203k Loan Pros and Cons
FHA has a special type of loan called the FHA 203k Loan. This mortgage gives potential buyers an opportunity to purchase a property and also get funds to repair or even remodel a home. With other types of financing, the buyer would need to get two separate loans; one for the purchase of the home and the second loan for the remodel. The two-loan method can be more costly and complicated. Thankfully, the FHA 203k loan makes it much easier.
In order to determine if this is the right program for you, we have assembled a list of the pros and cons of FHA 203k loan. This will give you details and allow you to make the best-educated decision for your situation.
Pros of FHA 203K Loan
When using the FHA 203k loan, borrowers will be able to lock in the low rates that are offered by FHA. This rate might be slightly higher than a loan for a straight FHA 30-year fixed mortgage, but it is negligible. When compared to the rate that is normally assigned for a remodel loan, the FHA 203k is certainly better.
And borrowers will only have to pay one payment using one interest rate. Compared to the two-loan model mentioned earlier, this one fact can save the homeowner thousands of dollars in interest over the life of the loan.
One Big Loan to Cover Everything
The beauty of the FHA 203k loan is the fact that borrowers can get the money for the purchase price plus more funds to either make necessary repairs or remodel, or both.
For example, suppose a family of four found a neglected home in a good school zone. The home is priced at $135,000 but other similar sized homes in the area sell for $215,000. With the FHA 203k program, the family could get the amount needed for the purchase plus an extra $50,000 to replace the roof, get new flooring and remodel the kitchen.
All of this would be financed at one interest rate over the life of the loan, saving the borrowers thousands of dollars in interest and multiple loan costs.
Full Loan Determined on Projected Value
With most improvement or remodel loans, the borrower must have enough equity in the property to cover the costs for the remodel. If the person is attempting to buy the home, they would not have any equity in the property.
The FHA 203k program does away with this requirement. In the case of a major remodel, the lender will consult with a local contractor to get a detailed estimate of all the repairs and improvements intended for the home. This information will be provided to an appraiser. The appraiser will then assign a future value to the home. This future value is used for qualifying the borrower and determining the overall loan amount.
Very Low Down Payment
FHA is known as the low down payment loan. Qualified borrowers are only required to pay 3.5% as a down payment at the loan closing. This down payment feature is also used for the 203K loan.
So, referring back to the earlier example of the family of four, their total loan with money for improvement would be $185,000. This would mean that the borrowers need to pay $6,475 at the closing of the loan.
The low down payment option makes this attractive to many first time buyers and saves them thousands of dollars in out of pocket costs.
Can be Used for Existing Home Owners
While this is a popular option for prospective home buyers, the FHA 203k loan can also be used by existing homeowners. Some homeowners may decide that they wish to stay in their home forever and would like to make major renovations to the home to make it more comfortable, more user-friendly or just more modern. However, homeowners do not always have the necessary equity built up in the property to the point that they can get a 2nd mortgage or a home equity line to make the desired changes. The 203k loan can solve this problem, as stated earlier since the new loan is based on the future value of the property.
Cons of FHA 203K Loan
Now it is time to look at some of the drawbacks of using an FHA 203k loan.
Loan Size is Capped
Although it may seem like there is unlimited money available for the purchase and repairs that have been discussed previously, the normal maximum loan amount restrictions exist for FHA 203k loans. In many places across the country, the highest loan amount that FHA will approve is $314,827. This amount can be bigger in certain high-cost areas. It is best to consult with your local lender to find out the FHA loan limits in your area.
The Mortgage Insurance Is for Duration of Loan
In order to allow borrowers to buy the home with such a small down payment, the lenders need some assurance that they will be covered for the risk of making a loan. This assurance comes in the form of the Mortgage Insurance Premiums charged for all FHA loans.
The Mortgage Insurance Premium, or MIP, comes in two forms. First, there is an up-front fee charged when the loan is closed. This amount is usually 1.75% of the original loan amount. The up-front fee can be added to the balance so that the borrower can pay the amount over the duration of the loan. The second part of the MIP is a monthly amount. The monthly amount will be paid as long as the person has an FHA loan. The only way to get rid of the monthly MIP is to either pay off the loan early or refinance to a non-FHA loan once the balance has dropped below 80% of the appraised value of the property.
More Paperwork and More Costs
In order to get the money for a major renovation, the borrower must acquire more paperwork. Documents related to the design and architectural changes have to be drawn up and submitted to the lender. These documents must be completed by professionals, which means the borrower is adding another cost to the loan process.
Furthermore, since the 203k loan involves much more work for the appraiser, contractor, and underwriter, there is an additional origination fee charged by the lender. Also factor in that an appraiser will add to their fee since they are making a value assessment based on the current condition of the property as well as the proposed, improved condition of the home. In fact, the appraiser will likely be asked to visit the home twice, once before the purchase and then again after the repairs are finished.
Summing Up The Pros and Cons of FHA 203k Loan
Getting an FHA 203k loan will be a bit more involved than a regular home mortgage. Getting the estimate from the lender for all the closing costs, acquiring estimates from contractors and settling on what improvements need to be made versus things that may have to wait for another day will all take some time.
However, this is a great program for buying a home and getting all the funds necessary for making significant improvements to the home while having one low-interest rate on a fixed rate term.
Additional FHA Resources:
Save Money On Remodeling Without Doing it Yourself via Jamohl DeWald
Buying A Home With An FHA 203k via Paul Sian
FHA Repair Requirements via Bill Gassett
FHA Guidelines To Know
About the author: This article on “Pros and Cons of FHA 203k Loan” was written by Luke Skar of MadisonMortgageGuys.com. As the Social Media Strategist, his role is to provide original content for all of their social media profiles as well as generating new leads from his website.
We provide award-winning customer service to clients who need to purchase a home or refinance an existing mortgage. Our branch currently serves Wisconsin, Illinois, Minnesota, and Florida. On our website, you will find state-specific mortgage program information. For example, take a look at our Wisconsin FHA loan page.