(MONEY Magazine) – Kathleen Strombeck was horrified last June when her husband Tom first walked her through the three-story St. Paul house that he had his eye on. Orange countertops, 30-year-old rust-colored carpeting and 1960s light fixtures effectively drowned out all the 1904 Victorian charm, and the house badly needed a modern kitchen and another bathroom. "My husband saw its potential," she recalls, "but I knew it was going to take a lot of money to make it work."

Eight months later the couple is just a few coats of paint away from their dream house, thanks to a new type of mortgage: Fannie Mae's HomeStyle mortgage. Rolled out nationwide in January after a five-city test last year, Homestyle lets buyers borrow based on the appraised value of their house after renovations. For the Strombecks, that meant they could take out a $157,000 mortgage, including $23,000 earmarked for renovations, on a house they bought for $152,000. Previously, home buyers in the Strombecks' situation would have had to delay repairs, deplete their savings or even take out a higher-rate personal or credit-card loan.

The Strombecks' mortgage gave them the freedom to decide which repairs to do--but not the freedom to run off to Bermuda with the kitchen money: The renovation portion of the loan was held in an escrow account from which their lender, Burnet Home Loans, paid contractors directly.

Though the Strombecks opted for a 30-year fixed-rate loan, adjustable-rate and 15-year HomeStyle mortgages are also available. Interest rates should be on par with market averages--as the Strombecks' 7.5% rate was--but some lenders may bump up the rate to cover the extra paperwork.

If you have already bought your money pit, don't despair. In January, Fannie Mae also introduced the HomeStyle Remodeler. It's similar to a home-equity line of credit, which lets you borrow against the portion of your home that you already own, but it's aimed at homeowners who haven't built up equity yet. With the Remodeler, you can borrow as much as $50,000, or 90% of the value of your home after repairs; rates are around 9%. One caveat: You could be stuck with a mortgage that is worth more than your house if renovations go awry (see "Don't Get Hammered," page 192). For more information and a list of HomeStyle lenders in your area, call 800-7-FANNIE or visit Fannie Mae's Website at www.fanniemae.com.

--S.R.