The FHA 203(k) Renovation

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The 203(k) can have more lenient qualification criteria than the Fannie Mae HomeStyle or Freddie Mac Renovation programs and therefore can be an option for borrowers who do not qualify for either of those programs.

For purchases, a 3.5% down payment is the standard for these loans even on multi-family homes up to 4 units.  You can obtain your down payment via a gift from family, an approved non-profit organization or a Down Payment Assistance program, commonly referred to as DPA's.  The property must be your primary residence.  Investment only properties are not allowed.

Generally, your renovations will have to be performed by a licensed contractor, supervised by an FHA Consultant and approved by the appraiser upon final inspection.  Work must begin within 30 days of closing and usually should be completed within 6 months.

                                                                                         HOW MUCH CAN I BORROW?

Again, the first step will be to get a preapproval to determine how much you can borrow based on your income, present debt and credit score.

Just like the Fannie Mae and Freddie Mac programs, the amount you can borrow with an FHA 203(k) loan is limited by the maximum allowable loan amount in the county the property is located in. However, the maximums in each county for the FHA program are different than the county maximums for the Fannie and Freddie programs. These maximums are increased for 2, 3 and 4 unit properties.

For purchases the next limitation will be based on the lesser of:

             (1) purchase price plus the cost of renovation, OR 

             (2) 110% of the “as completed” appraised value.

             (3) You can then receive 96.5% of the lesser amount of (1) or (2).

If you are refinancing your current home to do the renovations then the limitation will be based on the lesser of:

            (1) the appraised value prior to renovations plus the cost of renovation, OR 

            (2) 110% of the “as completed” appraised value.

            (3) You can then receive 97.75% of the lesser amount of (1) or (2).

How will you know if the home will be worth as much as you need?  Simple.  The appraiser will inspect the house and set a value for the house without the renovations.  After looking at your proposed renovation plans the appraiser will then set a value for the house once your renovation is completed.

The final limitation will be based on which FHA 203(k) program you choose.  There are 2 programs available:  The FHA Standard and The FHA Limited. Let's take a quick look at both.

                                                                                                  THE FHA LIMITED

The FHA Limited program is great for simple fixer uppers and is not for major structural changes to your home.  You are limited to borrowing up $35,000 for your renovations.  A 15% escrow for cost overruns is required.  (This is fully refundable if it is not used.)  But you do not need to hire an FHA Consultant to oversee the work as you do with the FHA Standard program and there is no minimum amount for repair/renovation costs.  So if your bathroom or kitchen are old and you need new appliances, energy efficient upgrades, roof, gutters, septic work, painting, flooring or new carpeting, you could use the FHA Limited program to modernize your new or existing home.  But if you want to do structural renovations such as an addition then you will need to use the FHA Standard program.  The 203(k) Program requires all building permits be obtained prior to commencement of work and posted onsite for the work being performed.  

                                                                                                THE FHA STANDARD

If you are looking to do major structural work then this is the program you would choose. With this program you can even do a complete tear down and rebuild - provided the original foundation stays in place.  This program has a minimum of $5,000 and an FHA Consultant must be hired to oversee the work until completion.  The 203(k) Program requires all building permits be obtained prior to commencement of work and posted onsite for the work being performed.  

Here are some of the things you can do with the FHA Standard program:

• Repairing, reconstructing, or elevating an existing foundation where the structure will not be demolished.
• Making structural alterations such as the repair or replacement of structural damage, additions to the Structure, and finished attics and/or basements.
• Rehabilitating, improving, or constructing a garage.
• Repairing/replacing plumbing, heating, air conditioning, and electrical systems
• Making changes for improved functions and modernization.
• Repairing or installing new roofing, siding, gutters, and downspouts.
• Installing or repairing fences, walkways, driveways, exterior decks, patios, and porches
• Installing a new refrigerator, cooktop, oven, dishwasher, built-in microwave oven, and washer/dryer.
• Repairing or removing an in-ground swimming pool.  (You cannot install a new swimming pool.  But you can make extensive repairs to an existing swimming pool.)
• Creating accessibility for persons with disabilities.
• Build an eligible accessory dwelling unit (ADU)
• Convert one-family unit to two- to four-family units
• Create additions, finish attics and basements
• Landscaping or groundwork 
• Replace windows or flooring
• Make energy efficient upgrades

You can accomplish almost any of your goals with the FHA Standard program.  Generally, the only exclusions are for luxury items like a swimming pool on a property that does not have one, barbecue pits, hot tubs or any other luxury type items that do not improve or repair the existing functionality of the property.

Let's look at some examples to tie all of this together:

EXAMPLE 1:

• Say you’re buying a 1 unit home that will be your primary residence for $100,000 and you need to borrow an additional $100,000 to do your renovations.  You are preapproved with your lender for up to $250,000.  The property is located in Worcester County where the FHA lending limit for a 1 unit property is $498,257, so you are well within the lending limits for this county.  
• The appraiser inspects the property and looks at your renovation plans and calculates the "as completed" appraised value is $220,000  110% of  $220,000 would give you a ceiling of $242,000 to complete your renovations. ($220,000 X 110% = $242,000.  
• BUT the  purchase price + the cost of renovations = $200,000.  $200,000 is the lesser of the 2 calculations so that is the number we use to calculate your maximum loan amount.  The down payment for this home would  be 3.5% of $200,000 or $7,000 dollars. With this 3.5% down, you are eligible to borrow $93,00 for the purchase price plus receive $100,000 for your renovations and/or set aside 6 months of mortgage payments if you will be unable to occupy the property until the renovations are completed.

• NOTE:  FHA loans require a one time Upfront Mortgage Insurance Premium of 1.75% of the loan amount paid to FHA at the closing.  This is usually financed as part of the mortgage.  Therefore, the final loan amount in this scenario would be $196,377.50 calculated as follows:  $93,000 purchase money + $100,000 renovation funds + $3,377.50 UMIP = $196,377.50.

EXAMPLE 2:  

• You want to buy a single family home that will be your primary residence in a great neighborhood located in Barnstable County.  The loan limit for 1 unit properties in Barnstable County is $701,500. You are preapproved with your lender for a mortgage loan up to $800,000. An available home in your desired neighborhood is on the market for $600,000, but it is older and needs a lot of work. Your contractor estimates all of the renovations you want would cost $200,000  The appraiser inspects the property and looks at your renovations plans and calculates the "as Completed" appraised value is $900,000. 

• You can receive up to $101,500 to complete your renovations.  How do we come up with this number? $900,000 X 110% = $990,000  BUT the purchase price + the cost of renovations = $800,000.  $800,000 is the lesser of the 2 calculations so that is the number we use to calculate the most you could receive with the 203(k) Renovation Program.
• However, because the maximum loan amount in Barnstable County is  $701,500 you must subtract that from $800,000.  Therefore, you are capped at a total loan amount of $701,500. The down payment for this home plus renovations would  be 3.5% of $701,500 or $24,552.50. With this 3.5% down, you are eligible to borrow $600,000 for the purchase price plus receive $101,750 for your renovations and/or set aside 6 months of mortgage payments if you will be unable to occupy the property until the renovations are completed.  On top of that you can use your $24,552.50 down payment for closing costs and renovations. The remaining amount necessary to complete your renovations would have to come from your own personal funds.  

            OR

• You could eliminate items worth approximately $73,100 from the proposed renovations so that the purchase price plus the cost of renovations = $726,900.  The appraiser looks at your changes and calculates the "as Completed" appraised value is now $800,000.   110% of this amount will again give you more than enough to complete your renovations.  ($880,000)
• BUT the  purchase price + the cost of renovations = $726,900.  $726,900 is the lesser of the 2 calculations so that is the number we use to calculate the most you could receive with the 203(k) Renovation Program.  Therefore, the loan amount will now be $701,458.  ($726,900 X 96.5% = $701,458)  This keeps you just below the Worcester County loan limit of $701,500.  And you would have almost the same down payment.  
• Remember, when deciding which renovation items to remove - the house will have to be ready for occupancy when your modified renovations are completed.

                                                                  CAN I REFINANCE MY CURRENT HOME AND RENOVATE IT?

YES!  If you want to renovate your home you can use the FHA 203(k) renovation program. The calculations used to determine the amount available to you are the same.  However, with a refinance the limitation will be based on the lesser of:

             (1) appraised value prior to renovations plus the cost of renovation, or 

             (2) 110% of the “as completed” appraised value.

             (3) You can then receive 97.75% of the lesser amount of (1) or (2).

EXAMPLES:

• Say you own a 1 unit home that is your primary residence in Worcester County where the FHA loan limit is $498,257. You have an existing mortgage with a balance of $200,000 and you need to borrow an additional $150,000 to do your renovations.  You are preapproved with your lender for a mortgage loan of up to $500,000. The appraiser inspects the property and looks at your renovations plans and calculates the "as completed" appraised value is $450,000.  This means you can receive up to $483,862 to pay off your existing mortgage and complete your renovations. How do we come up with this number?  $450,000 X 110% = $495,000 X 97.75% = $438,862.
• BUT the outstanding balance on your current mortgage + the cost of renovations = $350,000.  $350,000 is the lesser of the 2 calculations so that is the number we use to calculate the most you could receive with the 203(k) Renovation Program.
• 97.75% of $350,000 = $342,125.  At this number you are well within both your preapproval amount and the maximum loan limits for Worcester County. So you are basically putting 2.25% down on your current home and receiving $200,000 to pay off your current mortgage plus $142,125 to do your renovations and/or set aside 6 months of mortgage payments if you will be unable to occupy the property until the renovations are completed.

NOTE:  In addition to costs of inspection plus typical closing costs, FHA loans require a one time Upfront Mortgage Insurance Premium of 1.75% of the loan amount paid to FHA at the closing.  This is usually financed as part of the mortgage. Therefore, the final loan amount in this scenario would be $348,112.19 calculated as follows:  $342,125 203(k) loan amount + $5,987.19 UMIP = $348,112.19.  

NOTE:  If you will be paying off your current mortgage as part of your 203(k) renovation loan transaction, make sure to consider all of your options. Currently, many people have mortgages that carry historically low interest rates.  Due to a number of factors, these low rates are not available today. Therefore, you may want to consider a 2nd mortgage home equity loan - if you can qualify for it.

Here is an overview of the 3 stages of an FHA 203(k) loan:

1. Borrower owns or finds a property that requires rehabilitation.
2. Borrower talks to an FHA-approved lender and selects FHA 203(k) program.
3. Lender selects a 203(k) HUD-approved consultant from the roster. This step is optional for the Limited 203(k) Mortgage.
4. Consultant visits the home with borrower and prepares a work write-up and cost estimate.
5. Work write-up and bids are provided to the lender.
6. Lender processes, underwrites, closes, and funds the transaction. 
7. Lender submits the loan for endorsement and FHA insures the loan.
8. Improvements can begin.

1. Contractor obtains necessary permits prior to the start of the project.
2. Contractor completes the first phase of the project.
3. Borrower contacts the 203(k) consultant to request an inspection for draw release.
4. Consultant and borrower inspect the work and consultant certifies work is satisfactory.
5. Consultant and borrower sign the draw release and submit to lender for payment.
6. Lender issues a two-party check made payable to borrower and contractor.
7. This process continues until all work is completed.

1. Borrower provides a release letter indicating all work is completed.
2. Consultant verifies completion.
3. Consultant obtains certificate of occupancy or building permit close-out approval if applicable.
4. Remaining escrow funds are released.
5. Lender is responsible to close out the entire project and loan in FHA Connection.

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