If your property needs significant renovations or repairs, figuring out how to pay for renovation costs is likely at the top of your to-do list. You might be weighing the pros and cons of refinancing, taking out home equity loans, and running up credit card debt—but another option is a type of home improvement loan insured by the Federal Housing Administration (FHA) that combines both mortgage and repairs in a single payment. This is known as a 203(k) loan.
FHA 203(k) renovation loans are available for both current homeowners and for homebuyers who choose a fixer-upper. Instead of adding a separate source of debt to pay for home improvement, you can opt for a single, standard 203(k) FHA loan that covers repairs as part of a total mortgage loan.
So, is the FHA 203(k) loan program the right fit for your home investment needs? To answer that question, you’ll want to compare different options for home improvement and renovation funding to find the solution that’s right for you. Let’s start by taking a look at who qualifies for a 203(k) loan and how to apply.
Who Qualifies for a 203(k) Loan?
Any first-time or repeat homebuyer or current homeowner can qualify for a 203(k) loan if they meet the following criteria:1
- A credit score minimum of at least 500 to meet FHA guidelines
- The credit score minimum set by the specific lender, usually between 500–640
- No bankruptcy during the past two years
- The home is or will be the borrower’s primary place of residence
- A debt-to-income ratio (DTI) of less than 43%
- Proof of steady income or employment that supports your DTI calculations
- Timely repayment history on other debts
Additionally, repeat homebuyers and current homeowners must not have foreclosed on a property within the past three years, unless they can prove it was the result of select extenuating circumstances.
The 203(k) Loan Application Process
If you qualify for a 203(k) loan and decide to pursue this option, you’ll need to know how to apply. Below, we’ve gathered the steps for how to apply for a 203(k) loan from planning to application:
1. Check your credit score
Clean up any errors or outstanding issues if your score is low. This number will determine whether you qualify for a loan, and if you do, will factor into your down payment amount. This is especially important if you’re planning on getting an FHA loan with bad credit.
2. Estimate repair and renovation needs
Come up with a cost projection for your list of projects. This could be based on actual estimates or the use of sources that provide median costs by location, such as the Remodeling Cost vs. Value drill-down to zip code data.2
3. Total your loan
The amount of what you still owe on your current home mortgage plus what you need to cover repairs cannot exceed the FHA mortgage limit for your area.3 The total will also need to pass limits by the FHA and your lender, typically the lower of either the home price/current value plus renovation costs or 110% of the property’s anticipated future value.1
4. Calculate your upfront costs
Depending on your credit score, you’ll need a down payment between 3.5%–10% of the loan total. Your savings will also need to cover closing costs.
5. Update your monthly housing cost
What can you afford in monthly housing costs? Calculate your ongoing costs such as property tax, HOA fees, and homeowner’s insurance, and then determine what you can cover in a new combined 203(k) mortgage loan payment along with mortgage insurance.
6. Calculate your DTI
Using your estimated monthly housing costs above plus all other current debt payments, calculate your debt-to-income ratio. Add up all monthly debt payments and divide the total by your monthly pre-tax gross income. Your debt should not exceed 43%, and mortgage payments alone shouldn’t be over 31%.
7. Apply or prequalify for a 203(k) loan
Compare rates and terms among FHA-approved lenders.4 If you’re a homebuyer, obtain a letter of prequalification to include when you make an offer on a house. If you were pre approved for an FHA loan then denied, there are paths you can take to find a solution.
Consider a Sale-Leaseback: A Better Solution
If your primary goals are to remain in your home and improve its condition or add new features, a residential sale-leaseback is a debt-free option to consider, particularly as home mortgage interest rates have more than doubled in the past few years.
With a residential sale-leaseback, you sell your home to a real estate investor. Then, you can continue living in your home as a renter. You receive the full value of your home equity in cash and retain the legal right to remain in your home as long as you like. As a renter, you’re no longer responsible for property tax, homeowner’s insurance, and covered maintenance and repairs.
A reputable sale-leaseback buyer and service provider will also document and limit rent increases, so you know ahead of time what you’ll pay going forward.
FHA 203(k) loans are an all-in-one mortgage and repairs debt option for current homeowners with renovation needs and prospective buyers of fixer-uppers. Because the FHA 203(k) loan program is backed by the federal government (i.e. the Federal Housing Administration), borrowers with lower credit scores, substantial credit card debt, and other financial markers may qualify, but not every mortgage lender offers them.
When considering significant investment and debt options, be sure to shop around, weigh the FHA 203(k) loan pros and cons, and compare both traditional and alternative arrangements to find the just-right fit for your needs. For some homeowners, a sale-leaseback is a better real estate option to access renovation funds through your home equity without taking on new debt.
- Lucas, Tim. “What is an FHA 203(k) loan and how does it work?” The Mortgage Reports. December 7, 2022. https://themortgagereports.com/14946/fha-203(k)-loan-mortgage-lender-rates
- “2022 Cost vs. Value Report.” Remodeling. 2022. https://www.remodeling.hw.net/cost-vs-value/2022/
- “FHA Mortgage Limits.” U.S. Department of Housing and Urban Development. https://entp.hud.gov/idapp/html/hicostlook.cfm
- “HUD Lender List Search.” U.S. Department of Housing and Urban Development. https://www.hud.gov/program_offices/housing/sfh/lender/lenderlist