‘Home’ Can Start With a ‘K’ : Federally backed 203(k) loan helps buyers purchase houses that need repair or modernization by combining the mortgage and repair costs into one loan.

A year ago, Mark Swiatek made what he calls “the deal of a lifetime” on a four-bedroom house with a pool in the hills of Valencia.

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A 35-year-old engineering geologist, Swiatek learned about the earthquake-damaged house while doing a geological report for the owner, who told him she intended to demolish the 1970s tract home.

Realizing that he and his wife, Sally, a homemaker, couldn’t get conventional financing--the damage was too severe to qualify--the couple looked for other ways to make the purchase. “I originally thought of trying to get cash from friends, trying to take a second [mortgage] out on my other house,” Swiatek said. “I explored a whole bunch of different options.”

It was the seller’s accountant who ended the Swiateks’ search for a mortgage. He tipped them to one of the least-known and most-underutilized loans offered by the government--the 203(k) program--and helped put the couple and their three children into a new home.

The federally backed 203(k) loan is best suited for buyers of houses that need repair or modernization. The loan rolls the purchase mortgage and repair costs of the fixer-upper into one loan, which can’t top $152,362.

While the loans are made by private lenders, they are guaranteed by the Federal Housing Administration (FHA), which means that if the borrower loses the house through foreclosure, the FHA will help cover the lender’s loss.

In 1994, just 31 “K” loans, as lenders call them, were insured by HUD’s Los Angeles office, according to Ken Crandall, HUD’s chief architect for single-family development in Washington, D.C. A total of 3,500 loans were closed nationwide in 1994. This year the FHA expects to close more than 7,500 “K” loans.

One of 1994’s loans was to the Swiateks, who paid $100,000 for the damaged house, with an additional $40,000 budgeted for repairs to the drywall, foundation, pool and garage along with painting and new floor coverings. They put 5% down and have a 30-year mortgage at 9% interest.

The Swiateks and their three children, who had occupied a 1,000-square-foot house in Canyon Country, now have more living space and excellent schools. And they now share a neighborhood where comparable homes range between $260,000 and $280,000.

“The only way we could have ever financed this house was through this loan program,” said Swiatek, adding, “it worked out great for us. We got the house of our dreams.”

The 203(k) loan program was begun in 1962 as a way of improving the nation’s existing housing stock.

In spite of its potential to expand homeownership, it was used infrequently by lenders, who branded it a “nightmare” because of the time and paperwork involved.

However, as these glitches have been corrected in the last 10 years, the loan has become more user-friendly. And more recently, the Department of Housing and Urban Development, which oversees the FHA and the 203(k) program, has set up a nationwide network of lenders to help push the 203(k) even more. Locally, 21 HUD-approved lenders have been authorized to participate in the program.

The 203(k) is aimed at buyers of fixer-uppers whose purchase and repair costs are within the $152,362 maximum loan limit. A minimum of $5,000 must be spent on improvements. The 203(k) loan does not apply to condominiums.

By eliminating the usual need to take out a separate loan to make improvements on a new home purchase, the buyer avoids the more expensive arrangement of paying interest charges on two loans. And the down payment required is less than those with other loans.

The interest rate ranges from a half percentage point to a full percentage point above the going market rate, depending on the lender.

“The 203(k) is a program that puts a whole lot of people back into the housing market who otherwise would be excluded,” said Helaine Mack, chief property officer for HUD’s Los Angeles office.

“The conventional lender would not normally loan [to them] due to the condition of the property--they would require those repairs to be made ahead to time. If the [buyer] had the money to fix the house, he probably wouldn’t be buying in that price range.”

The beauty of the program is its versatility, Mack said. “The 203(k) allows you to improve anything on the site,” she said. “You [cannot] put in a new pool, but if the pool is there you can repair it. You can add rooms if you have a lot that is large enough. . . . There is no end to what you can do.”

However, as Mark Swiatek learned, a smooth purchase and rehab requires a lender who is knowledgeable about the 203(k) program.

Swiatek said he was strapped for cash when he bought the house and was counting on charging the down payment on his credit card. But his lender failed to tell him that the down payment also included 5% of the repairs, a mistake that brought the amount owed to $11,000 and jeopardized the sale of the house.

Fortunately, Swiatek was able to raise the extra cash, and he switched to another lender, who “pushed the [stalled] paperwork through in an amazingly short amount of time.”

Cost overruns were another problem that surprised Swiatek. While told by his first lender that the estimates could be revised, he later learned that HUD “stuck to the letter” of what were considered exact bids. However, by “shuffling” around some itemized costs and directly hiring some of the subcontractors, he managed to stay within the loan amount.

Would he do it again?

“I’d love to do it again, now that I understand how it works,” Swiatek said.

The 203(k) loan-application process starts after a home shopper finds a fixer-upper he or she likes and gets estimates of needed repairs, which can be made either by a general contractor or a HUD consultant. Once a HUD plan checker determines whether they are within FHA guidelines, a HUD appraiser is sent to the site to give an “as-is” and “after-rehab” appraisal.

Assuming that the sales price, plus the repair costs and the fees (inspection, credit and appraisal charges are added) are at or below the “after-rehab” value of the house, the lender can decide to move forward on the loan.

As the house is being examined, so is the buyer’s credit. “One thing to keep in mind is that you must be very upfront and thorough when you originally meet with the lender, so he can make a good credit evaluation,” said Katherine Luna of California Financial Express. “That is the trickiest part of the 203(k).

“If you think you’re going to spend $35,000 to repair this property, you may not qualify for $35,000--and you have just spent $700 to $900 in appraisal fees, inspection fees, etc. If the credit isn’t going to go why spend all this money looking at the rehab?”

The construction begins once the repair funds have been set aside in a special escrow account. As the work is completed, a HUD inspector verifies that the repairs match the original estimates and the escrow money is released to the homeowner and general contractor (if he has one), with 10% held in reserve as contingency money until the loan closes.

“The key is having enough money [to do the job],” cautioned Bill McGuire of Malone Mortgage. “It is unfortunate that homeowners, even investors, often go with the cheapest bid they can get their hands on. And when they find out that the [contractor] is just throwing the work together and they want to fire him--who are they going to hire? Cheaper is not better.”

Ellis Mellinger, a truck driver, and his wife, Carmel, an accounts payable supervisor, said the 203(k) was the only way they could have bought and expanded the two-bedroom Carson rental house that they had been occupying with their two children for the past seven years. The Mellingers had considered moving to Orange County. “We liked it down there,” Carmel Mellinger said. “But being realistic, [Ellis] works in Gardena and I work in Torrance. Driving would just not work for us.”

Using the 203(k) program, they borrowed $147,000 at 8.5%. The loan included $28,000 for a 500-square-foot master bedroom and bath addition, as well as a new roof and a stucco job.

“It worked out fine,” Ellis Mellinger said. “We didn’t have to move. That was a big deal to us.”

Joel and Gina Hendrickson had been looking for inexpensive ways to buy a home when a friend called to say a realtor’s sign had gone up in front of a 1,700-square-foot West Hills house last year.

By then, Hendrickson, a route salesman for Wonderbread, and his wife, who works for Pavilion’s supermarket, had already discussed the the 203(k) loan with their lender, who thought it would work perfectly.

The couple bought the early ‘60s tract house with a pool for $140,000, putting down 3% as FHA first-time home buyers, and spent $10,000 on the rehab.

While Federal Mortgage Co., which owned the property, agreed to replace the roof, provide a stove and garbage disposal and fix some of the major electrical and plumbing problems, the Hendricksons drew on the services of two friends--an electrician and a carpenter--for other improvements, with Joel acting as general contractor.

While everything worked out fine for the Hendricksons, the K’s flexibility in allowing borrowers to act as owner-builders can cause problems, said mortgage broker Luna. She refuses to take on such clients unless they have a background in home rehabilitation or remodeling.

“As a novice you don’t even know the way in which to demolish what it is you’re about to rebuild--you can do damage doing the demolition,” she said.

“If the roof [is] off his house and it pours for six or seven days. Or $10,000 was estimated and it turns into a $15,000 job. I feel the lender has to be more prudent in leading someone down this path.”

But Hendrickson has few major complaints. “I got to do everything I wanted to do to this place the way I wanted to do it,” he said. “The windows that were in here were shot. Those old louvered type. We got to put in new windows. It’s a lot of headaches. But I tell you it’s great.”