs may require a total debt-to-income ratio (DTI) of about 43 percent, while others may allow a higher DTI.

Generally, buyers must have a credit score greater than 600 to qualify. Additionally, buyers have to make a down payment of at least 3.5 percent of the total amount borrowed.

These loans are available only to people who will live in the home, although under certain situations, nonprofit organizations can also take out 203(k) loans.

What kinds of renovations does the 203(k) loan cover?

The 203(k) loans cover just about any expense the homeowner can think of, with the exception of certain luxury items. Those renovations include:

  • Remodeling, adding, or expanding rooms, such as bathrooms, bedrooms, kitchens and garages
  • Structural alterations and reconstruction
  • Changes that improve appearance and eliminate obsolescence
  • Repairing or replacing roofs, gutters or downspouts, as well as interior items such as carpeting
  • Major landscaping
  • Energy conservation improvements
  • Enhancing accessibility for the disabled
  • Adding a second story, a basement, a patio or deck, or renovating a swimming pool
  • Installing a septic system and upgrading plumbing
  • Upgrading electric wiring and heating
  • Installing energy-efficient appliances, including air conditioners or special windows and doors

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