The Federal Housing Administration (FHA), which is part of the Department of Housing and Urban Development (HUD), administers various single-family mortgage insurance programs. These programs operate through FHA-approved lending institutions which submit applications to have the property appraised and have the buyer's credit approved. These lenders fund the mortgage loans which the Department insures. HUD does not make direct loans to help people buy homes. The Section 203(k) Program is HUD's primary program for the rehabilitation and repair of single- family properties.
As such, it is an important tool for community and neighborhood revitalization and for expanding homeownership opportunities. Since these are the primary goals of HUD, it believes that Section 203(k) is an important program and intends to continue to strongly support the program and the lenders that participate in it.
Many lenders have successfully used the Section 203(k) Program in partnership with state and local housing agencies and nonprofit organizations to rehabilitate properties. These lenders, along with state and local government agencies, have found ways to combine Section 203(k) with other financial resources, such as HUD's HOME, HOPE, and Community Development Block Grant Programs, to assist borrowers.
Several state housing finance agencies have designed programs specifically for use with Section 203(k), and some lenders have also used the expertise of local housing agencies and nonprofit organizations to help manage the rehabilitation processing. HUD also believes that the Section 203(k) Program is an excellent means for lenders to demonstrate their commitment to lending in low-income communities and to help meet their responsibilities under the Community Reinvestment Act (CRA).
HUD is committed to increasing homeownership opportunities for families in these communities and Section 203(k) is an excellent product for use with CRA-type lending programs. If you have questions about the 203(k) Program or are interested in getting a 203(k)- insured mortgage loan, we suggest that you get in touch with an FHA-approved lender in your area or the homeownership center in your area.
Most mortgage financing plans provide only permanent financing. That is, the lender will not usually close the loan and release the mortgage proceeds unless the condition and value of the property provide adequate loan security. When rehabilitation is involved, this means that a lender typically requires the improvements to be finished before a long-term mortgage is made.
When a home buyer wants to purchase a house in need of repair or modernization, he or she usually has to obtain financing first to purchase the dwelling, additional financing to do the rehabilitation construction, and a permanent mortgage when the work is completed to pay off the interim loans. Often, the interim financing (the acquisition and construction loans) involves relatively high interest rates and short amortization periods. The Section 203(k) Program was designed to address this situation.
The borrower can get just one mortgage loan, at a long-term fixed (or adjustable) rate, to finance both the acquisition and the rehabilitation of the property. To provide funds for the rehabilitation, the mortgage amount is based on the projected value of the property with the work completed, taking into account the cost of the work. To minimize the risk to the mortgage lender, the mortgage loan (the maximum allowable amount) is eligible for endorsement by HUD as soon as the mortgage proceeds are disbursed and a rehabilitation escrow account is established. At this point, the lender has a fully-insured mortgage loan.
Eligible Property
To be eligible, the property must be a one- to four-family dwelling that has been completed for at least one year. The number of units on the site must be acceptable according to the provisions of local zoning requirements. All newly constructed units must be attached to the existing dwelling. Cooperative units are not eligible. Homes that have been demolished, or will be razed as part of the rehabilitation work, are eligible, provided some of the existing foundation system remains in place. In addition to typical home rehabilitation projects, this program can be used to convert a one-family dwelling to a two-, three-, or four-family dwelling.
An existing multi-unit dwelling could be decreased to a one- to four-family unit. An existing house (or modular unit) on another site can be moved onto the mortgaged property. However, release of loan proceeds for the existing structure on the non-mortgaged property is not allowed until the new foundation has been properly inspected, and the dwelling has been properly placed and secured to the new foundation.
A 203(k) mortgage may be originated on a mixed-use residential property, provided the property has no greater than 25% (for a one-story building), 33% (for a three-story building), and 49% (for a two-story building) of its floor area used for commercial (storefront) purposes. The commercial use also must not affect the health or safety of the occupants of the residential property, and the rehabilitation funds may be used only for the residential functions of the dwelling and areas used to access the residential part of the property.
Condominium Unit
HUD also permits Section 203(k) mortgages to be used for individual units in condominium projects that have been approved by the FHA, the Department of Veterans Affairs, or are acceptable to FNMA under the guidelines listed below. The 203(k) Program was not intended to be a project-mortgage insurance program, as large-scale development has considerably more risk than individual single-family mortgage insurance. Therefore, condominium rehabilitation is subject to the following conditions:
- Borrowers can be owner-occupants and qualified non-profits only -- no investors.
- Rehabilitation is limited only to the interior of the unit. Mortgage proceeds are not to be used for the rehabilitation of exteriors or other areas which are the responsibility of the condominium association, except for the installation of firewalls in the attic for the unit.
- Only the lesser of five units per condominium association, or 25% of the total number of units, can be undergoing rehabilitation at any one time.
- The maximum mortgage amount cannot exceed 100% of after-improved value.
- After rehabilitation is complete, the individual buildings within the condominium must not contain more than four units.
By law, Section 203(k) can only be used to rehabilitate units in one- to four-unit structures. However, this does not mean that the condominium project, as a whole, can only have four units or that all individual structures must be detached. For example, a project might consist of six buildings each containing four units, for a total of 24 units in the project, and, thus, be eligible for Section 203(k).
Likewise, a project could contain a row of more than four attached townhouses and be eligible for Section 203(k) because HUD considers each townhouse as one structure, provided each unit is separated by a 1-1/2-hour firewall (from foundation up to the roof). Similar to a project with a condominium unit with a mortgage insured under Section 234(c) of the National Housing Act, the condominium project must be approved by HUD prior to the closing of any individual mortgages on the condominium units.
How the Program Can Be Used
This program can be used to accomplish rehabilitation and/or improvement of an existing one- to four-unit dwelling in one of three ways:
- to purchase a dwelling and the land on which the dwelling is located and rehabilitate it;
- to purchase a dwelling on another site, move it onto a new foundation on the mortgaged property, and rehabilitate it; or
- to refinance existing indebtedness and rehabilitate such a dwelling.
To purchase a dwelling and the land on which the dwelling is located and rehabilitate it, and to refinance existing indebtedness and rehabilitate such a dwelling, the mortgage must be a first lien on the property and the loan proceeds (other than rehabilitation funds) must be available before the rehabilitation begins. To purchase a dwelling on another site, move it onto a new foundation and rehabilitate it, the mortgage must be a first lien on the property; however, loan proceeds for the moving of the house cannot be made available until the unit is attached to the new foundation.
Eligible Improvements
Mortgage proceeds must be used in part for rehabilitation and/or improvements to a property. There is a minimum $5,000 requirement for the eligible improvements on the existing structure(s) on the property. Rehabilitation or improvements to a detached garage, a new detached garage, or the addition of an attached unit (if allowed by the local zoning ordinances) can also be included in this first $5,000. Properties with separate detached units are acceptable; however, a newly constructed unit must be attached to an existing unit to be eligible under 203(k).
Any repair is acceptable in the first $5,000 requirement that may affect the health and safety of the occupants. Minor or cosmetic repairs by themselves cannot be included in the first $5,000, but may be added after the $5,000 threshold is reached. Examples of eligible improvements are listed below (this list is not all-inclusive):
- structural alterations and reconstruction (e.g., repair or replacement of structural damage, chimney repair, additions to the structure, installation of an additional bath(s), skylights, finished attics and/or basements, repair of termite damage and the treatment against termites or other insect infestation, etc.);
- changes for improved functions and modernization (e.g., remodeled bathrooms and kitchens, including permanently installed appliances, such as a built-in range and/or oven, range hood, microwave, dishwasher);
- elimination of health and safety hazards (including the resolution of defective paint surfaces or lead-based paint problems on homes built prior to 1978);
- changes for aesthetic appeal and elimination of obsolescence (e.g., new exterior siding, adding a second story to the home, covered porch, stair railings, attached carport);
- reconditioning or replacement of plumbing (including connecting to public water and/or sewer system), heating, air conditioning and electrical systems. Installation of new plumbing fixtures is acceptable, including interior whirlpool bathtubs;
- installation of a well and/or septic system. The well or septic system must be installed or repaired prior to beginning any other repairs to the property;
- roofing, gutters and downspouts;
- flooring, tiling and carpeting;
- energy-conservation improvements (e.g., new double-pane windows, steel insulated exterior doors, insulation, solar domestic hot water systems, caulking and weatherstripping, etc.);
- major landscape work and site improvement (e.g., patios, decks and terraces that improve the value of the property equal to the dollar amount spent on the improvements, or required to preserve the property from erosion);
- the correction of grading and drainage problems;
- tree removal is acceptable if the tree is a safety hazard to the property;
- repair of existing walks and driveway if it may affect the safety of the property; and
- improvements for accessibility for a disabled person (e.g., remodeling kitchens and baths for wheelchair access, lowering kitchen cabinets, installing wider doors and exterior ramps, etc.).
When basic improvements are involved, the following costs can be included in addition to the minimum $5,000 requirement:
- new, free-standing range, refrigerator, washer and dryer, trash compactor and other appurtenances (used appliances are not eligible);
- interior and exterior painting; and
- the repair of a swimming pool, not to exceed $1,500.
Luxury items and improvements that do not become a permanent part of the real property are not eligible as a cost of rehabilitation. The items listed below (though not limited to this list) are not acceptable under the 203(k) program, including the repair of any of the following: barbecue pit; bathhouse; dumbwaiter; exterior hot tub; sauna, spa and whirlpool bath; outdoor fireplace or hearth; photo mural; installation of a new swimming pool; gazebo; television antenna; satellite dish; tennis court; or tree surgery. Additions or alterations to provide for commercial use are not eligible.
Required Improvements
All rehabilitation construction and/or additions financed with Section 203(k) mortgage proceeds must comply with the following:
- A. cost-effective energy conservation standards:
(1) addition to existing structure: new construction must conform with local codes and HUD;s Minimum Property Standards;
(2) rehabilitation of existing structure: to improve the thermal efficiency of the dwelling, the following are required:
- weather-strip all doors and windows to reduce infiltration of air when existing weatherstripping is inadequate or nonexistent;
- caulk and seal all openings, cracks and joints in the building envelope to reduce air infiltration;
- insulate all openings in exterior walls where the cavity has been exposed as a result of the rehabilitation, and insulate ceiling areas where necessary; and
- adequately ventilate attic and crawlspace areas. For additional information and requirements, refer to 24 CFR Part 39.
(3) replacement of systems:
- heating, ventilating, and air-conditioning system supply and return pipes and ducts must be insulated whenever they run through unconditioned spaces; and
- heating systems, burners, and air-conditioning systems must be carefully sized to be no greater than 15% oversized for the critical design, heating or cooling, except to satisfy the manufacturer's next closest nominal size.
- B. smoke detectors: each sleeping area must be provided with a minimum of one:
(1) approved, listed and labeled smoke detector installed adjacent to the sleeping area.
- A. as-is value: A separate appraisal (Uniform Residential Appraisal Report) may be required to determine the as-is value. However, the lender may determine that an as-is appraisal is not feasible or necessary. In this instance, the lender may use the contract sales price on a purchase transaction, or the existing debt on a refinance transaction, as the as-is value, when this does not exceed a reasonable estimate of value.
- B. value after rehabilitation: The expected market value of the property is determined upon completion of the proposed rehabilitation and/or improvements .
- A "Plot Plan of the Site" is required only if a new addition is being made to the existing structure. Show the location of the structure(s), walks, drives, streets, and other relevant details. Include finished grade elevations at the property corners and building corners. Show the required flood elevation.
- "Proposed Interior Plan of the Dwelling: shows where structural or planning changes are contemplated, including an addition to the dwelling.
- "Work Write-up and Cost Estimate": Any format may be used for these documents; however, quantity and the cost of each item must be shown. Also include a complete description of the work for each item.