March 17, 1994
U.S. Department of Housing and Urban Development
Washington, D.C. 20410-8000
OFFICE OF THE ASSISTANT SECRETARY
FOR HOUSING-FEDERAL HOUSING COMMISSIONER MORTGAGEE LETTER 94-11
TO: ALL APPROVED MORTGAGEES
SUBJECT: Single Family Loan Production - Revisions To The 203(k)
Rehabilitation Mortgage Insurance Program
The purpose of this Mortgagee Letter is to inform you of a number
of substantial changes that are being made to the Section 203(k)
Rehabilitation Mortgage Insurance Program to make it more streamlined
and user-friendly for lenders and borrowers. As you know, the Section
203(k) program is the Department's primary program for the
rehabilitation and repair of single family properties. As such, it is
an important tool for community and neighborhood revitalization and
for expanding home ownership opportunities. Since these are the
primary goals of HUD, the Department believes that Section 203(k) is
an important program and we intend to continue to strongly support
the program and the lenders that participate in it.
Many lenders have successfully used the Section 203(k) program
in partnership with state and local housing agencies and nonprofit
organizations to rehabilitate properties. These lenders, along with
state and local government agencies, have found ways to combine
Section 203(k) with other financial resources, such as HUD's HOME
and Community Development Block Grant Programs, to assist borrowers.
Several state housing finance agencies have designed programs
specifically for use with Section 203(k) and some lenders have also
used the expertise of local housing agencies and nonprofit
organizations to help manage the rehabilitation processing. We urge
lenders to explore these opportunities for partnerships with state
and local governments and nonprofits.
The Department also believes that the Section 203(k) program is
an excellent means for lenders to demonstrate their commitment to
lending in lower income communities and to help meet their
responsibilities under the Community Reinvestment Act(CRA). HUD is
committed to increasing homeownership opportunities for families
in these communities and Section 203(k) is an excellent product for
use with CRA-type lending programs.
A strong secondary market for Section 203(k) mortgages has
developed over the last few years. Attached to this Mortgagee Letter
(Attachment 1), is a list of lenders who are interested in purchasing
Section 203(k) mortgages; Fannie Mae and Freddie Mac will also
purchase these mortgages. Many of these secondary lender will also
assist originating lenders in developing a successful Section 203(k)
program.
The Department is arranging with the Mortgage Bankers Association of
America (MBA) a series of training sessions for lenders to learn more about
the Section 203(k) program. It is expected that three training sessions
will be held this year in various parts of the country. You will be
receiving further notice about these sessions in the near future.
Many of the program changes described below are the result of a
series of workshops that the Department conducted over the past several
months with lenders, community organizations, state and local government
agencies and HUD Field Office staff. The Department wishes to thank all of
those who participated in these workshops. These revisions are effective
immediately, unless otherwise stated and will supersede the Department's
policies described in HUD Handbook 4240.4 REV-2, dated December 6, 1991,
and Mortgagee Letter 92-33, dated September 28, 1992.
1. FIELD OFFICE APPROVAL OF DIRECT ENDORSEMENT (DE) LENDERS.
Some HUD Field Offices require DE lenders to be approved for the
203(k) program in their jurisdiction even when the DE lender has
already been approved for 203(k) by another HUD Field Office.
Duplicate HUD approval is not necessary. DE Underwriters who have
received training in 203(k) procedures from one HUD Field Office do
not need to be trained again in another HUD Field Office. A DE lender
does not have to submit 203(k) cases on a preclosing basis, if it has
already been unconditionally approved for 203(k) by any other HUD
Field Office.
If, on a post-endorsement basis, the HUD Field Office determines that
the DE lender's 203(k) cases are being improperly processed and
submitted for insurance, the HUD Field Office can require more
training for the DE Underwriter and if necessary, place the DE lender
in a preclosing status until it is shown that the DE lender is
complying with program requirements.
2. CORRESPONDENT LENDERS. Loan Correspondents working with approved
DE sponsors may originate 203(k) mortgages. Also, the correspondent
lender may use the DE sponsor's staff appraisers, inspectors and plan
reviewers for processing.
3. DEFINITION OF A FIRST TIME HOMEBUYER. For the purpose of using the
Escrow Commitment Procedure, lenders have requested further guidance
on the definition of "first time homebuyer." A first time homebuyer
is a single person(s) or an individual and his or her spouse who have
not owned a home (as a tenant in common or as a joint tenant by the
entirety) during the three years immediately
proceeding the date of application for the 203(k) loan.
Any individual who is legally separated or divorced cannot be excluded
from consideration as a first time homebuyer on the basis that the
individual owned a home with his or her spouse or resided in a home
owned by the spouse. In this case, the three year waiting period does
not apply, provided the individual no longer has an interest in the
home.
4. 203(k) BORROWER'S ACKNOWLEDGEMENT. Form HUD-92700-A
(Attachment 2) must be completed prior to closing the 203(k) loan.
The form notifies the borrower(s) of their responsibilities as they
relate to the rehabilitation of the property. This form replaces the
203(k) Applicant Acknowledgement in Appendix 4 of HUD Handbook 4240.4
REV-2. The new Form 92700-A should be used for all loans closed on or
after May 1, 1994.
5. SEVEN UNIT LIMIT. The Section 203(k) program is the only FHA
program that can be used by private, profit motivated investors. However,
HUD regulations and policies still restrict, under certain conditions, the
number of rental units in which an investor may have an interest. In
general, a borrower may not have an interest in more than seven units
in the same subdivision or contiguous area. For 203(k) purposes, HUD
defines a contiguous area as within a two block radius. In addition,
Handbook 4240.4 REV-2, paragraph 4-6, states that an investor should
not be allowed to rapidly accumulate FHA insured properties that
clearly and collectively constitute a multifamily project. Lenders
should be cognizant of these restrictions on investor participation.
The local HUD Field Office can determine that units in a neighborhood
are not subject to the seven unit limit described above if: (1) the
neighborhood has been targeted by a State or local government for
redevelopment or revitalization; and (2) the State or local government
has submitted a plan to HUD that defines the area, extent and type of
commitment to redevelop the area. Nevertheless, the HUD Field Office
may still impose restrictions within a redevelopment area (or
sub-area) in order to prevent undesirable concentrations of units
under a single (or group) ownership. Therefore, in addition to the
above requirements, the HUD Field Office will determine that the seven
unit limit is inapplicable only if: (1) the investor will own no more
than 10 percent of the housing units (regardless of financing type) in
the designated redevelopment area or sub-area; and (2) the investor
has no more than eight units on adjacent lots.
DE Lenders must submit requests in writing to the HUD Field Office for
determination that the seven unit limitation does not apply.
6. NONRESIDENTIAL USE OF A 203(K) PROPERTY. A 203(k) mortgage may be
originated on a "mixed use" residential property provided: (1) The
property has no greater than 25 percent (for a one story building);
33 percent (for a three story building); and 49 percent (for a two
story building) of its floor area used for commercial (storefront)
purposes; (2) the commercial use will not affect the health and safety
of the occupants of the residential property; and (3) the
rehabilitation funds will only be used for the residential functions
of the dwelling and areas used to access the residential part of the
property. It is the intent of this change to allow storefront
properties to be eligible for Section 203(k).
7. APPRAISALS. Paragraph 2-2, Handbook 4240.4, requires an appraisal,
for all properties except a HUD-owned property, to determine the As-Is
Value of the property and another appraisal to determine the value of
the property after rehabilitation.
However, this requirement is now being revised. The lender must still
establish an As-is value, but the lender may now determine that an
As-is appraisal is not feasible or necessary. The lender may use the
contract sales price (on a purchase transaction) or the existing debt
on the property (on a refinance transaction) as the As-Is value when
it is clear to the lender that this amount does not exceed a
reasonable estimate of value. On a refinance transaction, when a
large amount of existing debt (i.e., first and secondary mortgages)
suggests to the lender that the borrower has little or no equity in
the property, the lender should always obtain an As-Is appraisal on
which to base the estimate of As-Is value.
For a HUD-owned property an As-is appraisal is not required and a DE
lender may request the HUD Field Office to release the outstanding HUD
Property Disposition appraisal on the property to the lender to
establish the maximum mortgage for the property. The HUD appraisal
will be considered acceptable for use by the lender if: (1) it is not
over one year old prior to bid acceptance from HUD; and (2) the sales
contract price plus the cost of rehabilitation does not exceed 110
percent of the "As-Repaired Value" shown on the HUD appraisal. If
the HUD appraisal is insufficient to make the loan viable, the DE
Lender may order another appraisal to assure the market value of the
property will be adequate to make the purchase of the property
feasible.
Paragraph 2-4.A of Handbook 4240.4 REV-2, which describes the
appraised value to be placed on the Conditional Commitment / DE
Statement of Appraised Value (Form HUD 92800.5B) is changed to read
as follows:
Homebuyer's Statement of Appraised Value (Homebuyer's Copy of
Form HUD 92800.5B.). The value of the property is the market
value accepted by HUD or the DE Underwriter after reviewing the
Uniform Residential Appraisal Report, if one is obtained.
8. PURCHASE OF HUD-OWNED PROPERTIES. Homebuyers (including
investors) who purchase HUD-owned property can refinance the property
using 203(k) within six (6) months of purchase, the same as if the
buyer purchased the property with a 203(k) insured loan to begin with.
Evidence of interim financing is not required; the mortgage
calculations will be done the same as a purchase transaction. Cash
back will be allowed to the borrower in this situation; Lines D2
through D4 of the 203(k) Maximum Mortgage Worksheet, Form HUD 92700,
will be used to determine the maximum allowable mortgage on the
property. A copy of the HUD Sales Contract and the HUD-1 Settlement
Statement must be submitted to verify the accepted bid price (As-Is
value) of the property and the closing date.
See paragraph 7, above, for additional information on the appraisal
of HUD owned properties.
9. REVISION TO THE DRAW REQUEST FORM. Effective for mortgages closed
on or after May 1, 1994, the new Form HUD 9746-A in Attachment 3 must
be used on all draw requests. The Compliance Inspection Report (Form
HUD 92051) is no longer required to be submitted with the Draw Request
form; however, the back side of the draw request form has been revised
to include an Inspection Report that must be completed by the fee or
staff inspector on each inspection of the property during the
rehabilitation period. The cost of the inspection will also be
included on the back side of the form; therefore, the fee inspector
will no longer need to bill the lender for the inspection fee. The
inspection report must be completed for the fee to be paid by the
lender.
10. ARCHITECTURAL EXHIBITS. To streamline the submission requirements
for the architectural exhibits, paragraph 3-2.C, Handbook 4240.4 REV-2,
the list of exhibits, is revised as follows:
1) A Plot Plan of the Site is required only if a new addition is
being made to the existing structure. Show the location of the
structure(s), walks, drives, streets, and other relevant detail.
Include finished grade elevations at the property corners and
building corners. Show the required flood elevation.
2) Proposed Interior Plan of the Dwelling. Show where structural
or planning changes are contemplated, including an addition to
the dwelling. (An existing plan is no longer required.)
3) Work Write-up and Cost Estimate. Any format may be used for
these documents, however, quantity and the cost of each item must
be shown. Also include a complete description of the work for
each item (where necessary). The Rehabilitation Checklist in
Appendix 1 of Handbook 4240.4 REV-2 should be used to ensure all
work items are considered. Transfer the costs to the Draw
Request (Form HUD 9746-A).
Cost estimates must include labor and materials sufficient to
complete the work by a contractor. Homebuyers doing their own
work cannot eliminate the cost estimate for labor, because if
they cannot complete the work there must be sufficient money in
the escrow account to get a subcontractor to do the work. The
Work Write-up does not need to reflect the color or specific
model numbers of appliances, bathroom fixtures, carpeting, etc.,
unless they are non-standard units.
The consultant who prepares the work writeup and cost estimate
(or an architect, engineering or home inspection service) needs
to inspect the property to assure: (1) there are no rodents,
dryrot, termites and other infestation; (2) there are no defects
that will affect the health and safety of the occupants; (3) the
adequacy of the existing structural, heating, plumbing,
electrical and roofing systems; and (4) the upgrading of thermal
protection (where necessary).
11. REHABILITATION LOAN AGREEMENT. This Agreement (see Attachment 4)
has been revised to help the lender and borrower more fully understand
their responsibilities when the 203(k) loan is closed. The revisions
include the following:
The Rehabilitation Escrow Account will cease paying interest to the
borrower when: (1) the loan payments are delinquent for more than 30
days; (2) the completion date (or an approved extension) has expired.
During this period, the interest will be paid down on the mortgage
principal. If the borrower(s) cure the delinquent or default status
and/or the completion date has not expired or an extension has been
approved, then the interest on the escrow account will begin again to
be paid according to the request on the 203(k) Borrowers
Acknowledgement (Form HUD 92700-A, Attachment 2).
In cases where the loan has gone into default and all attempts to get
the borrower(s) to make their payments have been exhausted, HUD
permits the DE Lender to pay the interest accumulated in the escrow
account down on the unpaid principal of the mortgage, without seeking
advance approval from the local HUD Field Office.
The DE Lender no longer needs to submit change orders to the HUD Field
Office for an extension of time to complete improvements. However, DE
Underwriters are reminded that an extension can only be granted if the
loan payments are current.
12. ALLOWABLE DISCOUNT POINTS. Mortgagee Letter 92-33, dated September
28, 1992, discussed the allowable discount points for a 203(k) loan.
The following examples will help your processors and underwriters
properly implement the Department's policy.
The discount is determined between the lender and the borrower on each
loan and is not regulated by the Department. A portion of the total
discount paid by the borrower can be financed and is included as part
of the Total Rehabilitation Costs on the Maximum Mortgage Worksheet
(MMW). The discount that may be financed (Discount Points on the
Repair Costs) is equal to the number of discount points multiplied
by Line B10 on the MMW and shown on Line B12.
NOTE: The number of discount points charged on the
rehabilitation amount CANNOT be more than the number of discount
points charged on the total loan, and must be equal to or less
than the points that will be paid in cash.
The cash discount is the difference between the discount on the total
loan, and the amount of discount being financed as discount on the
rehabilitation. This is the cash that the borrower will bring to
closing to pay for discount points. To calculate, multiply the
number of discount points by the total loan amount and deduct the
discount on the repairs (Line B12 of the MMW), where applicable.
Example 1: On a $100,000 loan with Line B10 equal to $25,000,
the discount on the total loan is $2,000 (2% of $100,000). The
portion that can be financed is up to 2% of Line B10, which would
be $500 (2% of $25,000). The firm commitment should reflect the
total loan discount. The HUD 1 will show the difference of
$1,500 ($2,000 - $500), as cash discount and the rest ($500) is
shown in the Total Rehabilitation Cost. Regardless of whether
or not any discount is financed, if 2% is charged on this loan,
the total discount points, whether paid in cash or financed,
cannot exceed $2,000.
Example 2: There is a loan of $75,000 with 3 discount points,
none of which are being paid by the seller; the subtotal on Line
B10 for repairs and fees is $12,500. The discount would be shown
as $2,250 on the total loan, and of that amount, the borrower
decides to finance two of the three discount points which could
be financed on Line B12. The borrower would finance $250 into
the Total Rehabilitation Cost (2% of $12,500) and the balance of
the discount points ($2,000) would be paid in cash at closing.
When the seller has agreed to pay any portion of the total discount,
multiply the amount of the discount on the loan times the Sales
Contract Price in Line A1 of the MMW. If the seller pays a financing
concession to include discount points for both the sales price and
rehabilitation costs of the dwelling, then the sales contract must be
very clear and concise to assure that the seller completely
understands the concession agreement. On HUD-owned properties, any
amount HUD has agreed to pay towards the purchaser's closing and/or
financing costs (Line 5 of the Sales Contract, form HUD 9548), applies
only to the contract sales price and not to the total of the purchase
price plus cost of rehabilitation.
Example 3: There is a loan of $120,000; $40,000 in repairs and
fees on Line B10; 3% discount points; the total discount is
$3,600 (3% of $120,000). The seller agrees to pay 2% of the
discount points on the sales price of the home (2% of $80,000),
or $1,600. The remaining $2,000 needs to be paid by the
borrower. The borrower can finance up to 3% of the repair costs
from Line B10 (3% of $40,000 = $1,200) leaving the remaining
$800 to be paid in cash at closing. (This is not a HUD-owned
property).
Example 4: There is a loan of $90,000 with a subtotal for
repairs and fees of $30,000 on Line B10. The discount on the
loan is 2.5%, or $2,250. The seller agrees to pay 2% discount
($1,800) on the total loan (stated in the sales contract) at
closing. The borrower is responsible for the remaining $450 by
either financing the entire amount on Line B12, paying cash at
closing or a combination of both.
Example 5: The borrower has purchased a HUD-owned property for
$46,000 and the seller, HUD, has agreed in the sales contract to
pay $2,200 in closing costs. The loan will be $58,000, with
$12,000 as a subtotal on Line B10 of the MMW; the discount on the
loan is 2%. (HUD only pays discount points on the sale price of
the HUD-owned property, not on the sale price plus cost of
rehabilitation; see the sales contract; Line 5, form HUD 9548).
Therefore, HUD would be responsible to pay $920 (2% of $46,000)
on only the sales price of the property. The remaining amount,
up to $1,280, could be used for other closing costs on the loan.
**** POINTS TO REMEMBER:
1. The discount points on the total loan (both financed and paid in
cash) should be shown on the Firm Commitment.
2. Any discount points paid in cash at closing should be shown on
the Mortgage Credit Analysis Worksheet, Form HUD 92900WS.
3. The financed discount points on rehabilitation costs should be
shown on Line B12; where applicable for a refinance transaction,
Line D1 of MMW.
4. The 203(k) Maximum Mortgage Worksheet (Form HUD 92700) must be
attached to the Conditional Commitment/DE Statement of Appraised
Value (Form HUD 92800.5B) and the Firm Commitment (HUD 92900.4).
13. HUD ACCEPTED 203(k) CONSULTANTS. The most time consuming and
difficult part of a 203(k) loan is for the borrower to properly
prepare the required architectural exhibits listed in Handbook
4240.4 REV-2, paragraph 3-2. To help DE Lenders streamline their
processing time on a 203(k) loan, HUD Field Offices have the
authority to designate fee plan reviewers who have been trained in the
requirements of the 203(k) program, to also act as consultants to
borrowers, for the purpose of preparing the architectural exhibits.
Since the consultant already knows how to properly prepare the
exhibits, no plan review will be required (no fee charged) and the
case can be sent directly to the appraiser to be appraised. This
consultant, who is also a plan reviewer and HUD approved fee
inspector, can inspect the property during construction.
A DE Lender can also nominate persons to be independent consultants to
the local HUD Field Office. This consultant is not authorized to
inspect the property for a draw inspection during the construction,
because he/she is not on the HUD approved fee inspectors panel. The
nominee must be trained by the HUD Field Office on 203(k) procedures
and requirements and how to properly prepare the architectural
exhibits. A plan review is required until such time as the HUD Field
Office is satisfied that the consultant is properly preparing the
exhibits. When fully trained, the consultant can be placed on a HUD
Field Office list of accepted 203(k) consultants and DE lenders may
refer their borrowers to these consultants for the preparation of the
architectural exhibits.
NOTE: A borrower can use a contractor to prepare the
construction exhibits or prepare the exhibits themselves. The
use of a consultant is not required, however, the borrower
should consider using this service in order to expedite the
processing of the 203(k) loan. When a consultant is used, the
DE lender must notify the borrower that HUD, because it has
included a consultant's name on a list, does not warrant the
competence of the consultant or the quality of the work the
consultant may perform for the borrower.
The fee charged by the consultant can be included on Line B7 of the
203(k) Maximum Mortgage Worksheet (MMW). The consultant must enter
into a written agreement with the borrower that completely explains
what services the consultant will perform for the borrower and the
fee charged.
A fee of $400 is acceptable for a property with repairs less
than $7,500; $500 for repairs between $7,501 and $15,000; $600
for repairs between $15,001 and $30,000; and $700 for repairs
greater than $30,000. For this fee, the consultant would
inspect the property and provide all the required architectural
exhibits. State licensed Architect or Engineer fees are not
restricted by this fee schedule and should be shown on line B6
on MMW. (However, these architect and engineering fees must be
customary and reasonable for the type of project.)
When a loan on a property does not close within 120 days of the date
the plan reviewer signs the Draw Request, Form HUD 9746-A, the DE
Underwriter should require a reinspection of the property to assure
that further damage to the property has not occurred. An inspection fee
of $50 can be charged. If additional items need to be added to the work
writeup and cost estimate, the DE Underwriter must reflect the change in
the mortgage amount (if the market value is not affected) or obtain cash
from the borrower to make the repairs.
14. ELIMINATION OF 203(k) SECOND MORTGAGES. Although the law allows
HUD to insure 203(k) second mortgages (provided there are no insured
advances), the Department considers this type of second mortgage to
be an unacceptable risk. For this reason and because there is no
secondary market for 203(k) second mortgages, the Department will not
insure 203(k) second mortgages. The Federal Regulations will be
revised to remove this provision in 24 CFR 203.50(i).
15. HOMEOWNER / CONTRACTOR AGREEMENT. Where the borrower uses a
contractor to rehabilitate the property, the Department recommends
that the borrower enter into an Agreement with the contractor(s) to
assure that the parties to the Agreement understand the applicable
provisions of the 203(k) program. (A suggested Agreement is provided
in Attachment 5). At a minimum, it is suggested that the Agreement
(1) describe the work to be done by the contractor; (2) when the work
will begin and when it will be completed; (3) the total amount to be
paid to the contractor for doing the work; (4) provide for binding
arbitration on any disputes; and (5) provide a one year warranty on
all work completed by the contractor.
Where the lender will allow the borrower(s) to do their own work or
act as the general contractor, the Department recommends that the
lender obtains a Self-Help Agreement (Attachment 6) from the
borrower(s). This will assure that the borrower understands their
responsibilities during the rehabilitation of the property.
16. REVISION TO CONTINGENCY RESERVE REQUIREMENTS. Effective
immediately, where the construction is not completed, the contingency
reserve account can be used by the borrower to make additional
improvements to the dwelling. A Request for Change, Form HUD 92577,
must be submitted with the applicable cost estimates. However, the
change can only be accepted when the DE lender determines: (1) It is
unlikely that any deficiency that may affect the health and safety of
the property will be discovered; and (2) the mortgage will not exceed
95% (Owner-Occupant) or 85% (investor) of the appraised value of the
property. If the mortgage exceeds 95% or 85% of the appraised value
(shown in line A3 of the 203(k) Maximum Mortgage Worksheet, Form HUD
92700), then the contingency reserve must be paid down on the mortgage
principal.
If the borrower (or anyone else) provides their own funds for the
contingency reserve account, then Line B2 on the 203(k) Maximum
Mortgage Worksheet should show "0," because the funds are not being
provided by mortgage proceeds and will not be used in the calculation
of the maximum mortgage amount.
The Plan Reviewer must suggest to the DE Underwriter what the
Contingency reserve amount should be. The DE Underwriter is
responsible for making the final decision. For a property where
only the foundation remains and basically all rehabilitation will
be new construction, the DE Underwriter can waive the requirement
for a contingency reserve.
17. SWEAT EQUITY. Labor to be performed by the borrower on the property
being rehabilitated may be used to create additional equity in the
property, but the borrower cannot receive any cash back for the labor
performed. The borrower can only be reimbursed for the cost of any
materials that the borrower may have purchased.
The Borrower must request reimbursement for the actual cost of any
materials on the Draw Request form. The difference between the
estimated cost to complete the work and the actual cost of any
materials must remain in the escrow account until all work on the
property is complete. After completion of all work, any excess funds
remaining in the escrow account may be used for (1) cost overruns,
where applicable; or (2) additional improvements to the property; or
(3) prepayment of the principal on the mortgage.
(This change affects paragraph 5-2.C.2) in Handbook 4240.4 REV-2 and
Mortgagee Letter 92-33, it