Buying a Fixer-Upper? There's a Special Mortgage for You

Dear Liz,

I am buying a house that is a fantastic deal but needs a bit of work. I was told that I could buy the home and then get a home equity loan to make the repairs, but then I heard that FHA has a loan that will let me finance the property improvements. How does that work?

Howard in Idaho

Dear Howard,

This is a great question. You are referring to the Federal Housing Administration's section 203(k) mortgages. This program allows you to get a mortgage to both buy your home and make repairs and upgrades to the property. This special home loan gets you the home purchase and the repairs with one set of closing costs and an ultra-low down payment of only 3.5% of the total acquisition (the purchase price plus the cost of upgrades and repairs).

Weighing the FHA 203(k) Rehabilitation Mortgage

Qualifying for the 203(k) home loan is the same as for any FHA loan, but your LTV (loan-to-value ratio, which is the percentage of the home's value that you can finance) is increased to 110% of the appraised value. You are bound by FHA loan limits in your county, and these loan amounts vary throughout the country. You may even be able to finance up to six months of mortgage payments into the loan as well, allowing you to skip mortgage loan payments while you remodel.

However, the 203(k) mortgages cost more than standard FHA loans, and those costs vary from lender to lender. That is why, in addition to making sure that your mortgage lender is approved to write FHA loans, you need to get mortgage quotes from several HUD-approved mortgage lenders and compare loan costs, interest rates, and terms. Only by shopping can you be sure of getting the best mortgage interest rate on your 203(k) loan.

Mortgage Help from Your HUD Consultant

If the cost of the work to be done exceeds $35,000, you'll work with a consultant with the US Department of Housing and Urban Development (HUD), who prepares what is called a work write-up. This write-up is forwarded to an appraiser to be incorporated into the final post-repair value of the home. When determining loan-to-value and how much they will approve, underwriters take the lower of the appraised value or acquisition costs (purchase price plus repairs). HUD consultants help make sure you don't overpay for the repairs by telling you what the cost should be in your area for the work being done.

Make Almost Any Home Improvement with a 203(k) Home Loan

Under this program, some of the things you can do are room additions, new flooring, new fixtures, bathroom and kitchen remodels, enclosing carports, installing new appliances, and repairs or upgrades to roofing, plumbing, and electrical systems. Anything health- and safety-related or anything considered functionally obsolete can also be repaired or renovated.

Choose Your Mortgage Loan Officer Carefully

These FHA 203(k) rehab loans are especially complicated, so in addition to getting a competitive mortgage quote from your lender, you want to make sure that your loan agent is exceptionally experienced and capable. Ask how many FHA rehab loans this person has originated and how long he or she has been closing FHA mortgages. Good luck with your renovation and thank you for writing.

I Have a Conventional Mortgage. Can I Refinance to an FHA Home Loan?

Dear Liz,

I bought my house with a normal 30-year loan at 6.5% with 10% down. I'd like to refinance to today's rate of about 5%, but my home value has dropped a little and so has my credit rating. Can I refinance from my Fannie Mae mortgage to an FHA loan?

Sean in Seattle

Dear Sean,

Of course you can refinance into an FHA mortgage, as long as your loan amount falls within FHA loan limits. In Seattle, that would be the King County limit of $567,500.

Many homeowners whose equity position isn't strong enough to allow them to be approved by a conventional lender are opting to get their best mortgage interest rates by refinancing to an FHA home loan. FHA loans do require a Mortgage Insurance Premium (MIP), which may be higher than the standard private mortgage insurance charged by conventional lenders, depending on how much equity you have. However, the upfront MIP can be financed into your FHA loan, so you don't have to pay it out of pocket.

The upside is that FHA does not impose the surcharges that Fannie Mae and Freddie Mac do with their risk-based pricing. Check out Fannie Mae's Loan Level Pricing Adjustment matrix, find your credit score, loan-to-value ratio, and property type, and see how easily you could end up with 3, 4, or more points tacked on to your loan fee. If your credit is a little tarnished and you don't have loads of equity, FHA may well be your best choice.

FHA underwriting guidelines are more flexible than those for conventional loans. A low credit score won't automatically get you disqualified; borrowers' applications are reviewed individually. Usually, bankruptcies must have been discharged at least two years ago, and a foreclosure must be at least three years old before you can get an FHA loan. Regardless of your score, if you can prove that past credit problems have been resolved and are unlikely to recur, you have an excellent chance of getting a loan. In addition, FHA lenders have some wiggle room when it comes to your income--for example, if your proposed housing payment is on the high side, but your refinance payment will be lower than what you have been paying, you are likely to get your loan approval.

FHA refinances have become very popular for a number of reasons. But even FHA has been slowly tightening its underwriting guidelines and appraisal requirements, and rates aren't getting any lower. I suggest that you shop for a good lender and start the process very soon.

I'm finally ready to buy my first home. How will the current economy affect my mortgage rates?

That depends on how much cash you're willing to pay up front and how well you've managed your money over the past few years. According to many experts, mortgage lenders have "rolled back" to the policies and protocols they used decades ago. Hoping to avoid the kind of lending that led to the subprime mortgage crisis, most lenders require higher down payments and higher credit scores from borrowers than they did only a few years ago.

If your credit has a few dings in it, don't worry. Be prepared to lock in something higher than today's best mortgage rates, and be prepared to pay extra origination fees in addition to your down payment. While you won't find many private lenders willing to finance more than 80--90% of your home's value, investigate FHA and other community home buyer options. You can use a stable employment history and community connections to find a fair financing deal.

Although I've made every mortgage payment on time for the past five years, our whole neighborhood has lost value and I'm upside down on my home loan. What should I do?

In certain cases, you might not have to do anything. If you locked in a solid mortgage rate during a previous period of low interest, keep making your payments. As real estate values normalize over time, you'll eventually regain home equity.

However, if your credit score is better now than it was when you originated your home loan, you may want to lock in today's best mortgage rates. Or you may qualify for a government-backed plan that can help your mortgage lender process a refinance. FHA, Freddie Mac, and Fannie Mae all have special money-saving programs. If your mortgage is backed or held by these entities and you meet some other qualifying criteria, you can cut the amount of interest you'll pay over the life of your loan.