The District government is preparing to give a developer $14 million in low-interest loans to buy and renovate an occupied middle-income apartment building in Southwest, lifting rent controls there and sparking a controversy over the appropriate use of the city's housing bond program.

Opponents of the plan for the 402-unit Capitol Park Apartments say the city should be using its authority to lend money at below-market interest rates for low- and moderate-income housing, not to help developers buy expensive properties and get around rent controls.

Members of the D.C. City Council are reviewing the bond program in light of the proposed loan.

"The time and energy that the Housing Finance Agency is devoting to this proposal could be better spent working with developers to 'take the boards off' vacant housing and to bring substandard buildings into compliance with the housing code," Gottlieb Simon, executive director of the Southwest-Near Southeast Advisory Neighborhood Commission, testified at recent finance agency hearings on the proposal.

Capitol Park "is a good building in a beautiful neighborhood with many amenities. It doesn't need public subsidies to be rentable," Simon said.

The new owners, local developers Scott and Gary Nordheimer, and the finance agency, which approves proposals and issues the housing bonds, say the loans would result in 119 units at the complex being returned from transient use to permanent apartments and would finance about $3 million in repairs and renovation.

The Nordheimers bought the building at 800 Fourth St. SW in October from Rep. James H. Scheuer (D-N.Y.). If they do not get the finance agency loan, they say, they will have to get conventional financing to pay for the building.

Scheuer had tangled with the tenants and the D.C. Rental Accommodations Office over his conversion of the 119 units to transient units several years ago, which the rental office found was illegal. The office was trying to negotiate a settlement when the building was sold, according to D.C. Rent Administrator John S. Hampton.

The owners have informed tenants that they can expect rent increases of about 20 percent by next October, but Gary Nordheimer said they have promised that no one will pay more than 30 percent of their gross income. As a result, some tenants will have rent reductions, Nordheimer said.

The average rent there is $440 for a one-bedroom apartment, he said.

The finance agency only recently received authority to issue tax-exempt bonds to raise money that could be lent at below-market interest rates for District housing projects. This would be the 12th multifamily project to get the agency loans but the first to be occupied, said agency Executive Director Thomas M. Zuniga.

A project that gets agency financing is not subject to D.C. rent controls.

"That needs to be reviewed," said City Council member Charlene Drew Jarvis (D-Ward 4), chairman of the Housing and Economic Development Committee. When a vacant building is being rehabilitated, absence of rent controls provides a needed incentive to developers, but "we need to rethink the use of the finance agency monies" for renovating occupied apartment buildings, Jarvis said.

The Capitol Park situation may point up a need to narrow the mission of the finance agency to ensure that the bulk of its assistance goes to low-income housing, she added.

"We think this project is poor public policy," said an aide to City Council member John Wilson (D-Ward 2), whose ward includes Southwest. Wilson tried to persuade Mayor Marion Barry to put a hold on the project, the aide said.

Zuniga said preliminary approval has been given to the developers for the financing but that he postponed a meeting last week to make a final decision on it so he could first brief the mayor. Barring serious concerns by the mayor, who has not yet expressed a view to the finance agency, the agency probably will move forward on it next week, Zuniga said.

The Nordheimers have extensive holdings in the Washington area and have converted a number of rental buildings to condominiums, including River Place and Prospect House in Arlington and the Whitehall and Parkside apartments in Bethesda.

With finance agency financing, 20 percent of the Capitol Park complex would have to be dedicated to low-income persons, but information sheets from the finance agency said that requirement is fulfilled by persons who live in the building.

Gary Nordheimer called the condition of the building "deplorable." A list of planned renovations includes landscaping, recaulking windows, paving, roof and air-conditioning repairs, and new kitchens and bathroom fixtures.

An engineering report two months ago on the 25-year-old, mid-rise building described its general condition as "good."

Resident Janet Hieber said the building does not need major rehabilitation and that the bond issue would establish a precedent for circumventing rent control laws citywide. The owners' verbal promise to keep rents below a percentage of gross pay "is certainly not a comfort to most people," she said.

The D.C. Housing Action Council, a coalition of 25 nonprofit organizations, opposed the loan plan in a letter to Zuniga, calling the proposed rehabilitation "primarily cosmetic, designed to address marketing needs rather than preservation of threatened low-income housing."

The finance agency has issued $93 million in bonds for multifamily housing involving 1,400 units, Zuniga said. There also are now about $100 million worth of proposed projects in the pipeline, involving 2,500 units, that the city hopes to issue bonds on by next September, he said.