Most home buyers take out mortgage loans to cover the purchase price of their new homes. But if you're buying a home that needs significant repairs, you might want to take out a mortgage loan in an amount higher than your home's sale price. Maybe the home you want to buy needs a new roof and a major kitchen overhaul. Instead of taking out a loan for the sale price, you'll take out a loan for $20,000 above it so that you have cash on hand to pay for these expensive repairs. Fortunately, there is a program for doing this offered through the U.S. Department of Housing and Urban Development's Federal Housing Administration.
Borrowers seeking to finance both the purchase of a home and its repairs can rely on the 203(k) program offered by the Federal Housing Administration. The FHA designed this program solely to help homeowners purchase and rehab homes in need of significant repairs. Under the program, the dollars to be used for repairs are placed in an escrow account. Your mortgage lender will then release these dollars to licensed contractors after they complete your home's repairs. To qualify for this program, you'll need to come up with a down payment of 3.5 percent of the total amount of the home's purchase price and repair costs. You also must live in the home; you can't take out a 203(k) loan for a home that you intend to use as an investment property. Note, too, that the FHA doesn't originate mortgage loans. It only insures them. To apply for a 203(k) loan, you'll have to work with a mortgage lender that deals with FHA-insured loans.
No matter how large a loan you seek, you'll have to meet certain income limits. Doing this becomes more challenging the more you want to borrow. Most lenders, even if participating in the FHA 203(k) program, require that your total monthly expenses -- including your estimated new monthly mortgage payment -- consume no more than 36 percent of your gross monthly income, your income before taxes are taken out. This is known as your back-end debt-to-income ratio. If you want to apply for a loan higher than your home's sales price through the 203(k) program, your ratio will still have to be at 36 percent or lower.
Lenders pay particular attention to credit scores. Most lenders consider scores of 740 or higher on the FICO credit-scoring scale to be good scores, indicative of borrowers who pay their bills on time. You'll need a score like this to persuade lenders to loan you a mortgage in an amount higher than your home's sales price. If you are applying for a 203(k) loan, the FHA is only providing insurance on that loan. You'll still have to work with a mortgage lender to originate your loan, and you'll still have to meet a lender's requirements. Lenders are taking on extra risk when they lend you a larger home loan. They stand to suffer a greater financial loss if you fall behind on your payments. A high credit score provides lenders some reassurance that you'll pay back the money they lend you.
To qualify for a mortgage loan through the FHA's 203(k) program, you'll have to provide your lender documentation from licensed contractors estimating the costs of these renovations. Lenders will study these documents to determine how much money you'll need to fix your new home's sagging foundation, cracked driveway and leaking roof.
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