What Is an FHA 203K Loan?

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203K loans help you purchase a fixer-upper.
203K loans help you purchase a fixer-upper. (Image: New home construction site on clear summer day image by Vaidas Bucys from Fotolia.com)

Most mortgage lenders only provide loans once the value of a property is securely established. This allows them to know the exact value of the collateral they are accepting in exchange for a mortgage. When a home is in need of repair, a home buyer will need to get transitional financing prior to a long-term mortgage. The Federal Housing Administration (FHA) offers the 203k loan program to address this problem.

Function

The purpose of a 203k streamlined mortgage is to provide the three portions of financing required for a fixer-upper in one step: initial financing, funds for repairs and a long-term mortgage. The borrower only has to secure one loan to do all three as opposed to three separate loans. This can save a tremendous degree of hassle and eliminate the chance a borrower will have difficulty securing a long-term mortgage once the rehabilitation is complete.

Structure

The FHA 203k loan is a loan guarantee. This means the loan comes from a private lender, typically one that is FHA qualified. Then, the FHA guarantees the loan, meaning it is insured against default. If the borrower cannot continue payments, the FHA will buy the loan out of delinquency. The lender has a very low degree of risk in this scenario.

Requirements

The FHA does work with low-income or low-down-payment borrowers. However, the FHA has very high credit standards. If you have outstanding tax payments, have defaulted on a previous installment loan or defaulted on a government loan, you will not qualify. In general, even if your credit history is short, you will be required to have no substantial negative activity on your report in order to qualify for the 203k loan option. The property you are purchasing must also qualify.

Benefits

If you do succeed in securing the 203k loan, you will be able to move through the rehabilitation process with greater ease than with separate, private loans. You will know the terms of your long-term mortgage up front instead of waiting until after the rehab is complete to know the total cost of your financing.

Risks

With the 203k option, you will see some disadvantages. The greatest risk is the limitations you may have on the improvements and changes you can make. Multiple inspections may take place while the property is being improved to assure the final product will meet the FHA's standards. Finally, these loans can take longer to finance because the government agency is involved and has more regulations on the existing property, plans for adjustment and final product.

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