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Home improvements can be funded but options are limited

Planning a remodel? Homeowners can tap their savings, take out a personal loan or borrow against their equity. A viable alternative is a government-insured FHA 203(k) rehab mortgage.

March 13, 2011|By Lew Sichelman

Reporting from Washington — The home-improvement sector, already benefiting from spending on rehabilitating foreclosed properties, can be expected to get an even larger boost in the coming months from owners who have deferred maintenance during the recession and newly minted empty nesters who want to turn Buffy's bedroom into a home office.

But the question is, how are you going to pay for that new roof you needed two years ago or that kitchen remodel you've been yearning for since the kids left the roost?

Turns out there are still options available. There just aren't as many of them, and with the exception of one tried-and-true alternative — a government-insured rehabilitation loan — the terms are somewhat more onerous than they were during the housing boom.

Of course, you can always rob your savings to pay for your home improvement. But that assumes you have enough cash socked away to cover the cost and still have some left over to pay for at least six months' worth of living expenses in case you find yourself out of work or hit with a major illness.

If your credit is good enough and you have a strong, long-term relationship with your bank, you might want to consider a personal loan. Your signature, not the property, secures such loans, and the fees tend to be lower than other loan choices. But the rates are high, and the interest you pay is not tax deductible.

If you still have some equity in your place, you can borrow against that, either as a straight loan or as a line of credit that you can tap as the need arises. But even if you own your home free and clear without any encumbrances whatsoever or have a low-balance mortgage, you might be surprised how much less your home is worth than you realize.

According to the Federal Housing Finance Agency, owners lost more than half their equity from 2006, when the housing market began its free fall, to 2009. That's when the economic recession ended, but not the housing recession. And according to some estimates, the bleeding hasn't stopped yet, especially in markets where foreclosures and short sales still dominate.

Even if you have enough equity to borrow against, it's going to be difficult to find a lender. It's not as hard as it was, say, 12 months ago, but the home-equity business is far different from what it was during the go-go years when lenders often were glad to lend more than 100% of a home's value.

One viable option, however, is the FHA 203(k) rehab mortgage.

This is the Federal Housing Administration's rehabilitation mortgage. It has been a hot ticket for investors who are picking up distressed properties because it allows them to roll both the price of the house and the cost to make it habitable or marketable into a single loan. And some foreclosures are in woefully bad shape.

But regular buyers also can use the 203(k), especially if they want to do some work before moving in. And more important, current owners can use it as a refinancing tool to incorporate the cost of their home improvements into a brand-new first mortgage.

The FHA doesn't make 203(k) loans directly. Rather, it insures loans made by primary lenders against the possibility that the borrower will not make his payments as promised. So you'll have to search for a lender in your neck of the woods who is familiar with the product. But once you find one, you'll discover that the guidelines are extremely liberal.

For example, there is no limit on how much you can spend on your improvements. As long as the total loan amount does not exceed the FHA maximum, you are good to go. The current FHA ceiling ranges from $271,050 to as much as $729,750 in the country's high-cost areas. (For the maximum loan amount in your area, go to http://www.fha.gov.)

On Oct. 1, though, the ceiling in expensive markets such as California and Massachusetts is scheduled to revert to the old maximum of $625,500. And the Obama administration has signaled that the high-cost ceiling may be whittled down even further. In addition, the FHA's annual insurance premium will be increased with the start of the next fiscal year.

As long as the "as improved" appraised value of your property — that is, the value of the house plus the value of the improvements — does not exceed the maximum loan amount, almost anything goes. Only luxury items are verboten, says Jim Ragan, who manages the 203(k) program for Bank of America Home Loans.

"You can't build Bobby Flay's outdoor kitchen or a swimming pool," Ragan says. "But other than that, practically anything else is permitted."

Actually, the extent of the project can range from something relatively modest to a virtual reconstruction. The cost must exceed $5,000. But as long as the existing foundation remains in place, you can tear down the house and rebuild it if you so choose. Even such "soft" costs as inspection fees, architectural fees, closing costs and permits can be included.

The formula for how much you can borrow is fairly straightforward. The maximum loan amount (subject to the aforementioned ceilings) is 97.75% of the improved value of the property.

If the appraiser says your project will add $125,000 in value to your $300,000 home, then you can borrow $415,438.

Better yet, there is no requirement for a reappraisal once the work is finished. Only a single up-front valuation is necessary.

lsichelman@aol.com

Distributed by United Feature Syndicate Inc.

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