There's a cheaper way to pay for major renovations when purchasing or refinancing a home.
A little-known federal loan program will finance the purchase and more than $5,000 in renovations, with less money down and lower interest costs.
The program offering loans insured by the Department of Housing and Urban Development is known as the Section 203(k) Rehabilitation Mortgage Insurance Program.
Although available since the 1970s, lenders only recently began offering 203(k) loans, after rules were changed to reduce their risks.
Loans are available to individuals or investors for residential property with as many as four living units. The maximum loan is $124,875.
Mortgage bankers say it's the most affordable way to purchase and renovate the home of your dreams.
"You get a better house," said M. P. "Pat" Potamkin, president of Boulevard Mortgage Co., Northeast Philadelphia. "It gives you the opportunity to repair and modernize, while spending less money up front. Your monthly payment would be a bit higher because you're getting a bigger loan."
The program allows buyers to get a run-down home at a low price and still qualify for a mortgage that includes all renovation costs. To obtain financing, the property would have to be located in a viable area, where the market value after renovation would exceed repair costs.
Buyers save money because they avoid having to get a separate construction loan at rates about 2 percent higher than mortgages. They put down less money because 203(k) allows financing up to 100 percent of closing costs. Regular federally insured loans limit financing to 57 percent of closing costs under rules adopted July 1.
Buyers can include up to six months' mortgage payments in the loan, so they don't have to make payments until work is completed and they move into the home.
"This is a good way to rehab property. You get the mortgage and construction loan in one shot," said Gerry Glavey, a HUD official overseeing housing development programs.
Mr. Glavey said HUD insures the loan before repairs are made. With a regular FHA loan, any repairs necessary to meet HUD requirements must be completed before HUD will insure the loan. In many cases, buyers must pay for replacing the roof or other repairs before obtaining a HUD-insured loan.
The 203(k) program will finance just about any type of renovation, provided the cost exceeds $5,000 and the work isn't merely cosmetic, Mr. Glavey said. Eligible projects include a new kitchen and bathrooms; adding rooms or a detached garage; new siding; and replacing plumbing, wiring and heating and air conditioning systems.
The program won't finance such luxuries as swimming pools and saunas. Mr. Potamkin said he has rejected several applications that included only repainting and wallpaper. But such cosmetic work can be included if plans include major repairs, he said.
Here's how much a 203(k) loan would cost, compared with a regular HUD-insured loan, assuming a 9.5 percent, 30-year loan.
Suppose you buy a home for $50,000 and plan $25,000 worth of renovations. The 203(k) mortgage would be $77,550, including purchase price and repairs. You would pay about $3,500 to $4,000 down, and your mortgage payment would be $652 a month, Mr. Potamkin said.
Compare that with buying a $75,000 home with a regular FHA loan. The mortgage would be $76,050. You would pay $5,700 in cash and $640 a month.
With a 203(k) loan, you save at least $1,700 up front. For only $12 more a month, you get a modernized home that might include a new kitchen, bathroom, roof and furnace. You avoid the cost of a separate construction loan with a rate as high as 11.5 percent.
For homeowners considering refinancing mortgages, the program lets them save on interest costs and pay for renovation with a single loan.