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Combination home loan

THE BALTIMORE SUN

The 5-acre property was beautiful. The only problem was that the farmhouse on it wasn't fit for human habitation.

The roof needed to be replaced.

The bathroom was unusable.

The kitchen was a mess.

And no central air conditioning existed.

But Wayne Johnson loved the land. He just had to find a way to get the house in shape. What he found when he went to his lender was an all-in-one purchase-renovation mortgage offered by Fannie Mae - called HomeStyle - that allowed Johnson to buy and renovate the home in Hanover using one mortgage.

In the past, a borrower would have had to first buy the house in need of updating, then go through the process of obtaining additional financing such as a second mortgage or a home improvement loan, often at a higher interest rate and a shorter term.

With the Fannie Mae HomeStyle loan he obtained from FT Mortgage in Pasadena, he wrapped the renovation costs into one mortgage and makes just one payment a month.

"It scared the hell out of my wife when she saw the house," Johnson said. "She thought I was nuts to try to renovate it." Johnson did a complete rehab and now basically has a new house including central air conditioning.

"The purchase-rehab loan worked fantastic, I was able to do everything in one fell swoop," remarked Johnson.

With the inventory of homes for sale at its lowest point in years and much of the housing stock aging in the surrounding counties, purchase-rehab loans are an answer to frustrated home hunters who can't find the perfect property.

Thirty to 40 years ago, houses in suburbs such as Lutherville, Glen Burnie and Woodlawn were new and people flocked to buy them, but now they're old and worn.

"Even houses in Columbia are 30 years old and need work," said David Elam, vice president of Housing and Community Development for Fannie Mae in Atlanta. "With the Fannie Mae's HomeStyle mortgage, these neighborhoods are getting a second look," he explained.

"These types of loans let you look past the outdated kitchens and bathrooms," added Alan Ingraham, vice president of MNC Mortgage.

Two emerging trends brought about the need for such a loan product, according to the lenders that offer them. First, some people who don't want to commute too far are willing to consider an older home. "Individuals would rather be closer in to the city," Elam said. The housing in the suburbs along the Baltimore Beltway may have aged, but it's still a quick commute into the city.

But the main reason was the renovation phenomenon. Although the current real estate boom has produced tens of thousands of new houses, Americans still spent $170 billion on home improvement last year, Elam said. Lenders developed special loan products to take advantage of this trend.

Only half of the $170 billion was financed out of pocket, which limits what the consumer can do, Elam said.

Aside from an opportunity for lenders to capture a share of the growing renovation market, there is an additional advantage of purchase-renovation loans that benefits Baltimore and the surrounding counties. They act as a tool to stimulate redevelopment in decaying older neighborhoods deemed no longer desirable.

Baltimore County had a program using a 203(k) FHA purchase/renovation loan to target five neighborhoods. Acquire Renovate Customize a Home (ARCH), which ended in December, was part of a state housing initiative that made $40 million at 4 percent interest available.

"The program represented a new generation of Smart Growth," explained Pat Keller, director of Baltimore County's Office of Planning. The Smart Growth Act, passed in 1997, seeks to concentrate growth and improve infrastructure in existing communities in the hopes of revitalizing them.

"The houses built in the '50s, '60s, and '70s are no longer desirable housing products. So it all comes down to keeping people in these older homes," Keller said.

First, determine loan

The first thing a buyer has to establish is what the total loan amount is available. This depends on the loan. The Fannie Mae HomeStyle Standard Mortgage has a maximum of $252,700 for the Baltimore metropolitan area that gives the buyer more purchasing power in the counties.

For example, a home with a purchase price of $185,000 would be eligible for $42,430 for renovation work, which brings the total to $227,430 or 90 percent of $252,700, the maximum that may be borrowed for an owner-occupied house.

Fannie Mae requires a 10 percent down payment, with the buyer responsible for closing costs. The renovation cost cannot exceed 50 percent of the completed value.

"Once you've set the purchase price, you need to get a contractor to go through the house and put a price on all the renovations you'll need," said John Watts, sales manager of Source One Mortgage Company, a member of Citigroup in Parkville. The contractor will present the cost in a formal contract. In order to get competitive prices, lenders suggest buyers get multiple bids. Both the purchase contract and construction contract are then given to an appraiser who evaluates the property as if the work were completed, said Watts, who recently did a HomeStyle loan in Lutherville.

Appraisal made

The appraiser determines the current value of the house and also the future value of the construction price for the scope of work being planned. The total value of both contracts must be comparable to what others would be willing to pay for the home when all the work is completed.

The ultimate question is whether the market will support the finished product, Ingraham said. If the total is $250,000 and a comparable house in the neighborhood sells for a maximum of $180,000, the lender will question the loan.

If the package does appraise, the lender will base the loan on that dollar figure and process the loan, which usually takes less than 48 hours. There is no income limit to be eligible for the HomeStyle mortgage, and a borrower can choose from either a 15-year or 30-year fixed rate or an adjustable rate mortgage.

At closing, the borrower receives funds to purchase and renovate the home all at the same time.

The borrower is expected to make the monthly mortgage payment on the total amount of the loan - not just the purchase price of the house. There is no upfront money paid to the contractor, and the borrower is responsible for monitoring the work.

In addition to signing a mortgage note, the borrower will also enter into a separate rehabilitation loan agreement with the lender, with the money for the renovation placed into an escrow account.

According to Watts, money cannot be released to the contractor until an inspection of the work has been made. Fannie Mae requires an appraiser to inspect the work and verify its completion.

If the amount of work is very small, one full payment can be made. The renovation, however, must be completed within six months, but time extensions can be arranged.

Unforeseen circumstances, however, can crop up during construction, so the HomeStyle mortgage builds a 10 percent contingency into the loan amount to rectify any problems.

But if the homeowner suddenly decides to replace those kitchen cabinets he thought he could live with and it's not in the original scope of work, he must pay for the work out of his own pocket. The lender will not reconfigure the loan for him.

Fannie Mae also has a HomeStyle loan to refinance an existing mortgage and include money for renovation.

"I wanted to roll a construction loan into the refinancing. I wasn't interested in a home equity loan or second mortgage," said Elizabeth Seidel, an interior designer, who had purchased a 65-year-old, four-bedroom house in Parkville in 1993.

She chose her home because of its solid construction and its details, including stained glass and a wide porch, but it still needed work. The porch piers were replaced, ceramic tile was installed on the kitchen floor and new electrical work was put in.

"I wanted to live in a traditional neighborhood that has character," explained Seidel. "This product enables one to make improvements rather easily."

FHA alternative

Another purchase-renovation loan that's been around since the 1980s is Department of Housing and Urban development's 203(k) FHA mortgage. It's based on the same principle as the HomeStyle, but there are some differences, primarily the $178,600 maximum loan amount a borrower can receive.

With higher and ever-rising home prices in the counties, the loan isn't as useful outside the city. But in Baltimore, where the 1999 average price of a home was $82,633, the loan is used quite frequently.

In addition, the down payment requirement for the "k" is only 3 percent, but its interest rate - because of the additional expense of processing and handling the loan - is usually a point over market rate. The HomeStyle's is generally a quarter or a half. The interest rate for a 203(k) loan today runs 9 percent; a HomeStyle loan is at 8.875 percent.

The 203(k) also has different criteria for determining the scope of the renovation work than the Fannie Mae product.

There is a $5,000 minimum requirement for critical repairs, which includes structural alterations, replacement of plumbing and electrical systems, modernizing bathrooms and kitchens, roofing, energy conservation improvements and flooring.

Cosmetic repairs do not count, but may be added after the $5,000 minimum is reached. "If you have a house from 'That 70s Show' with an avocado kitchen and shag carpeting, it wouldn't qualify as critical," said James Kelly of HUD's Maryland State Coordinator's Office. Air conditioning is not a critical repair, either.

If the borrower does not want to use their own consultant to prepare the scope of work, they may use a HUD consultant who can prepare one for a fee usually ranging from $400 to $1,000. Inspections of the work must be done by a HUD-approved inspector, who is also paid by the borrower for each visit.

When the work is complete, a final inspection is done and the final cash draw to the contractor is released. If there is any unused money, the lender will use it to prepay the mortgage principal.

The "k" is very popular in areas such as Federal Hill and Canton, according to Ingraham. "Many first-time buyers, especially those under 35, are willing to go through with such a project. They look at it as a challenge," Ingraham said.

Patrick Marsiglia and Candace Cassidy used the Federal Housing Administration program to buy and renovate a rowhouse in Federal Hill. They borrowed $25,000 for the renovation but, according to Marsiglia, used sweat equity to stretch out the amount of work done. "We gutted the house, put in new drywall [and] electrical, took off the Formstone and put a two-car parking pad in the rear yard. It's pretty much a brand new house," he said.

Contractor suggested

Most lenders prefer that the borrower use an outside contractor, but in some cases such as Marsiglia's, a self-help agreement can be signed if the borrower has proven contracting and construction experience.

"The jobs where people acted as their own contractors were nightmares," said Neil Sweren, president of Allymac Mortgage Services. "It doesn't wind up saving any money." Some borrowers have family members with construction experience who intend to help but it doesn't always work out that way. "Their uncle was supposed to help, but they get into a fight with him and he never shows up," Sweren said.

If a customer is interested in a purchase-renovation loan, they should talk with their lender to find the best product for their needs, said Watts and Sweren. "The loans aren't restricted to one category of home," added Ingraham. Purchase-renovation loans have a double benefit. They let a buyer repair a home they wouldn't normally consider. And they repair neighborhoods as well. "It's a great program because America's housing stock's not getting any newer, it's getting older," Sweren said.

More information

HomeStyle: 'To find a list of approved lenders that offer the Fannie Mae HomeStyle line, call 1-800-7FANNIE.

203(k) FHA Loan: Talk to a FHA-approved lender or call HUD's Homeownership Center at 800-440-8647, option 82.

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