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Loans for Fixer-Uppers

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Bargain hunters ought not to overlook properties in need of extensive repairs. A federally backed lending program enables buyers to roll the cost of necessary fixes into their mortgage, which can sometimes yield a quick return on their investment.

The Federal Housing Administration's 203(k) program provides for loans that cover purchase and renovation costs for single-family homes and multi-families with up to four units. The total loan amount is based on the property's appraised value once the repairs are completed. The down-payment requirement is just 3.5 percent.

Using this program, someone who buys a run-down home at a low price, and chooses the renovations wisely, can immediately come out on top, according to 203(k) loan specialists.

"When people are buying the houses correctly, they're actually generating instant equity," said Jeff Onofrio, the director of renovation lending at AnnieMac Home Mortgage in Mount Laurel, N.J. "It's a matter of getting the right house at the right deal."

Matt Perillie, a loan specialist at Campbell Mortgage in North Haven, Conn., had a similar reaction. "The properties that are going to give the instant equity are the bank-owned houses with no heat or a failing roof, and those shortcomings are accounted for in the sales price," he said.

Although the 203(k) program has been around since 1978, said Paul Welden, the director of the 203(k) Contractor Program in Tempe, Ariz., which trains contractors, "it was not widely used until this foreclosure mess started almost a decade ago, because there was never a big need for it." When that changed, "it became a necessary tool to be able to sell or buy distressed properties in poor condition."

Although 203(k) volume is low over all, usage has gone up. About 22,500 loans were endorsed by the housing administration in the fiscal year ended Sept. 30, 2012, compared with about 3,400 in the 2007 fiscal year, government data shows.

The loans are not available to investors — borrowers must live in the properties. But Mr. Onofrio said he had seen borrowers use a 203(k) loan to buy and renovate a multifamily property, live there a year or so, refinance into a conventional loan, and move on.

The loans are more expensive than conventional financing, because the interest rates are slightly higher (the average 30-year fixed rate is now around 3.75 to 4 percent) and private mortgage insurance is required.

In addition, borrowers must pay a building consultant, who writes the initial estimate of the cost of planned repairs. (Fees range from $400 to $1,000, depending on the extent of repairs.) The consultant also ensures that the repairs will bring the house up to government health and safety standards.

The loans do not cover the addition of a luxury item like a pool. But allowances are made toward the cost of repairing or removing a pool, as well as for the addition of solar panels.

Renovations must be completed within six months after closing. The contractor is paid in intervals after periodic inspections of how the work is progressing. Borrowers should make sure they hire experienced contractors who understand that they won't be paid upfront and must adhere to strict timelines, Mr. Welden advised.

About 60 percent of Mr. Onofrio's clients use 203(k) loans to buy bank-owned houses or short sales. Others use them to buy and update older homes, or refinance and redo their homes.

Loan limits depend on where the property is. For a single-family property, the limit ranges from $271,050 to $729,750.

Although 203(k) loans have had a bad reputation among some real-estate brokers as too slow to get to closing, delays are often the fault of mortgage representatives who don't really know all that's involved, said Mr. Perillie of Campbell Mortgage.

"Now, the agents are more apt to do them," he said, "a lot of times because it's the only way to get financing on a property that has no plumbing."

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