Sometimes, when you live in a city, the best place to look is up. That's what Wes and Michala Costello decided when they discovered a fixer-upper in the neighborhood they wanted to live in.

"It was the ugliest house ever," Michala, a real estate agent, says of the two-story carriage house tucked away on a side street in Chestnut Hill. But her husband, who had experience with mortgages and appraisals, had a vision.

"He drew a quick sketch of the home with a third story, and asked me, 'What if it looked like this?' " she says.

Though it was complicated, it was the right move: "We fell in love with the location, the depth of the backyard, and the potential."

The couple had outgrown their 1,280-square-foot rowhouse in Roxborough. They were torn between Mount Airy and Chestnut Hill, they say, but this 1,900-square-foot home had the right $299,000 price tag.

They took out an FHA 203(k) renovation loan with the intention of transforming the house into a three-story dwelling - the mortgage provided them with the money to buy the house and do the needed repairs and expansion. After the purchase in 2008, they had six months to do the majority of the renovations, which included reframing the house from close to a gut and adding the third story.

First, they took down a wall to open up the kitchen, which now includes an island, light wood cabinets, black granite countertops, and the original hardwood floors. They pulled up orange shag carpet in the family room, and removed a back deck that was sectioned off with caution tape because carpenter bees had eaten through it.

Today, the cozy, modern family-room space boasts a wall of windows overlooking the double yard and a new deck, a bar that replaced a closet, a large sectional sofa, and a basketball hoop.

In the living room, the Costellos kept two large bay windows that date to the 1930s, when the structure was a garage with an apartment above.

On the second floor, they renovated a bathroom and transformed three bedrooms into an office and two children's rooms. To finish off their $80,000 loan, they replaced the aluminum siding outside with stucco and added the third floor, to make room for a master bedroom and bath.

Over a year later, they did a second addition encasing stairs to the third floor, putting in a second office, and completing the third floor. The house now has 2,700 square feet and has been appraised at more than $500,000.

"The biggest hurdle is not having a good designer. There's some things we'd do differently," Michala says. "We did a lot of things on the fly. We know a lot more now than we knew then."

For the second round of renovations, they hired an interior designer.

"I'm thankful we didn't finish it right away," Michala says. "The first time, you take an hour to look at tile. Second time, with a toddler, you don't have time to make choices."

Three resources got them through the process of adding the third floor, the Costellos say: a contractor familiar with the 203(k) loan; a renovation lending specialist, and a market analysis to make sure doing the work would be worth it.

The couple saved money by picking out their own supplies, including kitchen cabinets, bathroom vanities, and paint. They obtained their own permits and spent time on the phone with Michala's brother, an architectural designer. And they did some work themselves.

"I missed the Eagles-Cowboys game [in 2008] for that," says Wes, standing on the landing to the third floor and pointing to the crown molding. "It was an amazing game."

The third-floor master bedroom, painted in eggshell blue, includes farmhouse beams, a 17-foot vaulted ceiling, and hotel-chic decor. A hallway, featuring a chandelier and wall-length closets, leads to a spa-like bathroom with a custom-built vanity, a basket-weave Carrara marble tile floor, and a claw-foot tub.

Adding the third floor likely cost three to four times more than refinishing a basement would have, because of roofing, stucco, plumbing, and electric.

"The house was the right size in the neighborhood that we wanted," Wes says. "If the location is right, you can really win for all your headaches."

"The house has transitioned with us. The children have switched bedrooms. We have switched offices," Michala says. "We don't have any intention of going anywhere. I see a lot of houses. I still like our home the best."