Financing home improvements with FHA mortgages: what to know

If you rode out the recession waiting for the housing market to recover, you may finally have your chin above water, and now you are looking around for a way to make those home improvements you had to neglect for so long. Of course, you may have had enough financial drama for one lifetime; all you want is to spruce up your house so you can sell it and make a fresh start. Or maybe you've been hunkering down in a rental, hoping to snag a deal on a fixer upper you can call "home" one day -- except you barely have enough for a downpayment saved, much less the "fixing up" part.

Whatever your circumstances, you may simply need a way to borrow for home improvements because your savings have taken a beating these last few years. The Federal Housing Administration (FHA) provides a means for a home buyer or homeowner to finance the home and the renovations all in one. In addition, because FHA mortgages are insured against default, lenders can offer them to qualified applicants even if they have less than the 20 percent downpayment needed for conventional financing.

Buyers with as little as 3.5 percent down may secure a 20- or 15-year FHA mortgage at current rates and include what they need for rehabbing it. Homeowners with less than 20 percent equity in their homes are also eligible to refinance and roll their approved home remodeling costs into the loan, paying mortgage rates that are much more attractive than interest rates for other types of loans or financing arrangements. If you have regular, verifiable income and an average, or even a less than average credit score, an FHA 203(k) loan could be a perfect fit for your home financing and home improvement needs.

FHA 203(k) mortgages for home improvements

FHA 203(k) rehabilitation loans are designed specifically for acquisition and/or rehabilitation of single and multifamily (up to four unit) homes that are at least a year old. If you are a home buyer, first time home buyer or homeowner and the home is or will be your primary residence, you are eligible to apply for one of these mortgages.

With the regular FHA 203(k), you must borrow a minimum of $5,000 to be used specifically for your proposed home improvements. Renovations can range from simple repairs to extensive structural changes and even rebuilding a demolished house from an existing foundation. Examples of improvements you can make include the following, among many others:

• energy efficiency upgrades from simple weather stripping to entire HVAC systems
• structural conversions from single to multifamily housing up to 4 units and vice versa
• major landscaping, decks, patios, and site grading
• universal design and accessibility for occupants with special needs
• new roofing, gutters and downspouts
• modernization such as plumbing, electrical, and even overall appearance

Everything from new cabinet hardware to new kitchens and new floors to entire room additions may be eligible improvements. You can borrow either up to 110 percent of what the appraised value of the home will be with the proposed renovations completed or the current selling price of the house plus the cost of the upgrades -- whichever is less. Your proposed renovation must meet Department of Housing and Urban Development (HUD) structural and energy-saving requirements.

FHA Streamlined 203(k) for repairs and non-structural upgrades

The Streamlined 203(k) differs from the regular FHA 203(k) in these significant ways:

• Structural changes are not permitted. It's strictly for repairs, replacements, and simple remodels. In other words, any plans that would require architects and engineers are not permitted.
• You may be eligible to borrow up to $35,000 toward home improvements, with no minimum required as with the regular FHA 203(k).

Power Saver Pilot Program: energy upgrades plus

The Power Saver Pilot Program, which expires May 4, 2015, is another option that can help with all types of home improvements from cosmetic to structural as long as $3,500 of the loan is specifically used for energy-saving upgrades. You may be eligible to borrow as much as $35,000.

All FHA loans are limited by the following conditions:

• Only FHA-approved lenders such as certain banks, savings and loan associations, and mortgage companies offer them.
• HUD restricts the amount that can be insured; FHA loan limits may vary by geographic area.
• Luxury renovations are excluded, for example, in-ground pools.

In addition to a home appraisal and all of the usual documentation required to apply for a mortgage such as employment verification, tax returns, and credit scores, with an FHA 203(k) you must also provide a proposal for the scope of work that includes an estimate of costs.

So what's the catch? Remember the part about these mortgages being insured against default? What makes this a safe and attractive proposition for lenders and your opportunity for home ownership and/or rehab is the mortgage insurance that you will pay monthly for the life of the loan. Unlike other FHA loans, you won't be able to eliminate the mortgage insurance once you have 20 percent equity in the home; however, a tax consultant can advise you about how taking those payments as a tax deduction may or may not benefit you financially. All things considered, an FHA 203(k) loan may be the golden opportunity to have the home you've wanted -- and waited for -- for a very long time.

Photo credit to Myryah Shea