Title One loans make it easier to finance home renovations
By Michael D. Larson • Bankrate.com

Title One home improvement loans seem to be going the way of the dodo, judging from recent volume. Lenders say proposed changes to the Department of Housing and Urban Development program will only make things worse.

But borrowers looking for a smart way to finance renovations during the busy spring and summer season may not want to write the loans off as quickly as lenders seem to be. They often have lower rates and fees, as well as more lenient underwriting standards, than conventional improvement loans. And there are no income limits on eligibility.

With rising temperatures and the upcoming start of hurricane season making big-ticket items such as air conditioning systems and shutters look more desirable, now's a good time to give the decades-old program a once-over.

"If you were to buy a house, like your first home, and you kind of stretched to get in, this loan is there to make the house that you bought, which may not be the home of your dreams, better," says Mike McGuire, president of Firstplus Bank in Tustin, Calif. "You can improve it to make it far more yourself and add your personal touch."

Popularity comes and goes
Title One loans have been around since the days of FDR, but they've faded in and out in popularity over the years. Like Federal Housing Administration first mortgages, they're issued by private lenders and backed by government insurance that protects those lenders from losses. But unlike FHA mortgages, which help people purchase houses, Title One loans assist borrowers looking to upgrade properties they already own.

Consumers can get up to $25,000 for single-family home improvements over loan terms of as long as 20 years. The improvements may consist of just about anything except luxury items. New windows, air conditioning systems, storm shutters or roof repairs qualify, whereas a new pool or hot tub doesn't. Borrowers obtain the money either by applying to a direct lender, or applying through a "dealer" -- typically a building contractor who works in partnership with a HUD-approved indirect lender.

In both cases, a homeowner puts together a list of materials needed for the project and how much they cost. On the direct loan side, a lender reviews that list, approves the loan and advances the money straight to the borrower, who starts making payments soon thereafter. The customer usually has six months to get the work done, after which time the lender inspects the results to make sure everything went OK.

On the dealer side of the business, the borrower fills out an application and qualifies. The contractor then orders the materials and starts work. After the project is completed, the consumer signs off on it and the indirect lender has it inspected. If all is well, the contractor gets paid, the lender assumes the loan and the borrower starts sending in monthly payments.

Advantages over second mortgages
Though they resemble traditional second mortgages, Title One loans offer customers a host of advantages. For starters, the government doesn't require borrowers to have equity in their homes. That gives new homeowners and those with high loan-to-value first mortgages a chance to renovate. Title One loans can be in any lien position, too. That means somebody with first and second mortgages already could still get a HUD renovation loan if sudden repairs were necessary.

Lenders can't charge more than five points, or 5 percent of the loan amount, in fees on Title One loans either. Since HUD doesn't require a property appraisal, closing costs are sometimes lower than they are with conventional home equity loans, too. Interest rates are typically lower as well because the government insurance protects lenders from almost all of their losses if a borrower defaults. Lastly, credit standards aren't as onerous with Title One loans as they are with some other financing options.

"You've got somebody who might be living there that just moved in as a candidate or somebody who's lived there for a while," says Skip Schenker, assistant vice president of National Pacific Mortgage in Anaheim, Calif. "The benefit is that you don't have to have an appraisal and you can improve the value of the property."

Because of its allure, the program soared in popularity through the middle of the 1990s. Lenders made slightly more than 97,000 single-family Title One loans in 1996 for $1.4 billion, up from almost 48,000 loans for $375 million in 1988. But since then, volume has plummeted. Only 26,000 loans for $380 million were underwritten last year and the numbers look even worse so far in 2000.

"125s" and scandal
Experts cite many reasons, but the explosion of non-government high loan-to-value lending takes most of the blame. Beginning in the middle of the last decade, lenders began aggressively soliciting homeowners to take out mortgages for more than the value of their properties. Consumers have taken the bait, too, because they can use money from these so-called "125s" (named for the maximum overall loan-to-value ratio that most lenders allow) for purposes other than home improvement, such as debt consolidation.

"Some of the (HUD) rules and the criteria are a bit antiquated in today's market vs. the conventional home-improvement market," says Mike Yuhas, vice president of indirect consumer lending at Harris Savings Bank of Harrisburg, Pa.

"Title One was the mainstay for a long, long time and it was the only option that was out there probably until about the late 1980s," he adds. "What has happened more recently, over the last five, six years, is the high-LTV market developed."

Scandals in the dealer loan portion of the Title One program haven't helped either. A few years back, it came to light that shady contractors were taking advantage of a program loophole to perform shoddy work and get paid anyway.

As Peter Bell, the executive director of the Home Improvement Lenders Association in D.C. explains, Title One rules require a borrower to inspect the contractor's work and sign off on it before that dealer gets any money from the indirect lender. The lender has to send a professional inspector to review the job, too. But the professional inspection can be performed as many as 60 days after the money is disbursed. So, scammers had a chance to profit and split.

HUD's response was to propose tighter restrictions on dealer loans. They even discussed eliminating that portion of the program in favor of direct-to-consumer loans. While that didn't happen, lenders say the hard-line approach scared many companies away from the program.

"The Secretary of HUD had a rule published to abolish the dealer part of the program," Yuhas says. "They never followed through with the action but when you send those type of signals in the marketplace, nobody has confidence. Lenders, dealers -- they all realize that it's on thin ice."

Still, it's a cost-effective way to borrow
Yet for all the headaches it's caused industry participants, the Title One program still offers consumers a cost-effective way to borrow.

Schenker of National Pacific points out that homeowners can get rates in the 10 percent to 12 percent range on Title One loans vs. 12 percent to 14 percent for non-government, high-LTV loans. Private lenders sometimes charge as many as 10 points, too, double what HUD allows. Consumers can't use Title One loans for frivolous spending either, so there's somewhat of a debt-deterrent benefit not found in the conventional market.

There is an insurance charge with Title One loans though. It comes to one-half of 1 percent of the loan amount, multiplied by the number of years the loan will be outstanding. That means somebody borrowing $10,000 on a 10-year term would have to fork over $500 in small monthly increments tacked onto their monthly payments. But because there's no need for an appraisal, the consumer catches a closing cost break with a HUD-backed loan.

Changes in the wind
Still, it's unclear how long Title One loans will be available in their current form and whether they'll remain a good deal.

A bill making its way through Congress may boost the loan limit to $32,500 from $20,000, for example. But a new set of rules proposed by HUD could boost the insurance fee to 1 percent of the loan amount. Those rules could also make it so that loans for more than $7,500 would have to be at least in second lien position. Consumers who borrow more than that amount directly would have to get their money via multiple draws, too, rather than in one lump sum payment.

The inspection process may be changed as well. The proposal would require either two or three reviews be performed, depending on the loan amount, instead of one. Lenders who make loans through dealers would have to conduct a telephone interview with the borrower before releasing money to the dealer, too.

The HUD rules, which the agency introduced at the end of March, are in a public comment period until May 30. Lenders complain they'll all but wipe out dealer loans by making them too expensive and cumbersome while the government says the changes would make consumers safer from fraud. For now, though, consumers will be able to borrow as before.