Is a FHA 203K Loan Your Fix to Buying a Fixer?

You love the idea of a fixer-upper, but you know they often cost quite a lot to “fix up.” As a new buyer then, you might be interested in an FHA 203K loan. Distributed by the office of Housing and Urban Development (HUD), these loans specifically target buyers who want ready access to the extra cash needed for remodeling and repair.

203k loanLenders and Fixers

The frustrating part of fixer-upper dreams? Lenders don’t dream the same way you do. In the style of a cliché romance novel, while you dream of the damaged but achingly gorgeous home you can love back to perfection, banks are more interested in the “sure thing.” Herein lies the catch-22. You want to put your stamp on a fixer; tragically, you can’t borrow the money to buy the house, because the bank refuses to make the loan until the repairs are done, and the repairs can’t be done until the house has been purchased. So Shakespearean! Queue the violins! Who can save the day? HUD to the rescue!

THE HUD 203K

The HUD 203K is meant to do 2 things: 1) help you buy a home and 2) help you fund its repairs. As this is a federal program, initiated largely in response to the glut of foreclosed and otherwise dilapidated, abandoned homes on the market, it’s meant for persons wanting to occupy the home in question, not for landlords or vacation home buyers.  And it’s not intended to help people flip homes for quick profits either—though that doesn’t mean some folks can’t use the loan to do so. In fact, the loans aren't intended for DIY people, unless those DIY people are also experts in the building trade.

What It Costs

Because the down payment requirement for an FHA 203K  is higher than a normal FHA loan, many people who opt for FHA loans in the first place can’t qualify for the 203K: Most often, buyers must come up with not just 3% of the original accepted price, but 3% of that price and the estimated cost of repairs needed to bring the home up to the lender’s definition of “loanable.”  In other words, suppose a seller accepts my offer of $180K for a home, but the home inspector reports to the bank that the house will need $40K in repairs. I’m now on the hook for 3% of $220K  instead of just $180K.

Note also: the interest rate on this type of loan is higher than traditional FHA loans, usually around 1% higher, but sometimes more.

First-Hand Experience

For a clearer picture of who the 203(k) really serves, I interviewed ZipRealty Realtor® Jeremy Fershleiser, who lives and works in Portland, OR. A couple he helped buy foreclosure used the 203K successfully.  “It worked out very well for them because they scored an under-valued property (foreclosure that had a horse barn with stables which were worth more than the house itself). These clients knew that, were able to scoop it up and pay far less than such a property would cost under normal market conditions, or what it would cost to add the barn with stables. They didn't mind having a higher interest rate to obtain this loan because it was such a steal.”

Is It Right for All Buyers?

Jeremy says no. “The bottom line is that these types of loans have their place; it's fantastic that they exist. Many think that it sounds like a great plan. But the devil is in the details...”

What kind of details? 

  • Aside from costing more up front (down payment) and over the long haul (interest), these loans are complex. They can cause escrow to become a protracted mess, and sometimes that can lead to monetary penalties.
  • The buyers have to pay for a special, more expensive home inspection, to find out what the repair costs will be.
  • Buyers only have 60 days after closing to complete all repairs.  This works best for people who can do the bulk of the repairs themselves, DIY experts or contractors. Again, HUD specifically intends experts to buy and fix these homes.
  • Harder to get in healthier markets: if people are having bidding wars over available inventory, not much incentive to complicate things.

Alternatives

“Instead of spending more money on a home that needs an FHA 203K,  some buyers decide to just spend more up front on a house that does not need repairs,” says Jeremy. There’s also the option of buying a home—with any kind of loan product that works best-- waiting a while to build up equity, then refinancing or taking out a line of credit to do repairs later on.  

Still In? Steps for Applying for an FHA 203K

Aside from speaking to a Realtor® and a mortgage broker about this program, there is additional information online that might help you decide if the 203K works for you. Check out About.com  for an exhaustive checklist of the steps involved in the process.

Anna Marie Erwert writes from both the renter and new buyer perspective, having (finally) achieved both statuses. She focuses on national real estate trends, specializing in the San Francisco Bay Area and Pacific Northwest. Follow Anna on Twitter: @AnnaMarieErwert

Updated 10/11/12: HUD contacted Jeremy to make sure the correct information is out there for all; he asked that the following information be added to the article. Although the loan Jeremy was citing did need to have all work completed within 60 days, and lenders (or HUD if they deem that the work shouldn't take as long) may impose stricter guidelines on a case by case basis;officially, all work needs to be completed within six months per HUD guidelines. Additionally, HUD did stress that they specifically don't encourage DIY people to use these loans. The reason that this was stressed is primarily because most who think that this loan will work for their DIY plans aren't experts in the work being performed. HUD does specify that anyone performing work on an FHA203K loan needs to be expert in the particular task in order to complete the work themselves.