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

Borrowers looking for a smart way to finance renovations during the busy spring and summer season may want to check out Title One home improvement loans. 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.

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. In many cases, Title One loans are avaliable for homeowners with first and second mortgages.

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.

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 in 1999 and in 2002 there were only 6,411 loans for about $75 million.

"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 took the bait, too, because they could 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.

Scandals in the dealer loan portion of the Title One program didn't help 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.

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.

Homeowners can get rates in the 10 percent to 14 percent range on Title One loans. Private lenders sometimes charge 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 1 percent of the loan amount. But because there's no need for an appraisal, the consumer catches a closing cost break with a HUD-backed loan.

--Updated: Aug. 15, 2003