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203(k) Loans: Two-in-one Mortgage Solution for Homebuyers

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Not all properties look lovely from the get-go. In some cases, they have excellent bones, but they need a lot of changes to be considered habitable.

Usually, when faced with this situation, homebuyers have two options. First, they can include a contingency clause, which will then pass on the responsibility of fixing and maintenance to the home seller. Second, they can look for another.

What many don’t know, though, is that there’s a third choice: they can go to a mortgage company that offers 203(k) loans.

What Are 203(k) Loans?

Conventional loans are straightforward: homebuyers borrow money to finance the remaining home price after putting a down payment. Based on the terms and conditions too, they may not be able to use the funds for other things, such as remodeling the house.

If this is their intention, they may need to apply for another loan. However, this may mean that the buyer will now have to pay two types of loans simultaneously, each potentially using the house as collateral. The interest rates may not only vary but may also be higher since there are more debts to settle. The risks of non-payment increase.

All these are on top of the other associated costs when one applies for a loan, such as private mortgage insurance (PMI) and closing fees.

To resolve the problem, the Federal Housing Administration (FHA) offers the 203(k) loan. This is a kind of mortgage that lets the homebuyer cover not only the remaining costs of the property but also its renovations or repair.

What the Loan Offers

Under the 203(k) loan, the homebuyer may be able to:

  • Apply a loan that’s backed by the government, which is the FHA. While the FHA doesn’t provide the money—homebuyers still need to look for a lender—the chances of getting approved are high.
  • Use the money to buy a new property or refinance their home as well as fix the property
  • Buy a house with a low down payment. With this, they can already secure a loan even if they provide only less than 5 percent upfront.
  • Secure a mortgage even when they don’t have the best credit score. Like other FHA loans, those with average to fair credit scores can apply, but the minimum down payment may vary.
  • Sort of consolidate the needed loans to make the home safe and hopefully ready for a sale in the future. The odds of missing a repayment can decrease.
  • Speed up the increase of home equity

man writing with a woman

The 203(k) loans are also available in two types. First, there’s the limited loan, wherein up to $35,000 of the borrowed amount may be allotted for renovations. However, the borrower cannot apply the amount to major structural repairs. These may include replacing the roof, fixing the foundation, or remodeling the basement.

The other option is the 203(k) standard loan, which may allow the borrower to use a part of the funds for a wide variety of repairs or renovations as long as they cost at least $5,000. Some of the projects they can undertake include transforming the property into a smart home or making it more energy-efficient, replacing or installing new floors, adding accessibility features, enhancing the functionality and aesthetics of the space, and reducing house hazards like upgrading the electrical wiring system.

However, those who choose the latter will need to work with an HUD consultant, who will oversee the remodeling or repair from start to finish.

Things to Remember About 203(k) Loans

The 203(k) loans do sound attractive, but like other types of debt, they also come with caveats:

  • This is intended only for single-family homes. They are not meant for investment properties like an apartment and other multi-dwelling spaces. Some use this to buy a fixer-upper, but if the lender finds out this is the intention, they may deny the application.
  • Borrowers may still end up paying for PMI. This happens, however, only when the down payment falls below 20 percent.
  • The loanable amount is still subject to the FHA loan limits. The figures can vary, depending on where the lender operates, but on average, it should be no more than $822,375.
  • The age of the house matters. One may apply this loan for a property that is at least a year old. It can also work for foreclosed homes, but borrowers should not have bought the house from an auction since it doesn’t give the HUD consultant and the future homebuyers enough time to assess the possible costs of repairs.
  • The entire process can be lengthy. Usually, this occurs once the repair phase kicks in. Homebuyers need to receive bids from various contractors.

Overall, though, the 203(k) loan is an excellent choice for low-income and first-time homebuyers who may have no choice but to settle for a cheaper property that needs some fixing.

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