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Financing a fixer-upper

Finally, you've found a house that's in a great location and falls within your budget, but ... it needs work. Major work. You're wondering just how you can swing both a mortgage payment and the cost of repairs or renovation.

Fortunately, you have several financing options available. These include the Section 203(k) mortgage, available through the Federal Housing Administration, or FHA. Another product is Fannie Mae's HomeStyle Renovation Mortgage. In addition, some private lenders offer their own mortgage products geared to buyers of fixer-uppers.

These programs allow home buyers to finance both a mortgage and the construction work at one shot.

"These provide a great opportunity for folks to buy a more affordable house that needs work, and at the same time, be loaned the money to bring it up to their standards," says Tim Doyle, director of government affairs with the Mortgage Bankers Association of America, a Washington, D.C.-based trade association.

Doing everything at once can save time and money as it eliminates the need for two appraisals, title searches and the like. And, while interest rates on the products vary, most are comparable to rates on standard mortgages.

Section 203(k)
Perhaps the most well known product in this group is the FHA's Section 203(k) mortgage, which combines the cost of renovation and the purchase of the house within one loan.

These mortgages are available across the country and, contrary to some misperceptions, can be used on homes in urban, suburban or rural areas, as long as they're at least a year old. The planned renovation work has to total at least $5,000. Interest rates are in line with those for typical home loans, says Vijay Lala, senior vice president of product development and support with Countrywide Financial Corporation, Calabasas, Calif.

Here's how the process typically works: the borrower, having found a house that needs renovation, heads to a mortgage lender that handles 203(k) mortgages. A list of such lenders is available through the Web site of the Department of Housing and Urban Development.

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The borrower also hires a HUD-approved consultant, who identifies the rehabilitation projects that are most urgent. Not surprisingly, projects that address health and safety concerns go to the top of the list. Next in line are projects that enhance the value of the house. The HUD Web site also lists consultants.

Then, the lender hires an appraiser to determine the post-renovation value of the house. This is key, because "The benefit of the 203(k) is that you use future value, or the 'after-improved' value," says Lala.

For example, if a home has a price tag of $100,000 and will require $25,000 in improvements, the loan can be for the entire $125,000. The portion of the loan earmarked for improvements is disbursed in installments as the work is completed.

Loan calculations
The final amount of a 203(k) loan will be the lesser of two numbers. The first is the sum of the as-is value of the property plus the cost of the renovation work to be done, and up to six months mortgage payments. The second is the value of the post-renovation property plus 10 percent.

"We take the lower of the two," says Adam Glantz, a New York-based spokesman with the FHA.

In addition, the loan is subject to FHA mortgage limits, which vary across the country. In the Chicago area, for instance, FHA mortgage loans for single-family houses are capped at about $234,000.

The lender will also consider your ability to handle the proposed mortgage loan, based on your credit and work history, says Glantz. He or she will want to be confident that you can handle the monthly payments, which will be based on the cost of the mortgage and the renovation work.

Finally, prospective home buyers need to bear in mind their responsibilities for the success of the renovation.

"The homeowner ultimately is responsible for ensuring that the work gets done," says Doyle. "If they don't know what they're getting into and they're not really ready to manage a project like this, it's better for them to wait, save their money and buy a house in good condition."

HomeStyle renovation
Fannie Mae, a provider of home financing products based in Washington, D.C., also offers a mortgage product that allows borrowers to finance the cost of a house and renovation work within one loan. While Fannie Mae's HomeStyle Remodeler is similar to the Section 203(k) program, it differs in a couple of key ways.

For starters, the mortgage limits are somewhat higher. For most of the United States, loans for single-family houses can go up to $323,000. With a HomeStyle Remodeler loan, that amount would include both the cost of the house itself and the work that's done.

And, Fannie Mae doesn't require the use of a consultant. However, the borrower has to find a licensed contractor, who submits detailed work plans and specifications to the lender, says Jim Matheson, senior product manager with Fannie Mae. Before signing off on the loan, the lender determines whether the work proposed is likely to add value to the property. While Fannie Mae doesn't specify the types of repairs allowed, the work has to be on structures that are permanently attached to the property.

Options from private lenders
Some private mortgage lenders have their own programs for borrowers looking at a handyman special. One is the Plus Mortgage program offered by Market Street Mortgage Corporation, Clearwater, Fla.

"This program allows people to purchase homes, or refinance existing homes, and include the cost of improvements," says Randy Johnson, president and chief executive officer.

Plus Mortgage loans can be used with either FHA or conventional loans. Conventional loans aren't subject to the FHA caps.

Under the Plus Mortgage Program, the mortgage amount is based on the current market value of the house, plus the cost of the renovation work. As with the Section 203(k) mortgages, however, the portion of the loan that covers the renovation projects is disbursed in installments as the work is done.

In addition, Market Street checks the contractor's credentials.

"We look at their corporate credit rating, liquidity position and overall experience," says Johnson. "We want to make sure that we're comfortable with their qualifications."

During construction, the borrower pays prime plus 1 percent. When the loan converts to a standard mortgage, the interest rate is the same as on any other similar mortgage.

Once the renovation is complete, the loan for the entire amount is modified to a standard mortgage.

"It just requires signing a modification page," says Johnson.

-- Posted: April 7, 2003


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