A 203k loan is a rehabilitation loan issued by the Federal Housing Administration (FHA) that includes purchase price and construction budget for a property. 203k loans are issued by participating mortgage lenders to qualifying homebuyers who intend to live in the property once construction is completed. A licensed general contractor is required to ensure the construction is completed on time and on budget. The budget is determined by a 3rd party 203k inspector who issues a Specification Of Repairs ("SOR") which is reconciled with the general contractor's budget.
203k loans require just a 3.5% down payment on the value of the purchase price plus the SOR budget.
Let's say you buy a house that needs significant rehab before moving in. The purchase price is $100,000 and the rehab budget based the SOR is $100,000. You just need to put down 3.5% of the $200,000 value or $7,000 plus closing costs. That leaves a loan of $193,000. The bank issuing the loan has an appraisal conducted to make sure the rehabbed property is worth at least as much as the investment price (purchase price plus rehab budget).
An appraisal is conducted and the appraiser determines, based on comps, that the complete house will be worth $250,000. The rehab is completed on budget, with the contractor being paid in 3 separate draws based on work performed against the SOR.
At the end of the project, you move into a house that is worth $250,000, with a $193,000 mortgage loan. That means you have 22.8% equity in the property worth $57,000. You went from 3.5% equity down payment to 22.8% equity, for a gain of $50,000 in equity. Not too shabby!