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Is It Ever a Good Idea to Max Out Your 401(k)?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

The earlier you start saving for retirement and the more you contribute, the better. But should you max out your 401(k)? Whether maxing out your 401(k) is a good idea really depends on your personal financial situation.

The maximum amount you can contribute to your 401(k) is currently $19,500 a year if you are under age 50, and $26,000 if you are 50 or older. Once contributed, this money usually can’t be withdrawn until age 59½ without incurring penalties.

If you stash away this money now, you’ll be giving up part of your income and possibly making it more challenging to achieve other financial goals, such as saving up to buy a house or paying off your student loan debt. Still, you want to make sure you have enough cash saved to retire when you want to.

Should I max out my 401(k)?

There are a number of exceptional reasons to consider maxing out your workplace retirement account if you’re financially able.

As a baseline, you should at least make sure you’re saving enough to secure your entire employer match, if your workplace offers one. This match is a specific amount of “free money,” usually offered as a percentage of your own contribution, that your employer might offer to incentivize you to save for retirement.

But reaching your retirement goals may require contributing beyond your employer match. Alex Caswell, a financial advisor at RHS Financial, said three main reasons that people usually aim to maximize their 401(k) include:

  • Saving enough to actually retire one day
  • Reducing taxable income to save on taxes
  • Growing wealth on a tax-advantaged basis

Additionally, most people drastically underestimate how much they’ll need to retire one day, and many forget that retirement could last up to 30 years or even longer, Caswell said.

“Somehow you will need to make a fraction of your annual income grow and accumulate to the point where it can provide for you fully every year,” he said. “When you think about it from this perspective, it becomes very clear how important it is to contribute as much as you can.”

With all this being said, stashing $19,500 in your 401(k) each year can be easier said than done. While saving for retirement should be a financial priority, it shouldn’t necessarily come at the expense of other important financial goals, like building up an adequate emergency fund or paying off high interest debt.

You also don’t necessarily have to do all of your retirement saving in your 401(k) plan — especially if it has high fees or limited investment options.

Financial goals to complete before you max out your 401(k)

Depending on your salary and financial situation, it may make sense to check off some important to-dos before you start maxing out your 401(k). If you’ve already crossed all of these off your financial to-do list, that could also be a sign that you’re well-positioned to max out your 401(k).

Here are some of the most important goals you should consider when weighing whether you can realistically afford to max out your 401(k).

Building up an adequate emergency fund

Roger Whitney, host of the podcast Retirement Answer Man, says that it’s important to build up an emergency fund before you start maxing out your retirement fund. “Think of an emergency fund as the financial airbag of your life,” he said.

Having an emergency fund can give you financial options when anything unexpected comes up and help you keep your long-term assets for the long term. If you don’t have an emergency fund, you may be forced to deplete your resources if you face a job loss or a financial emergency.

How much should you save? Caswell suggests saving three to six months of expenses in a “safe and liquid bank account,” such as a high-yield savings account.

Paying off high-interest debt

You may also want to consider paying off high-interest debt before you max out your 401(k) entirely, advised financial planner Brandon Renfro.

If you have high-interest credit card debt, for example, it may be a good idea to go ahead and get that paid off first, he said. That’s because the average credit card interest rate is nearly 17% as of the date of publishing, meaning you’ll pay a lot in interest each month if you carry this debt over the long term instead of prioritizing paying it off.

Purchasing an adequate amount of life insurance

Make sure you have enough life insurance coverage to provide for your family if you were to suddenly pass away.

This shouldn’t be too difficult considering how inexpensive term life insurance coverage can be. Still, if you’re stretching yourself too thin to max out your 401(k), it might be tough to add another monthly bill.

Purchasing enough disability insurance coverage in case you’re unable to work

The importance of disability insurance is also worth taking into consideration when deciding whether to max out your 401(k). You should purchase enough disability insurance to provide coverage if you wind up being unable to work for six months or longer, said financial planner Ryan Inman.

Remember that your 401(k) funds can’t be used to replace your income if you cannot work for some reason without paying a hefty penalty. Disability coverage, on the other hand, can help you pay your bills and living expenses until you can get back to work.

Saving money in a health savings account, or HSA

According to financial advisor Matthew Kircher, health savings accounts (HSAs) offer one of the best tax-advantaged ways to save for high-income individuals.

“This is the only triple-tax-free option available that provides an upfront tax-deduction, tax-deferred growth and tax-free distributions,” he said.

The key to maximizing the HSA is to pay all actual medical expenses out of pocket, with the idea that you keep adding to and growing your account. You do have to have a high-deductible health plan to qualify for an HSA, however.

In 2020, this means a deductible of at least $1,400 for individuals (up from $1,350 in 2019) or at least $2,800 for a family (up from $2,700 in 2019). Maximum out-of-pocket amounts also apply to high deductible plans, and in 2020, your maximum out-of-pocket amount can be no more than $6,900 for individuals ($6,750 in 2019) or $13,800 for families ($13,500 in 2019).

While individuals and families could contribute up to $3,500 and $7,000 to HSA accounts in 2019, respectively, those figures increased to $3,550 for individuals and $7,100 for families in 2020.

Save up to purchase your first home

Depending on your situation, you may want to prioritize homeownership. If you’re spending a lot of money on rent right now, for example, being able to purchase a place of your own could help you stop renting and start building equity.

“If homeownership is a goal of yours, you may want to get that taken care of before you start maxing out your 401(k),” Renfro said.

When you should max out your 401(k)

While you’ll want to balance your other financial goals, there are situations in which maxing out your 401(k) might be a good idea. You may want to consider maxing out your 401(k) if:

  • You earn a lot and want to reduce your tax bill. Terms may apply.
  • You want to give compound interest a chance to help your money grow, tax-deferred.
  • You’ve achieved some of the important non-retirement goals we’ve outlined above.

In addition to making sure you have enough saved to retire, the tax benefits of maxing out your 401(k) are real.

“Contribution to a regular 401(k) doesn’t get counted toward your income,” Caswell said. “If you are in a high tax bracket, every dollar you manage to protect from taxes will increase the power of that money to grow your wealth. At an annual contribution limit of $19,000 [$19,500 for 2020], maxing out your 401(k) is one of the most powerful ways to reduce your tax bill.”

And, as we noted, don’t forget about the advantages of letting your money grow in a 401(k). All investments in your 401(k) grow tax-free.

“All the gains, dividends and interest you will incur year after year will be tax-free,” Caswell said. “This is unlike a regular brokerage account where you will receive a 1099 at the end of every year and be saddled with a tax bill.”

Other options besides maxing out your 401(k)

Whether or not you decide to max out your 401(k), there are plenty of other investment options to consider that can also help you to retire on your own terms. You may consider saving for retirement in other places as well, especially if your company’s 401(k) plan carries high fees or lackluster investment options.

Invest in a Roth IRA

According to Renfro, another retirement account option you may want to consider is a Roth IRA, which lets you invest for retirement with after-tax dollars. One strategy is to save enough in your 401(k) to get the employer match and then put anything you want to save above that amount in a Roth IRA, said Renfro.

“Saving in a Roth IRA in addition to a 401(k) can diversify your tax liability and help lower your overall tax rate when considered over multiple years,” Renfro said.

In 2020, most people can contribute up to $6,000 to a Roth IRA. If you’re age 50 or older, you can contribute up to $7,000.

Contribute to a traditional IRA

If you have the option to contribute to a traditional IRA, you may consider it before maxing out your 401(k). While 401(k) accounts are a great savings vehicle, they can be restricted in their investment options,.

“If you are looking for more control of your investment strategy, then you may consider saving in an IRA once you have taken full advantage of the 401(k) match,” Caswell said.

Note that the same contribution limits apply to traditional IRAs as Roth IRAs, and that the limit applies to both accounts combined.

Open a brokerage account

If you’ve already maxed out tax-advantaged retirement savings accounts like your 401(k), you can also consider opening a taxable brokerage account with any firm that offers one, such as Vanguard, Fidelity or Schwab.

Inman says that, while a taxable investment account won’t provide any tax savings, “it will provide another pool of assets to provide you with income in retirement.”

The bottom line

At the end of the day, having enough income in retirement is the underlying goal anyway, right? By contributing to a 401(k), simultaneously pursuing other financial goals and letting time and compound interest do their work, you should be well on your way to a secure financial future. Whether you decide that maxing out your 401(k) is a good idea to get there ultimately depends on your financial situation and other financial goals.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Holly Johnson
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Holly Johnson is a writer at MagnifyMoney. You can email Holly here

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Mortgage

How Much Does It Cost to Build a House?

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If you’re thinking about building your home from the ground up instead of purchasing an existing home, it’s critical to have a thorough understanding of what the home construction process entails and what it means for your wallet.

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How much does building a house cost? The average construction cost for a single-family home that is 2,776 square feet is $237,761, according to the National Association of Home Builders (NAHB). That breaks down to $85.65 per square foot.

We’ll look at what you should know before building, what factors can change the cost and what steps you can follow along the process, among other things.

What to consider before building a house

Building a home is best for those who are detailed and know what they want, said Frank Nieuwkoop of new-home builder Valecraft Homes Ltd., based in Ottawa, Ontario, Canada. Building is also ideal for people who don’t care as much about cost as long as they get a brand-new home and the ability to pick and choose each feature and finish.

It is “also best for buyers who are patient and willing to endure some bumps along the road,” Nieuwkoop said. “If you’re high stress and don’t want to deal with any issues, you may be better off buying a newer existing home.”

One of the main considerations of building a home is cost. Not only do you have to worry about the expenses related to constructing the house, but you’ll need to factor in the land on which the house will be built. Let’s look at a breakdown of the average cost of building a house, according to data from the NAHB.

You can compare this to the median existing-home sales price, which was $277,700 in May 2019, according to the National Association of Realtors (NAR).

Factors that influence the cost of building a house

The average cost to build a house can give you a general idea of how much you’ll pay, but it’s important to note that the costs of building any home can vary dramatically. For example, where you live can play a huge role in the cost of land and the price of the permits and other fees you’ll need to cover.

There are also other factors that will dictate how much your pay, of course, from the type of home you select to the choices you make for its interior. These factors include:

  • Your lot: The NAHB reports that the average cost for a finished lot (including financing) was $91,996 in 2017 — the most recent year for which data is available. However, this cost can vary depending on the lot you buy, the size of the lot and the local real estate market in which you buy.
  • Home size: The larger the home, the more construction costs you’ll encounter. Larger homes also require more materials (more flooring, more lighting, more fixtures, etc.), which can lead to higher costs in a hurry.
  • Upgrades: If you opt for fancy upgrades, you’ll pay more for a new home. Granite or marble, upgraded fixtures and custom woodwork can make any home considerably more expensive. This is one area, however, where you can also save on the costs of building. Where laminate countertops may cost around $30 per square foot, you’ll pay more — $50 to $90 per square foot — for quartz, according to Home Depot. If you multiply those savings across all the rooms that need counters in your home (kitchen and baths), it’s easy to see how you could pay more or less depending on what you choose.
  • Home design: The design of the home can play a factor in cost. If you build a home that has a standard design, you may pay less than if you build a custom home with a unique design or special features. If you design a truly custom home, you may also need to hire an architect to draft a design. An architect’s rate can range from $60 to $125 an hour, according to HomeAdvisor.
  • Siding: What you choose to cover the exterior of your home can play a big role in your total price. If you choose a custom stone exterior, you may pay more — $35 to $50 per square foot — than you would if you choose vinyl siding — $2 to $7 per square foot — according to HomeAdvisor.
  • Landscaping: Will you opt for an elaborate outdoor landscaping scheme or some simple greenery? Your landscaping choices will play a role in the costs of your home, and so will ongoing outdoor maintenance. You’ll also pay more for a fenced yard.

Should you build or buy your home?

Using the example above of the 2,776-square-foot home, the total sales cost, per the NAHB, would be $427,892. That includes the cost of construction, the lot, financing and more.

Before you choose between building your dream home or shopping among the homes in your desired area, consider the benefits and drawbacks of both options.

Building your own home

Pros:

Cons:

  • Less competition: Existing homes stayed on the market for an average of 26 days before being sold in May 2019, according to the latest report from the NAR. By selecting your own lot and building a home, you can avoid stiff competition for existing properties and still get the home you want.
  • Everything is new: People love that everything will be brand new when they build, Nieuwkoop said. Having new fixtures, a new roof, new appliances and a new HVAC system may also mean you’ll have fewer repair bills during the first few years of homeownership.
  • Choose your home’s location: Building a new home on a lot you choose puts you in the unique position of selecting where you’ll live. This can be advantageous if you hope to live near work or near public transportation, or if you want a lot with a certain view.
  • Select your own floor plan and finishes: Whether you build a custom home or select a floor plan through a builder, you get to choose how your new home is set up — including your floor plan. You may even be able to select your own finishes, including paint colors, countertops, flooring and cabinets.
  • Moving delays: Building a home often means longer delays when it comes to moving. “Building a home can take as little as two months all the way up to a year,” Nieuwkoop said.
  • Building surprises: Especially if you design a custom home, you may not know how the floor plan flows until your home is already built. Fortunately, this isn’t typically a problem with larger builders and developers since they often have model homes you can walk through, Nieuwkoop said.
  • Pricing surprises: With custom homes, pricing can easily surge — especially if you make changes as the plan moves along. Plus, there are added costs that come with building that many people forget. Adding window blinds and treatments can add up, as can new décor, shelving and other interior fixtures that don’t come in the home price. Builders rarely put a fence in the yard, so that’s possibly another expense to consider.
  • Less negotiation power: You may be able to negotiate the price on an existing home if a buyer is motivated to sell, but there may be less wiggle room on the price of a new build.
  • Construction traffic: If you’re building in a new development, you may deal with ongoing construction traffic for months or even years.
Buying an existing home

Pros:

Cons:

  • Save money with existing features: Existing homes can have a lot of additions and upgrades already. These may include mini blinds, a privacy fence and appliances.
  • Move in quicker: While it could take months until you move in after closing on an existing home, the timeline typically is faster than if you were building.
  • Property maturity: Existing homes tend to have more mature trees and landscaping, which could be advantageous if you don’t like the idea of growing new grass on your own.
  • No construction zone: If you’re buying a home in a mature neighborhood, you likely won’t have to deal with ongoing construction issues.
  • Lack of customization: You don’t get to pick out the floor plan or fixtures when you buy an existing home. You get what is there already.
  • Upgrade costs: If you buy an existing home that is out of date, you may need to spend thousands to make important updates or replace old fixtures.
  • Hidden problems: Existing homes may have problems you don’t see, and home inspectors don’t always find every issue. For example, if a seller replaces drywall after a water leak but doesn’t fix the issue properly, you may not find out about further repairs until after you move in.

The 5 steps of building a house

The process of building a house can vary depending on whether you design it independently or work with a developer. However, the main steps of constructing the house are pretty much the same. We’ll outline the five steps to building a house from beginning to end, based on insights from Nieuwkoop.

Step No. 1: Create a budget

Before you decide to build or buy a home, it’s crucial to have an understanding of how much you can afford to spend on the land and the construction of the house. The best way to establish a budget is to apply for a mortgage preapproval. That way, you’ll be ready to work with a builder when you decide what you want. If you need extra help and have questions, consult a loan officer or mortgage broker. You can also compare mortgage offers online to help you find the best deal.

Step No. 2: Purchase land or select a lot

Once you have your budget (house and land included), it’s time to find a lot in an existing community or buy land on which you plan to build. Keep in mind that the price of the land you buy will need to be included in your mortgage amount unless you plan to buy the land in cash separately. If you’re choosing a piece of land that hasn’t been developed, you should ask your builder about the costs of adding utilities to the property, cutting down trees or leveling the land.

If you’re buying from a developer or builder who is overseeing the construction of a new neighborhood, it’s possible the price of your chosen lot will be built into the price of the floor plan and home you select, Nieuwkoop said.

Step No. 3: Develop your floor plan and design

Chances are good if you’re working with a builder that they’ll offer a range of floor plans and new home designs from which you can choose. For custom homes, on the other hand, you’ll likely need to hire an architect to create a realistic housing design that encompasses all the features you want.

During this step, you’ll need to decide how many bedrooms and bathrooms you want, along with the general layout of your home. From there, you can select or design a housing plan that fits your budget and style.

Step No. 4: Select appliances, features and finishes

Once you’ve chosen the layout of your home, you’ll need to choose what goes inside. Work with your builder to decide on the interior finishes in your home, from the kitchen cabinets to your light fixtures, plumbing fixtures, flooring and paint colors.

Step No. 5: Watch the construction of your home

Once your home is commissioned and ready to be built, you can watch as the process takes place over the weeks and months. Ideally, your builder will let you walk through the home during various stages of the process, Nieuwkoop said. By seeing the work firsthand, you may be able to discover and point out issues that need to be addressed, such as incorrect fixtures or design problems.

Financing your home’s construction

The process for financing a new build is similar to financing the purchase of an existing home, according to mortgage adviser Jeremy Schachter of Fairway Independent Mortgage Corp. in Phoenix.

When you build a home, it’s crucial to get a mortgage preapproval with a bank or lender. During this process, the lender will take a look at your credit score, income, assets and debts to determine how much you can borrow.

The biggest difference with a new build is that you’ll likely need to get preapproved for a mortgage once and then start a portion of the process over again, especially if the process spans several months, Schachter noted, adding that the final home closing doesn’t take place until the house is completed, and that at this stage you’ll start making mortgage payments.

Many lenders will let you lock in the interest rate on your home loan for up to a year when you’re building a home, Schachter said. Still, check with your lender about your mortgage APR to make sure you’re not stuck with a higher interest rate if your new build takes several months and rates surge during that time.

What type of mortgage can you borrow?

Homebuyers can use any type of home loan to build a property that they would use to buy a traditional home, Schachter said. Among those loan types are:

  • FHA loans: You can apply for an FHA construction loan to finance a new build. To qualify for an FHA loan, you’ll need at least a 3.5% down payment, a minimum 580 credit score and proof of income. You may qualify for an FHA loan with a credit score lower than 580, but you’ll need to make a down payment of 10% or higher. Lenders will also look at your debt-to-income ratio (the percentage of your monthly income that is dedicated to repaying debt, including your estimated mortgage payment). For example, if you have $3,000 in bills each month and your gross monthly income is $5,000, your DTI ratio is 60%. In most cases, lenders want you to keep your DTI ratio at or below 43%.
  • Conventional loan: Requirements for a conventional mortgage can vary, although you’ll typically need a credit score of 740 or higher to qualify for a loan with the best mortgage rate. Lenders also look at your employment history, income and DTI ratio.
  • VA loans: Most lenders expect borrowers to have a minimum 620 credit score to qualify for a VA loan, though exceptions can be made for borrowers contributing a larger down payment. You’ll also need sufficient income and a valid Certificate of Eligibility (COE) based on your level of service. You must also plan to live in the home full time.
  • Construction loans: Individuals building a custom home may need to get a special construction loan from a lender or bank. These loans cover the initial costs of building a house, including the lot, building materials and architect fees. Construction loans are typically short-term loans with variable interest rates that are good for less than a year, according to Schachter. Ultimately, construction loans are converted to permanent home loans once construction is complete.

The bottom line

Deciding to build your home can come with a heftier price tag than what it could cost you to buy an existing home.

While you’ll reap the benefits of a newly constructed home, like brand-new appliances and major systems, the time it takes to complete your home can likely surpass the contract-to-close timeline on a home that already exists.

Before you make your final decision, be sure you understand the estimated costs of building a home — and make room in your budget for price fluctuations.

The information in this article is accurate as of the date of publishing. 

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Holly Johnson
Holly Johnson |

Holly Johnson is a writer at MagnifyMoney. You can email Holly here

Crissinda Ponder
Crissinda Ponder |

Crissinda Ponder is a writer at MagnifyMoney. You can email Crissinda here

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Understanding the FHA 203k Loan

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If you’re angling to buy a home at a price you can afford, you may consider making some compromises, like looking outside your dream neighborhood, for example. You might also need to consider homes that aren’t in perfect shape, or even ones that require a complete overhaul. Fortunately, some mortgages allow you to wrap the costs of a remodeling project into the loan. This could be true when you use this type of mortgage to purchase a property, or when you decide to remodel a home you already own and refinance to access funds for your project.

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The Federal Housing Administration (FHA)’s 203(k) rehab loan is a popular option that works in these scenarios. This type of loan allows homeowners to roll remodeling funds into their primary mortgage.

In this guide, we’ll go over the following details to explain how the 203(k) loan works:

What is a 203(k) loan?

Imagine you want to purchase a $100,000 home that needs a minimum of $20,000 in upgrades and repairs to make it habitable, clean and safe. You could purchase the home and move in until you can finance the improvements separately, but you could also take out a 203(k) rehab loan that covers both the initial mortgage amount and the cash you need for repairs.

While many consumers use the 203(k) loan for purchases, also note these loans work for refinancing as well. In other words, if you already own your home but need cash for important updates and improvements, you could refinance your current mortgage with a 203(k) loan and borrow additional funds to pay for the repairs.

The 203(k) loan program offers two versions that work best for different situations:

  • The Standard 203(k) is perfect for updates and repairs, although there is a minimum repair cost of $5,000 and you have to work with a 203(k) loan consultant to complete the process.
  • The Limited 203(k) is for modest upgrades and repairs. This loan does not require you to use a 203(k) consultant, but the maximum repair cost cannot exceed $35,000. There is no minimum repair amount for this type of 203(k) loan.

Generally speaking, 203(k) loans can be used for projects that increase the value of your home, make it safer or improve structural integrity. The FHA lists the following eligible activities for loan funding on its website:

  • Structural alterations and reconstruction activities
  • Improvements to a home’s function or utility
  • Improvements that improve health or eliminate safety hazards
  • Changes that improve a home’s appearance
  • Replacing or repairing plumbing, a well or a septic system
  • Replacing or repairing roofing, gutters or downspouts
  • Replacing or adding flooring
  • Major site improvements or landscaping projects
  • Improvements that make homes accessible for people with a disability
  • Energy-use improvements

Eligibility for using a 203(k) rehab loan

While 203(k) loans tend to offer flexible terms for both borrowers and the homes they suit, they do come with some basic requirements.

Property eligibility requirements

For a property to qualify for a 203(k) rehab loan, it must have been completed at least one year before it is assigned a case number. This means 203(k) loans cannot be used for brand-new construction that is less than 1 year old. Other property requirements for 203(k) loans include:

  • Must be a one- to four-unit building of single-family homes
  • Can be a condominium if it is in an FHA-approved condominium unit; improvements are limited to the interior of the unit in most cases, and the unit is in a building with no more than four units
  • Can be manufactured housing if the upgrades and improvements do not affect the structural components of the building
  • Can be a mixed-use property with one to four residential units, provided at least 51% of the unit is residential
  • The home cannot exceed dwelling-unit limitations for the area
  • The home must be located in the United States.

Borrower eligibility requirements

There are also borrower eligibility requirements for 203(k) loans. These requirements determine who is eligible and under what circumstances.

To qualify for a 203(k) loan, you must:

  • Have a valid Social Security number (unless you are a state or local government agency, instrument of government or nonprofit approved by the U.S. Department of Housing and Urban Development, or HUD)
  • Be able to provide the lender with your SSN, name, date of birth, original pay stubs, W-2s, valid tax returns and any other required information to obtain a mortgage
  • Have a minimum credit score of 500
  • Be a U.S. citizen or an eligible noncitizen
  • Not have any delinquent federal tax debt
  • Not have a delinquent FHA home loan
  • Must live in the property as a principal residence.

How to get an FHA 203(k) rehab loan

To determine eligibility for an FHA 203(k) loan, you’ll need to search for a lender that’s approved to offer FHA loans. Fortunately, HUD offers a tool on its website that allows you to search for FHA-approved lenders in your area. It even includes a featuring of searching only for lenders that have dealt with a 203(k) rehab loan in the last 12 months.

If you plan to apply for a Standard 203(k) rehab loan, you’ll need to work with a 203(k) consultant. This consultant, who must meet stringent requirements in terms of their work experience and licensing, will inspect the property and prepare the architectural paperwork, work write-up and cost estimate for your project.

The FHA 203(k) consultant is also charged with overseeing the renovation funds, which are initially placed in an escrow account. Your consultant is able to sign off on when these funds are released to contractors and service providers working on your project.

Pros and cons of an FHA 203(k) loan

FHA 203(k) rehab loans come with both advantages and disadvantages. Some reasons to consider these loans are listed below, along with some of the pitfalls that make them a less attractive option.

Pros of FHA 203(k) loans

  • FHA loans have low credit-score requirements: You can qualify for an FHA 203(k) loan with a credit score as low as 500. It’s a much lower minimum standard credit score than many other types of home loans.
  • Wrap your remodeling costs into your home loan: The biggest benefit of FHA 203(k) rehab loans is that you don’t have to pay for remodeling costs out of pocket. You can wrap the costs of your project into your primary home loan instead.
  • Interest rates are typically lower than some other mortgage options: FHA loans also come with low closing costs, and FHA interest rates may be lower than some other types of home loans.

Cons of FHA 203(k) loans

  • Standard 203(k) loans require you to work with a loan consultant. Not only can working with a 203(k) loan consultant cost up to $1,000 in fees for the service, but this layer of work adds yet another step to the process. Remember that your 203(k) loan consultant will have to complete an inspection of the home, sign off on all improvements and their costs and address any health and safety issues.
  • Government-backed loans tend to come with a lot of rules. Government-backed FHA loans have many rules, and FHA 203(k) loans are no exception. For example, you cannot use this type of loan for “luxury items” including hot tubs, outdoor fireplaces or swimming pools.

Alternatives – other renovation loans

As you dig deeper into the prospect of taking out an FHA 203(k) rehab loan for home improvements, don’t forget there may be other options that work for your situation. Some 203(k) loan alternatives include:

  • Fannie Mae HomeStyle® Renovation: Fannie Mae’s HomeStyle Renovation loan is another type of home loan that lets you include renovation and repair costs in your mortgage amount. These loans tend to offer competitive rates that can be lower than those you can get with a home equity loan or home equity line of credit (HELOC), and they work for the purchase of a home as well as refinancing an existing home.
  • Home equity loan: A home equity loan lets you borrow against the equity in a home you already own to free up funds for repairs, renovations or any other type of spending. This type of loan comes with a fixed interest rate, fixed monthly payment and fixed repayment timeline.
  • Home equity line of credit (HELOC): A HELOC is a line of credit that works similarly to a credit card except but is secured by the equity in your home. These loans have fluctuating monthly payments that vary based on how much you borrow, as well as variable interest rates.
  • Personal loan for home improvement: Also be aware that you can take out an unsecured personal loan for home improvements. Like home equity loans, these loans come with a fixed interest rate, fixed monthly payment and fixed repayment timeline.

Conclusion

If the home you love needs some love, it’s nice to know there are plenty of ways to access the cash you need. Compare your options, including 203(k) rehab loans, and weigh the pros and cons of each before you decide.

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Holly Johnson
Holly Johnson |

Holly Johnson is a writer at MagnifyMoney. You can email Holly here