The Section 203(b) and 203(k) lead the FHA’s portfolio of insured home loans. Section 203(b) is the purchase mortgage most commonly used by consumers while Section 203(k) is used for buying and rehabilitating a home. Which between the two FHA-backed purchase mortgages is most applicable to you?
FHA 203(b): The Basic FHA Mortgage Loan
To purchase a single-family home in “as-is” condition, you may use the 203(b) mortgage. This purchase mortgage is the basic home loan insured by the FHA; its use is so widespread that it has come to be the representative “FHA loan”.
An appraisal is to be made to determine if the home meets the FHA’s minimum property requirements. If there are any minor repairs identified by the appraiser, they have to be completed prior to the closing of the loan.
At closing, the Section 203(b) loan proceeds will be disbursed in full.
FHA 203(k): The Rehabilitation Loan
To purchase a single-family home and finance its repairs as well, you may use the 203(k) home purchase mortgage. Home repairs, improvements, and upgrades must be at least $5,000.
There are two ways you can finance the repair costs into your Section 203(k) mortgage:
- Streamlined or limited 203(k): Applicable to home improvements and repairs that are less extensive and costing up to $35,000, e.g. replacing the roof, remodeling the kitchen, or painting the home’s interior.
- Standard 203(k): For more extensive work worth more than $35,000, including virtual reconstruction of the home.
A 203(k) appraisal takes into account the projected value of the home once the rehabilitation work is completed. Supposing you buy a home worth $100,000 with $80,000 worth of repairs to be completed. The appraisal will determine if the house’s value (i) is $180,000 post-rehabilitation and (ii) falls within the FHA mortgage limit in your county.
Unlike the 203(b) loan, the 203(k) loan proceeds are disbursed in tranches, at closing to fund the home’s acquisition costs and as the improvements get completed.
FHA 203(b) for Repairs?
In its general form, the Section 203(b) mortgage does not finance repairs and requires the home to be delivered in as-is condition at closing.
However, there is the Section 203(b) with repair escrow that allows up to $10,000 in home repairs. While the repairs can be completed post-closing, the home must be safe and habitable for occupancy at the loan’s closing date.
203(b) vs 203(k) Lending Guidelines
The basic eligibility standards for a Section 203(b) purchase mortgage are more or less applicable to that of a Section 203(k) mortgage in that:
- The borrower can have a less-than-perfect credit.
- The borrower can have a low-to-mid-sized income.
- The borrower can finance up to 96.5% loan-to-value ratio. Those with credit scores of 580 can avail of the 3.5% down payment (in the case of 203(k) loans, the purchase price + repair costs) while those with scores of 500 need to put 10% of the purchase price.
- The borrower must occupy the home as his/her primary residence. With respect to repairs, they must be completed within 120 days and the property may be unoccupied for 30 days only.
Do note that Section 203(k) lenders can charge other fees with respect to preparation and review of additional documents related to the home rehabilitation as well as a higher appraisal fee.
Justin McHood is a managing partner at Suited Connector and has been recognized by national media outlets as a financial expert for more than a decade.
