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This old house gets rehabbed.

Fannie Mae has a new nationwide pilot program to make it easier for homeowners to find the money to bring an older, outdated home up to today's living standards.

LAST SEASON, ABC'S TIM ALLEN CREATED A HIT show with "Home Improvement," a take off on the successful do-it-yourself home repair show, of which "This Old House"--a PBS staple for years--is a prime example.

Popular culture often mirrors real trends. In this case, the National Association of Homebuilders (NAHB) estimates that overall remodeling activity will grow significantly during 1993 and after that just keep on growing. The figures tell the story: In 1980, rehabilitation constituted 67 percent of new construction. This number increased to 88 percent in 1991. The NAHB estimates that some time after 1995, remodeling activity will total about $125 billion a year and is expected to exceed new residential construction activity. By the year 2000, remodeling is projected to be substantially outpacing new residential construction.

So, with all that on the horizon, now is an excellent time for lenders experienced in the remodeling business to increase their market niche. Thrifts and commercial banks, as well as mortgage companies, will find home improvement lending worthy of pursuing on its own merits, rather than merely being a means to get some more attractive business. To help consumers and lenders finance remodeling, Fannie Mae is modifying its programs and providing educational material on this service.

Remodeling, not moving

Now, more than ever, homeowners and potential homeowners are viewing remodeling or renewing a home as an attractive option and for just about as many reasons as there are lifestyles. The fixer-upper home provides an opportunity for first-time homebuyers eager to own and energetic enough to undertake a renovation. At the other end of the spectrum, elderly couples are deciding to retire in place. Instead of moving to retirement communities, they choose to retrofit their homes, making it convenient to live out their lives in a home they love. Aging baby boomers and empty-nesters find they are already living in their "dream house." No longer willing to pull up roots every couple of years, they want to stay put. Many have built substantial equity in their homes and choose to remodel to accommodate a changing lifestyle. And, with home price appreciation slowing down from the pace set in the 1970s and 1980s, others simply cannot afford to trade up their homes; so they remodel to acquire the amenities they want.

Changing attitudes are not the only reason home renovation and remodeling are becoming a growing trend.

Escalating land costs are driving up the costs of new home construction, making it difficult for many builders to compete in the new home market.

Remodelers--many of them former builders--are increasing their share of remodeling business because they find it is less expensive and harbors fewer risks than new home construction. Market conditions also contribute to the upturn in remodeling activity. For example, as baby boomers age, the demand for starter units will decline. Household formation is slowing in the 1990s, affected by such factors as slower population growth, housing costs, marriage rates and divorce rates.

Aging housing stock

Add to these trends the fact that America's housing stock is aging and requires upgrading, and the impetus for remodeling becomes even stronger.

More than one million homes in the United States were built before 1919, and the vast majority went up in the 1960s and 1970s, according to the U.S. Census Bureau 1989 statistics. In the Northeast, for example, three-fourths of the homes were built before 1970. In major cities such as New York, 60 percent of the existing rental stock is more than 60 years old. That picture is duplicated in central cities throughout the country. Repair and maintenance constituted the largest share (51 percent) of overall remodeling activity in 1991, up from 41 percent in 1988, according to the NAHB.

Other factors also drive remodeling activity including per capita income, average age of the housing stock, home values, home equity and the impact of weather on structures.

In June 1992, Fannie Mae released the results of its national housing survey conducted by the Hart-Teeter polling firm. More than 1,500 Americans from all regions of the country were interviewed about their housing attitudes for the survey. Fifty-four percent of the respondents polled in the survey said they are not likely to move within the next three years.

Among the nonfinancial reasons the respondents gave for owning a home, the freedom to remodel was at the top of the list. Put another way, one convincing reason to own, they said was--"you can make the changes you want to your home."

More bedrooms

What do people most want to change about their homes? Fannie Mae's housing survey indicates the number and size of bedrooms tops the list; bathrooms are second; heating and cooling systems follows; and kitchens are fourth. Homeowners also would like to add more storage space and change the size of their living room, family room and other common living areas.

While baby boomers like to watch home improvement shows on television, they are not necessarily inclined to undertake the projects themselves. Sweat equity was once a popular trend among baby boomers, many of whom were pioneers in the urban homesteading surge of the 1970s and 1980s. These days, however, more and more homeowners prefer to have the work done by professional contractors. The Census Bureau's homeowners and home improvements survey reports only 37 percent of homeowners between the ages of 35 and 44 do all of their remodeling work. This number drops to 16 percent for those 65 or older.

The one group that continues to tackle remodeling jobs themselves is the less affluent baby busters (under 30), who are often left with little financial choice but to do the work on their own. This group also may have more time, and they also may be more naive about the pitfalls of do-it-yourself projects. About half the people in this group do all of the work; 21 percent split the work with an outsider; while 25 percent have a contractor do all the work.

Advantages to the lender

Whatever the reasons and whatever the circumstances, more Americans are finding remodeling and home renewal an appealing choice.

Now we get down to the real business discussion of why a lender would want to consider home renewal mortgage products. Renovation lending is a way for institutions to invest in their communities. This type of lending helps to solidify neighborhoods, creates jobs and spurs business growth, while satisfying CRA requirements and making the existing housing stock more habitable. Moreover, it is a way for lenders to offer borrowers a broader range of housing finance options. (For this article, the terms remodeling, rehabilitation and renovation will be used interchangeably.)

The remodeling business offers the lender greater flexibility and fewer risks than new construction lending. Not bothered by large projects, the lender may make as few, or as many, loans as desired, based upon market conditions. With remodeling mortgages, the lender deals directly with the occupant. There's no sale or construction loan risk associated with this type of lending. And the buyer is present, primed for cross-selling services, if the lender so desires.

However, renovation lending does take considerable time and resource management to ensure profitability and quality loans. Originating the loan is expensive, so borrower prequalification is prudent for both parties.

Currently, homeowners can finance their home remodeling projects in several ways. The most popular, according to an NAHB remodeling survey, is by using personal savings. Half of all remodeling projects are financed by savings. Twenty-seven percent of remodelers use home-equity lines of credit. The costs of these loans are generally low for the borrower, who is often not required to pay for a full appraisal. Home-equity loans command a very high yield for the lender, demand few resources and require minimal processing and paperwork.

Second mortgages constitute 18 percent of remodeling financing, while federal and local government loan programs, credit card loans and cash refinancings make up the other methods homeowners currently use to finance renovations. Traditionally, however, loans of these types are restricted to the property's current value. This limits the availability of these loans to borrowers with a great deal of equity or cash before they start the process. Other financing options for remodelers and rehabers, such as HUD's Title I and 203 (K) programs, offer limited financing.

In fact, most borrowers, because of the restrictions on each type of available financing, must resort to the frustrating, expensive and inefficient process of putting together their own rehab package. To do this, they use a combination of second mortgages, equity loans, credit card advances and personal savings, which leaves little cushion to meet unforeseen expenses.

Secondary market participation

Although the secondary market has played a limited role in the rehabilitation market for some time, lenders and consumers can look forward to increased activity in this decade. This greater participation in the renovation lending arena will bring new efficiencies to the market while broadening the financing options available. Lenders will benefit from standardization and the infusion of capital from the secondary market; consumers will benefit from lower interest rates and reduced risk of fraud.

Fannie Mae offers several ways to make it easier for lenders to do this business and safer for homeowners to take on the remodeling projects they want, thus adding value to their property without becoming prey to risky financing.

Currently, Fannie Mae offers several rehabilitation loans designed to offer a full range of options to lenders and consumers.

Second mortgages securing remodeling loans are an important financing alternative for borrowers who want to use a variety of first mortgage products or who wish to leave their existing financing undisturbed.

Although second mortgages can be sold in the secondary market, in the past lenders generally have held them in portfolio because of the higher yields they earn. However, lending institutions must post additional capital to hold these loans now.

Furthermore, loans backed by rehabilitation generally could not be sold to an investor until the improvements were finished, which has created warehousing risks for the lender.

A new nationwide pilot program

To address these concerns, Fannie Mae is expanding its conventional second mortgage products through its HomeStyle renovation product initiative. This project is a $500 million nationwide pilot that provides a way for experienced lenders to sell home improvement loans into the secondary market without requiring the lender to hold the loan until the renovation is completed.

Property value will be calculated on an as-completed basis, rather than on current market value of the property.

The new second-loan limits, calculated with a maximum 90 percent loan-to-value ratio on the value of the renovated property, have been raised to $101,150 for the second mortgage, and a combined loan limit of $202,300 for both the first and second mortgage, if both loans are sold to Fannie Mae. (Fannie Mae loan limits are subject to change on an annual basis and may vary depending upon which company insures the loan.)

Also, as a part of its broad effort to support home remodeling, Fannie Mae

plans to purchase qualified FHA 230 (K) loans, which are available to homeowners or homebuyers for purchase, refinancing and rehabilitation.

The Community Homebuyers Improvement Loan, known as CHIML, is another Fannie Mae rehab loan product available to low- and moderate-income homeowners who want to redo the homes they are about to buy, or those they currently inhabit. CHIML loans are helping cities, such as St. Paul, Minnesota, to revitalize their central cities.

In St. Paul, the city's housing finance agency swapped for securities more than $10 million of mortgage revenue bonds, which were credit-enhanced by Fannie Mae.

Lenders participating in the HomeStyle pilot must be experienced in rehabilitation lending, and those selling second mortgage rehab loans must be specifically approved by Fannie Mae.

Setting standards

To provide guidance to a market that has grown up with fewer standard documents or procedures, Fannie Mae is developing uniform procedures to help lenders originate and administer this business. A lender workbook and consumer brochure describing the various HomeStyle financing options are designed to help lenders and homeowners cut through the rehabilitation lending maze and understand the process more fully. Both are available through Fannie Mae's regional offices.

Make remodeling work for you

Underwriting the loan is the first in a series of steps that make solid renovation lending possible. Fannie Mae requires the lender to use an appraiser experienced in rehabilitation or construction lending, who can balance two pre-loan appraisals ("as-is" and "as-completed"), and who can make an accurate valuation of the property's worth when the project is completed.

If a second mortgage structure is used, the lender must balance the inherent risk of the second mortgage by lending with protection to the first mortgage. Mortgage default insurance on the second mortgage guards against this risk.

Many experienced rehab lenders keep an experienced contractor on staff to manage the myriad aspects of rehab lending. "The best cost-benefit analysis...and control is done with an in-house staff," says John Carlisi, Fannie Mae's director of community relations and a former rehab lender. "Cost overruns, contractor errors, noncompletion of repairs, loan-to-value exposure--all are variables that must be successfully managed," Carlisi adds.

This on-staff contracting expert can obviate problems such as disbursing funds before all the work is complete; making sure there are no mechanics' liens placed on the property (by subcontractors who are not paid by the borrowers' contractor), and monitoring other issues commonly associated with remodeling projects.

Also, because timed disbursements often are part of the remodeling/rehabilitation loan process, the lender will need to have his or her staff expert, or some other designated professional, make sure that work has been completed at the required intervals.

"For the most part, this is very local lending. The lender must know the area, valuation, the market and so forth...and be aware of the environment," says Carlisi.

Ensuring that the work that is done represents top-quality workmanship is another area of concern for the lender and the homeowner. Fannie Mae encourages borrowers and lenders to work with experienced, qualified contractors who meet all applicable state and local registration or licensing requirements.

Making the remodeling pay

Then, there's the issue of valuation. Will the proposed improvements add value to the property? In every case, the lender must judge the valuation of the improvement, which is determined by the local economy and the neighborhood. In some places, kitchens are worth more than bathrooms; in others, decks are worth more than bedrooms.

There are a number of instances where a home addition will not add dollar-for-dollar to the sales value of the property. For example, if a three-bedroom house sells for $100,000, market demand is for three-bedroom houses, and it costs $30,000 to add a fourth bedroom, then building the additional bedroom may increase the property's value by only $10,000. In such a case, the loan might still be feasible, if the borrower puts cash in or if subordinate funding can be obtained from another source, such as a local housing agency or a non-profit group.

Consumer education is another essential link in successful remodeling lending. Fannie Mae's "Consumer Brochure for Rehabilitation Lending" helps lenders properly inform remodelers of their responsibility in the loan process. This factor is particularly important for first-time homebuyers undertaking rehabilitation projects. These people may need homeownership counseling, as well as help in understanding the remodeling process. Fannie Mae's community lending brochure, "Unraveling the Mortgage Mystery," explains this complicated process.

For those renovating an old house, the National Trust for Historic Preservation can provide valuable information. Homeowners need to understand that they are ultimately responsible for the remodeling project and for making loan payments, whether the work is completed on schedule or not. Even the most experienced homeowner must be careful during remodeling projects.

One homeowner--a rehab lender--engaged a construction company to remodel his waterfront home and install a deck overlooking a lake. At each stage of the disbursement process, he visited the site to ensure the work had been completed as planned. At one stage of the project, however, he asked a competent surrogate to inspect the framing for the job.

Assured by the stand-in inspector the work had been successfully completed, funds were disbursed and the work proceeded. The next time the homeowner made a site inspection, he made a startling discovery. The deck was built and it was spectacular. But it had been attached to the wrong side of the property. In the end, the homeowner and his contractor solved the issue to the homeowner's satisfaction, without extra cost, by modifying the plans. More often, things don't turn out so well. In worst-case scenarios, litigation may be required.

As John Nevin, Fannie Mae's manager of mortgage standards sums it up, experience is the key to profitably satisfying the market demand for this business.

Nevin recommends a number of safeguards that can help lenders and remodelers offset occurrences like the one just described.

* A contingency fee of at least 10 percent of the project cost should be set aside for cost overruns.

* Timed disbursements should be made only after the lender's representative has inspected to ensure completion of work at appropriately set intervals and after a title search has been made to make sure the property is free and clear of mechanics' liens.

* Disbursements checks could be made out to both the contractor and the homeowner to further ensure mutual satisfaction by the homeowner and the construction firm.

Fannie Mae encourages all of these measures, when the nature of the rehab work is extensive, to reduce risk to all parties.

Certainly the benefits of rehabilitation and remodeling lending can bring rewards to communities, consumers and lenders alike. Fannie Mae is working assiduously to broaden lending opportunities by enhancing its programs and by providing educational materials that support lenders and consumers who need this service.

Larry Dale is executive director of Fannie Mae's national housing impact division. Andrew Stowers is assistant director of housing initiatives for Fannie Mae and a certified mortgage bankers (CMB).
COPYRIGHT 1992 Mortgage Bankers Association of America
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992 Gale, Cengage Learning. All rights reserved.

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Title Annotation:financing services for house rehabilitation offered by Federl National Mortgage Association
Author:Dale, Larry H.; Stowers, Andrea
Publication:Mortgage Banking
Date:Nov 1, 1992
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