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Borrowing for a fixer-upper
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October 15, 1999: 6:39 a.m. ET
FHA's 203k plan rolls acquisition, renovation into one low-interest loan
By Staff Writer Shelly K. Schwartz
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NEW YORK (CNNfn) - Ron Satterwhite, a career salesman in Armuchee, Ga., was dealing with one tough customer.
He had just stumbled across a 1954 three-bedroom home in the neighborhood he had long admired. It was new to the list of foreclosed properties in the area and it needed some major repairs -- but it had potential.
"The house wasn't even up for bid yet and I took my wife over there to look at it," Satterwhite recalls. "She walked in and walked right back out again and said: 'There is no way.'"
Months of discussion ensued, and in the end pragmatism prevailed -- with a little help from the Federal Housing Administration.
"I told her we can just buy the new house down the street if she wanted, but that we'd have to put up with [the previous owner's] wall paper, their linoleum, their kitchen, and their carpet," he said. "If we bought this house, we could gut it and pick all of it ourselves. That convinced her."
The Satterwhites purchased the house in 1997 for a bargain-basement $42,000 and borrowed an additional $26,000 for renovations under the FHA's 203k program -- which allows home buyers to finance the acquisition and rehabilitation costs under one low-interest loan.
Today, the home is valued at $85,000 -- a 25 percent return on their investment in just two years.
"We were able to take a house in the neighborhood we wanted and make it the house we wanted," Satterwhite said. "It was a lot of hard work, but it paid off in the end. We have a beautiful home."
The loan
The 203k mortgage was created as a financing vehicle to help revitalize economically depressed communities and to make the dream of home ownership a reality for more Americans.
As you might expect, the government does place restrictions on how much individuals can borrow and under what circumstances loans will be granted. But, contrary to popular belief, the program itself is not exclusively set up for lower-income borrowers.
It's open to everyone -- from existing property owners looking to modernize their high-priced homes to those who can only afford a fixer-upper.
(Click here for HUD's description of 203k loans)
"Most frequently, the 203k loan is connected with HUD foreclosures because many of those properties are in bad shape and they've been left alone for a long period of time," said David Bronson, a 203k loan processor for National City Mortgage. "But anyone can qualify for them. I just finished processing a loan for a client who owns a $300,000 home in Hawaii."
He noted the majority of his 203k clients use the loans to purchase and renovate previously owned homes in the $50,000 range. Not all are HUD foreclosures.
The benefits
Perhaps the greatest advantage of the 203k loan, advocates say, is the break you get in interest rates.
The loans are offered at about 1 percentage point above standard FHA loans. Today, you can lock in a 203k loan for roughly 9.25 percent -- more than a conventional mortgage, but considerably less than the rates for renovating an existing structure.
And renovation is hardly an uncommon expense. According to Brian Carr, chief operating officer for Housing Made Simple in Fairfax, Va., 203k consulting firm, more than 60 percent of individuals who purchase a new home spend at least $5,000 on renovations in the first year.
Thus, those who fail to investigate the benefits of a 203k loan often end up footing the bill with the kid's college fund, a second mortgage, or with 19 percent (or worse) interest-bearing credit cards.
Others still opt for traditional construction loans -- many of which will cost you 15 percent or more.
"If you're doing more than $10,000 in renovation work to your home, the 203k loan is by far the cheapest way to go," Carr said.
The rules
Before you can get a 203k mortgage approved, however, HUD does makes you jump through a few hurdles.
First, you have to hire a certified inspector, such as Housing Made Simple, to complete a basic report on whether the property meets the minimum health and safety standards. The feasibility study also includes a cost analysis on how much renovations will likely set you back.
Because it's HUD-regulated, that inspection report will only cost you $100 -- not a bad investment if you're still unsure which financing options are best.
If you decide to move forward, you'll need to shell out a little more to cover the costs of a detailed proposal describing the work that will be done.
You can get either a consultant, engineer or architect to draw it up for you. And you should expect to spend anywhere from $500 to $1,000, depending on the amount of work involved in the proposal and the area of the country you're in.
The good news is that all the fees you incur throughout the process, including closing costs, can be rolled into the 203k loan once it's approved.
More good news
One other key benefit of the 203k loan is that, in most cases, the projected appraisal value of your home -- which factors in renovations -- is higher than the loan amount itself. That means you're walking in with instant equity, Carr said.
That's the reason the FHA allows 203k applicants to borrow not only the combined cost of the acquisition and renovations but an additional 10 percent above the projected appraisal value once the work is complete.
It's also the reason why refinancing makes sense.
"You take this loan and agree to pay a slightly higher mortgage payment because you want the renovations rolled in -- but then since you've got the instant equity you can turn right around and refinance to lower your monthly payments," Carr said.
A bad rap
The 203k loan program has been around for decades. But for the majority of that time, real estate agents and lenders processed very few since the paperwork involved was tedious and it took too long to close.
"It didn't used to work very well because it was so heavily regulated by the government," Carr said.
Not anymore.
In an effort to streamline the process and spark interest in the program, HUD revamped regulations three years ago and handed over much of the administrative duties to the lenders.
Today, the average 203k loan -- including the closing -- takes anywhere from 30 to 45 days to process. That compares with two months or more before the process was privatized.
HUD's plan appears to be working.
Nowadays, Housing Made Simple completes 100 feasibility studies each month in the Maryland, Virginia and District of Columbia region alone. That's up from one to two every four months before the changes in the program took place
Lessons learned
While the 203k mortgage can be a good deal, those who have been through the process say it's important to do your homework before you begin -- and to get a good sense of how much you're prepared to spend on renovations.
"The biggest obstacle we ran into was the added expense," Satterwhite said. "You really need to sit down and evaluate it. Have a good contractor really look at it and not just physically look at it. Have him get under the house and test the wood and look for damage."
Satterwhite said he and his wife projected they'd spend $1,000 on an updated kitchen. They ended up deciding on top of the line cabinetry and spent $7,000 instead.
"We should have figured we'd spend at least $5,000 in the kitchen to begin with rather than figuring that out three days after all the paperwork had been signed," he said. 
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