A Home Improvement Loan with No Home Equity?
FHA Offers Two Options for Funding Home Improvements
You might know that the Federal Housing Administration (FHA) can help you fund your home renovations, from room additions to smaller maintenance projects. Of course, the best FHA loan program for you depends on your situation and your needs. You can choose the "FHA 203(k)" mortgage for larger projects -- buying a fixer-upper or refinancing your home while also funding a home improvement. Another option is FHA's "Title 1" loan, which allows you to finance your smaller renovation and isn't tied to a refinance or home purchase. For either of these loans, you need to go to an FHA-approved mortgage lender.
FHA 203(k) Mortgage
The FHA 203(k) home loan allows you to buy a home or refinance a mortgage while incorporating home improvement into the project. To be eligible, you must:
- Meet FHA's credit, income and other underwriting guidelines;
- Finance a house that is at least one year old;
- Borrow a total amount that is less than the FHA's maximum loan amount for your area; and
- Have at least $5,000 for rehabilitation or renovation costs.
Luxury items and improvements are not eligible as a cost of rehabilitation, but many upgrades are. Here are just some of the repair and remodeling projects that can be financed with a 203(k) loan:
- Making structural changes or reconstructing
- Modernizing and improving your home's function
- Eliminating health and safety hazards
- Improving your home's appearance and eliminating obsolescence
- Reconditioning or replacing your home's plumbing
- Installing a well and/or septic system
- Adding or replacing roofing, downspouts, or gutters
- Adding or replacing flooring
- Making site improvements or adding landscaping
- Making the home handicap accessible
- Undertaking green renovations or energy conservation projects
These projects are especially useful for bringing an old home up to code.
Your maximum refinance loan amount (subject to FHA loan limits) is the lowest of these three calculations:
- Your current mortgage(s) on the property plus rehabilitation and certain closing costs.
- The current property value plus rehabilitation costs.
- 110% of the improved value multiplied by FHA's 96.5% maximum loan-to-value ratio.
If the property was owned for less than one year, the acquisition cost plus the documented rehabilitation costs must be used. Two appraisals are performed -- one to determine the "as-is" or current property value, and the other to get an "improved value." If, for example, you owe $200,000 on a property worth $205,000, you need $50,000 for improvements, your closing costs are $5,000, and the improved value of the property would be $250,000, your loan amount would be the lowest of:
- $200,000 + $50,000 + $5,000 = $255,000
- $205,000 + $50,000 = $255,000
- $250,000 x 1.10 x 0.965 = $265,375
So in this case, your maximum loan amount is $255,000. Your current mortgage is paid off and replaced with an FHA mortgage.
Don't Want to Refinance Your Mortgage? FHA Title 1 Home Loan
If you like your current mortgage (perhaps because you have a low interest rate or are not subject to mortgage insurance premiums), and you don't need a huge loan for your home improvement, an FHA Title 1 loan may be perfect for you. You can't buy luxuries like swimming pools with the loan, but you can borrow up to $25,000 for up to 20 years on approved improvements. Some of the advantages of Title 1 Loans are:
- Low closing costs since you aren't refinancing your first mortgage
- Easy processing. If your loan is less than $7,500, all you need is a signature--there is no lien recorded against your home
- You can do the work yourself if you are qualified
- Manufactured homes are eligible for Title 1 loans (a max of $17,500 for 15 years)
Keep in mind that these loans are funded by lenders, not by HUD, and that the interest rates and loan fees are determined by the current market. So, shop with different FHA-approved mortgage lenders to find the best mortgage rates, just as you would for any other home loan.
Gina Pogol has been writing about mortgage and finance since 1994. In addition to a decade in mortgage lending, she has worked as a business credit systems consultant for Experian and as an accountant for Deloitte.