Ask Brian: Can Buyer Benefit from a FHA Section 203(k) Mortgage?



Ask Brian is a weekly column by Real Estate Expert Brian Kline. If you have questions on real estate investing, DIY, home buying/selling, or other housing inquiries please email your questions to askbrian@realtybiznews.com.

Question. Suzan from Mobil, AL asks: Hello Brian. My husband and I have four children and will being having another in five months. We’ve definitely outgrown our three bedroom home. Of course, our large family also stretches our budget. We’ve been looking at the few four and five bedrooms on the market but these are all out of our price range. We’ve also thought about adding on to this house but we think the lot is too small and we would have to put in a new and much larger septic system. We’d simply like to find a place we can afford that is suitable for our large family. Any ideas?

Answer. Hi Suzan. What comes to mind is that you might want to take a look at houses other people aren’t much interested in. Mostly houses that need some work. These can languish on the market for many months because they aren’t move-in-ready. But that doesn’t mean you need to settle for something unsuitable for your family. You could look into a combination loan that covers the standard mortgage and also provides funding for a major remodel or upgrade.

Not many people consider a FHA Section 203(k) loan. These aren’t for everyone and not every lender offers them. There are other purchase and improvement loans available but almost all others come with higher interest rates, short repayment terms, and a balloon payment. Section 203(k) offers a solution that helps both borrowers and lenders insuring a single, long term, fixed or adjustable rate loan that covers both the acquisition and rehabilitation of a property. These loans can be funded before the rehabilitation even begins. These loans are for more than the purchase price. But they do come with government red tape.

A few of the common requirements are:

  • A portion of the loan proceeds are used to pay the seller, or if a refinance, to pay off the existing mortgage.
  • The remaining funds are placed in an escrow account and released as rehabilitation is completed.
  • The cost of the rehabilitation must be at least $5,000.
  • The total value of the property must still fall within the FHA mortgage limit for the area.
  • The value of the property is determined by either:
    • The value of the property before rehabilitation plus the cost of rehabilitation, or
    • 110 percent of the appraised value of the property after rehabilitation, whichever is less.

Suzan, a 203(k) loan isn’t likely to get you into a multi-million dollar home. A 203(k) loan does follow many of the rules and restrictions of FHA basic single-family mortgage insurance products and can be relatively convenient for lower income borrowers. However, lenders may charge some additional fees, such as a supplemental origination fee, fees to cover the preparation of architectural documents and review of the rehabilitation plan, and a higher appraisal fee.

The types of improvements that borrowers may make using Section 203(k) financing include: 

  • Structural alterations and reconstruction. 
  • Modernization and improvements to the home’s function.
  • Elimination of health and safety hazards.
  • Changes that improve appearance and eliminate obsolescence.
  • Reconditioning or replacing plumbing; installing a well and/or septic system.
  • Adding or replacing roofing, gutters, and downspouts.
  • Adding or replacing floors and/or floor treatments.
  • Major landscape work and site improvements.
  • Enhancing accessibility for a disabled person.
  • Making energy conservation improvements.

Also Suzan, don’t hesitate to contact a real estate agent or local HUD-approved housing counseling agency to learn more about programs in your area that might best apply to your situation.

What are your thoughts and comments about alternative mortgage loans? Our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions or inquiries to askbrian@realtybiznews.com.

Author bio: Brian Kline has been investing in real estate for more than 35 years and writing about real estate investing for 12 years. He also draws upon 30 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, near a national and the Pacific Ocean.