What Are Renovation Loans and How Do You Qualify?
When you’re looking to buy a home, you may find one that is very nearly perfect. It could be in an ideal location with just the right number of bedrooms and a style that speaks to you. Sometimes, however, that nearly perfect home could have one or two fatal flaws. Maybe it needs a new kitchen. Or perhaps the electrical or plumbing needs to be updated. Many lenders can look at too many repairs as a deal breaker, and conventional loans don’t usually cover repairs. So how do you finance a home that’s a bit of a fixer-upper?
An FHA 203k loan is a loan program designed to roll both a mortgage and a home renovation loan all into one package. While a 203k loan can be used just for renovation, it’s primarily used to help you purchase a home that needs a little love and attention. You can also use a 203k to refinance if you’re planning to do renovations to your existing home.
Eligibility for a 203k Purchase
When deciding if an FHA 203k is right for you when purchasing a home, you’ll need to understand the eligibility criteria. A 203k refinance or purchase loan is only available if you plan to live in the home. While it is also available to nonprofit organizations, it is not available to investors.
There are also restrictions to what type of home you can purchase. Single family homes can qualify for a 203k loan. Condos and townhomes may qualify as well, but the renovations to those homes are limited to the interior only. While you may buy a home that has up to four units, such as a 2-flat or home with an apartment in it, you are limited to up to four units.
Because a 203k loan is backed by the FHA, credit requirements are less stringent than a conventional loan. You must, however, have sufficient income to pay back the loan and have a debt to income ratio of around 31/43.
203k Loan Details
A 203k renovation loan for your fixer-upper can be either a fixed or variable loan. The length of the loan maybe up to 30 years, just like a conventional loan. The minimum amount that you may borrow is $5,000, though if you’re borrowing a small amount just for renovations you may want to look at other options. The maximum you can borrow depends on the area in which you live, your income, and other variables.
Expect to pay about 1% more in interest for a 203k loan over a conventional loan for a couple of reasons. The first is that your credit can be lower than what is required for a conventional loan. The second is the paperwork involved for the lender, which is more robust not only when you get the loan, but also when you hire contractors to do repairs.
Like a standard FHA loan, you’ll also be required to pay a Mortgage Insurance Premium (MIP) at the outset of the loan and as a monthly fee. This upfront as well as recurring fee is designed to protect the lender against default and must be paid through the entirety of the loan. That’s not as bad as it sounds though, because once you reach 20% equity in your home, you’ll likely be able to refinance with a loan that has no mortgage insurance.
The Fannie Mae HomeReady requires as little as 3% down and also comes with mortgage insurance. The benefit of Fannie Mae’s program is that your mortgage insurance payment is only required until you reach 20% equity in your home, unlike an FHA loan that requires you to pay the premium for the lifetime of the loan.
Who Can Do the Renovations with a 203k Loan?
Unfortunately, with a 203k renovation loan you can’t do all the work yourself. Licensed contractors must do all the work and must be pre-approved. This requires a lot of paperwork and a bit of patience. The contractor has to fill out paperwork as well. Once it’s completed, you’ll have to submit it for review and approval which can take some time.
While a 203k purchase and refinance loan may not be for everyone, it may allow you to purchase a home that you otherwise could not through traditional financing. It’s a little more expensive than a traditional loan, but has lower credit requirements and gives you the chance to buy a house that’s almost perfect. Remember to review your options, but if you’ve fallen in love with a fixer-upper, take a look at an FHA 203k loan to purchase and renovate your nearly perfect dream home.