How much do you qualify for?
Qualifying for a 203k loan is very similar to qualifying for other types of loans. To give more exact numbers, I generally like to spend some time on the phone or in person with the borrower, and take a look at their credit, income, and assets. A rough guide is to buy a home worth 2.5-3.5 times what you make combined in a year. Some people recommend, “buying as much house as you can qualify for, because it’s the biggest investment you’ll likely ever make.” I don’t agree with that. I believe that you should have a payment you are comfortable with, and one that gives you enough room to save a bit, and allow for unexpected expenses. For example, a couple making $80,000 per year should be looking in the $250-300k range, tops.
There are mortgage calculators available to tell you how much the payment would be at a given interest rate and loan amount, but real estate taxes and insurance also come into play. FHA loans require escrows for taxes and insurance. Take 1/12th of the annual taxes and add that to your payment and 1/12 of the annual insurance also. Rough numbers would be somewhere around $75-100 per $10,000 borrowed, including taxes and insurance. So, depending on the county, etc, a $250,000 house would be in the $2000-2500/mo range, roughly.
The FHA guidelines are 42% debt-to-income ratio, but depending on credit scores and reserves, you might be able to get away with 50%. For example, let’s say you make $6000 per month, and you have $600 per month in car payments, and $400 a month in student loans and credit cards. $6000/2=$3000 mo (50% DTI) – $1000 (other debts) = $2000/mo maximum for total PITI (principle, interest, taxes, and ins), which means the maximum loan would be somewhere around $200,000 to $225,000 or so. The minimum down payment for a FHA loan is 3.5% of the purchase price (15% for 3-4 units). You also want to have at least 3 to 6 months PITI reserves after the down payment.
What is the process to get a 203k loan?
FHA loans are only for owner-occupied properties, not investments. The first part of the process is to get pre-qualified. For clients I take a look at income, credit, etc, and make sure you can get a loan. We’d write up a pre-approval letter that the buyer and/or real estate agent puts in with the offer. You reach an agreement with the seller, get estimates on any needed repairs, then process and close the loan. The seller gets the money for the purchase price, and the money for the repairs goes into an escrow account to be disbursed by a HUD counselor as repairs are finished. And, of course, there are inspections along the way.
Very important: There are two types of 203k loans: regular 203k, and a streamline 203k.
- If you can keep the total to less than $35,000 the hardest part is getting a “spot approval” for the contractor.
- A “full blown” 203k is much harder to get the contractor approved, and everything gets reviewed much more thoroughly, and just makes your life a little tougher in general. You can also set some of the money aside to be put toward your PITI payments until the work is finished, so that you aren’t paying rent and a mortgage.
What is the interest rate on FHA vs. 203k vs. conventional?
Regular FHA rates are pretty close to conventional rates. Right now they are around 5% or so, with no points. I want to put an asterisk (*) by this, because obviously we haven’t locked a rate, and lower credit scores (under 660 on FHA, and 700 on conventional) can be slightly higher. Also smaller loan amounts (under $150,000 or so) are usually a little higher.
The biggest difference is the mortgage insurance. All FHA loans have mortgage insurance (MI). If you are putting down 20% or more, and have very good credit scores, a conventional loan probably makes more sense. For higher loan to values (LTV), or slightly lower scores, FHA is probably the way to go. But, 203k rates are considerably higher. Right now, it’s probably about 6% with 1.5-2.0 points (a point is one percent of the loan amount), so take that into consideration for your down payment, along with underwriting fees, title fees, FHA counselor fee, and transfer tax if you are buying in Chicago.
FHA does allow for a seller concession of up to 6% of the purchase price to go toward your closing costs. It may be more advantageous for a buyer to negotiate a little more back for closing costs rather than just lowering the price as much as possible. On the plus side, once the work is completed and a few mortgage payments have been made, the homeowner can do a FHA streamline refinance and take the rate down to the current market FHA rate. Also, single family residences (SFR) are much easier to get done through an FHA loan than condos or townhomes. Associations can be deal killers to FHA loans.
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