Get Help Renovating Your Home With an FHA 203(k) Mortgage

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Renovating a home can be very expensive, and getting a loan to buy a home needing substantial repairs can be difficult, too.

Fortunately, the FHA 203(k) home renovation loan — made through private government-approved lenders but insured by the FHA — offers an option. In fact, it's sometimes the only option for buying a fixer-upper because most lenders won't finance a home that's not habitable. (See also: 10 Home Renovations That Almost Pay for Themselves)

Home buyers can use the home renovation loan to purchase homes at substantial discounts, and current homeowners can use it to refinance their current mortgage and pay for renovations, repairs, or additions. It's the perfect option for handyman specials, homes needing "tender loving care," and foreclosure sales.

Purchasing and renovating a home typically entails a mortgage to buy the property, a short-term loan with a higher mortgage rate to finance rehab work, and another loan to pay off the interim renovation loan. But the FHA 203(k) program finances the purchase and renovation of homes — or the refinance and renovation — with a single loan.

FHA 203(k) Home Loan Advantages

The loan program has other advantages beyond convenience.

• Down payment requirements are low — currently 3.5% for loans under $625,500 and 5% for loans above $625,500.
   
• Application standards, like other FHA home loans, are looser than typical home loans.
   
• The loan can finance mortgage payments for up to six months, so you don't have double housing costs while the home is not habitable.
   
• The loan can be combined with the FHA's Energy Efficient Mortgage.
   
• Homeowners can opt for either a fixed-rate or adjustable-rate loan.

Because appraisal is based on the value of the home after renovation work is completed, borrowers qualify for a larger loan amount. Home buyers can finance up to the purchase price or 110% of the property's after-improved value.

Eligible Projects

Many kinds of projects are eligible, including additions, landscaping, energy-efficiency projects, kitchen remodeling, finishing basements or attics, as well as replacing roofs, plumbing, and HVAC systems. (See also: What to Look for in a Fixer-Upper)

The loans can also be used to move a building to the mortgaged property or convert a single-family home into a duplex, triplex, or four-unit home.

Cooperative units are not eligible for the program, but the interiors of individual condo units are eligible if the condo complex has FHA approval.

The FHA may let you do the work yourself if you can prove you're qualified. You can use the loan to pay for supplies, but not to pay yourself. (See also: Is DIY Home Renovating for You?)

Approval Process

After you find a property and estimate rehab costs, you can use HUD's lender search page to locate lenders. After the loan is approved, an escrow account holds money for rehab work and funds are disbursed from the account as work proceeds.

Disadvantages

The program's largest drawback is probably that it's paper-intensive with plenty of bureaucracy.

• Obtaining loan approvals and reaching the closing table can take longer than other loans, perhaps 60 to 90 days.
   
• Fees for title reviews, appraisals, and other items are higher than for other FHA loans.
   
• Homeowners must live in, or plan to live in, the home. You can't use the mortgage to flip properties.
   
• Improvements must cost at least $5,000, so you can't use it for minor work.
   
• Guidelines do not allow luxury items — no gold-plated toilets.

Some Quick Tips

First of all, avoid some of the bureaucracy by investigating the FHA's Streamlined 203(k) program if you're interested in a smaller project. The streamlined program lets home buyers and homeowners finance up to $35,000 for rehab work and provides easier access to funds.

• Work with a lender that has FHA 203(k) experience.
   
• Be prepared for time-consuming documentation and visits by an FHA inspector.
   
• Work with a good contractor. You cannot increase your loan amount, so be careful that your contractor does not underestimate costs.
   
• Be careful not to over-invest. There's no guarantee that a particular renovation project will increase your home's value.
   
• Don't put the project on the back burner — or let the contractor forget about it. Work has to start within 30 days of the loan closing, cannot stop for more than 30 days, and has to be finished within six months.
   
• Talk to your real estate agent and accountant about any possible property tax implications, which vary by county or municipality. Some renovations can be used for income tax deductions. Other improvements, like energy-efficiency upgrades, can be used for tax credits.

Have you taken advantage of the FHA's 203(k) loan program? What was your experience like?