MORTGAGEE LETTER 95-40
TO: ALL APPROVED MORTGAGEES
SUBJECT: Single Family Loan Production - Revisions to the 203(k)
Rehabilitation Mortgage Insurance Program
This Mortgagee Letter describes additional changes undertaken
by the Department to further streamline the Section 203(k)
Rehabilitation Mortgage Insurance program. Since increasing
the supply of affordable housing through rehabilitation and
repair of existing housing stock is one of the primary
goals of FHA, we intend to continue to support the Section
203(k) program and the lenders that participate in it.
The revisions described below are the result of a Working
Group that met in June 1995, consisting of HUD Offices,
lenders, non-profit organizations and government agencies.
These changes are effective immediately.
I. THE CONSULTANT
Responsibility: The home inspection and completion of the
work write-up and cost estimate are essential elements in
processing the Section 203(k) insured loan, in addition to
the underwriting steps applicable to a regular mortgage.
Therefore, when a consultant is used, it is the responsibility
of the consultant, as well as the local HUD Office and the
lender to assure that the architectural exhibits are properly
prepared. Mortgagee Letter 94-1 explains the role of
consultants to borrowers under the 203(k) program.
Each HUD Office must assure that the consultants and plan
reviewers are properly trained. On a representative sampling,
a consultant's work write-ups and cost estimates are to be
desk reviewed by the HUD Office; a field review may also
be necessary. Results of the reviews should be forwarded to
the consultants, plans reviewers and lenders. These reviews
are also integral parts of the annual re-certification
sessions for consultants, plans reviewers, and inspectors.
When acceptable by the local HUD Office, the consultant
can also perform inspections during the construction period.
A Direct Endorsement (DE) staff consultant can also do the
inspections for that lender as well as its correspondent
lenders. A checklist designed to help the consultant in
preparing the architectural exhibits is included as
Attachment 1.
Qualifications: HUD requires at least three years experience
as a remodeling contractor, general contractor or home inspector
in order to qualify as a 203(k) consultant. The consultant
must be able to perform home inspections, prepare the necessary
architectural exhibits, and be able to complete the draw
inspections on the property during the construction phase of
the project. A state licensed architect or engineer may
also be accepted. To apply for HUD acceptance, the consultant
must submit his or her qualifications (resume') to the local
HUD Office and be trained.
In addition, on a demonstration basis through January,
1996, we will also grant automatic acceptance of consultants
meeting the above experience requirements and trained and
certified by either Countrywide (818-304-5602) or CrossLand
Mortgage Corporation (410-825-5700). Both Countrywide and
CrossLand will provide lists of trained individuals to
the appropriate HUD Offices and to HUD Headquarters.
Consultants trained by either Countrywide or CrossLand
(or other trainers acceptable to the local HUD Office)
should provide a copy of the training certification stating
that they have acceptably completed the 203(k) Consultants
Training Course. Consultants approved by either are allowed
to do business with other lenders and within any HUD
jurisdiction and are also approved to do Section 203(k)
inspections.
Fees charged by consultants: The fee charged by the
consultant can be included in the mortgage as a part of the
cost of rehabilitation. The consultant must enter into a
written agreement with the borrower that completely explains
what services will be rendered and the fee charged. Neither
HUD nor the lender will be responsible to the consultant for
fees owed by the borrower.
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 between $30,001 and $50,000; $800 for
repairs between $50,001 and $75,000; $900 for repairs
between $75,001 and $100,000; and $1,000 for repairs over
$100,000. An additional fee of $25 can be charged for each
additional unit in the property under the same FHA case number.
For this fee, the consultant inspects the property and provides
all required architectural exhibits.
In some cases, the borrower will request a feasibility study
by a consultant prior to submitting a sales contract to a
seller. An additional fee of $100 can be included in the
mortgage for this type of service. Basically, the consultant
will do a quick home inspection of the property, with a
"rough estimate" of the work that will be necessary to
comply with HUD's requirements. Maximum fees for compliance
inspections on completed work will continue to be set by each
HUD Office.
If additional services are required of a state licensed
architect or engineer, then the fee is not restricted by
the above schedule and can be included in the mortgage as
a cost of rehabilitation, provided the fee is customary and
reasonable for the type of project being proposed.
II. LENDER ISSUES
Administration of the rehabilitation (construction) stage:
DE lenders approved for Section 203(k) are authorized to
permit staff other than its underwriters to sign draw requests
and change orders. This delegation of authority for properly
managing the inspection and disbursement functions of the
203(k) Rehabilitation Escrow Account must be included in the
lender's quality control plan.
Acceptance of DE staff consultants and inspectors: The
increasing volume of Section 203(k) loans has required many
lenders to use staff consultants and inspectors beyond the
HUD Office jurisdiction in which they were originally approved.
In order to facilitate expansion of the program, lenders may
use staff consultants and inspectors acceptable to any HUD
Office without additional review by each office. The lender
must notify the HUD Office that it will be doing the
consulting/inspecting. HUD Offices will actively share any
information that may be helpful in preparing cost estimates,
and will retain the right to reject consultants or inspectors
based on poor quality of work in that Office's jurisdiction.
Proposal for lenders to appoint authorized agents to
underwrite 203(k) loans: We are in the process of drafting
a proposed rule to permit any approved Non-supervised and
Supervised Mortgagee to appoint an Authorized Agent(s) to
process and/or underwrite FHA insured mortgages. If
implemented, this will permit a lender with or without 203(k)
experience to use another lender with 203(k) experience for
processing and underwriting loans it originates.
Draw request administration and accounting of rehabilitation
escrow funds: lenders with unconditional Section 203(k)
approval do not need to send the construction documents
(interim and final draw requests, extensions, change orders,
final release notice and the complete and final accounting
form) to the local HUD Office until the Final Release Notice
has been issued. At completion, the lender must send all to
the local HUD Office.
The 203(k) Maximum Mortgage Worksheet (HUD 92700) and the
MCAW: The mortgage credit analysis worksheet (MCAW, form
HUD-92900WS) does not lend itself to mortgage calculations
for Section 203(k) loans. Form HUD-92700 is used to calculate
the mortgage amount while the MCAW is used to qualify the
borrower. Attachment 2 is provided to demonstrate those
sections of the 203(k) maximum mortgage worksheet that are
to be transferred to the MCAW.
III. UNDERWRITING ISSUES
Qualifying Ratios (investment properties): The calculation
of qualifying ratios proceeds as described below:
From the monthly net rental income of the subject property
(gross rents minus the 25 percent reduction or local
office's percentage reduction for vacancies and repairs),
subtract the monthly payment (principal, interest, taxes,
insurance). If this yields a positive number, add it to
borrower's monthly gross income; if negative, consider it
a recurring monthly obligation; then,
Calculate the mortgage payment-to-income ratio ("top
ratio") by dividing the borrower's current housing expense
(principal residence) by the monthly gross income.
(The monthly gross income will include any positive cash
flow from the subject investment property.); and
Calculate the total fixed payment-to-income ratio
("bottom ratio") by dividing the borrower's total monthly
obligations, including any net loss from the subject
investment property, by the borrower's total monthly
gross income.
Mixed Use Properties: If a portion of a residence is being
devoted to commercial purposes, the property value assigned
shall be as if completed for residential use, not commercial
use. The local office's residential appraisal fee schedule
is to be used.
However, the income from the commercial space may be used to
support the mortgage as long as it is being currently used as
a commercial enterprise and there is a valid lease. This
income is to be treated just as is housing unit rental
described above.
Recently Acquired Properties (less than six months):
If a borrower (owner-occupant or investor) purchases a
property with cash within the previous six months, the
original sales price may be used as the estimate of value
in determining the maximum mortgage amount for a
Section 203(k) loan. This will allow the borrower to
replenish funds used at the time of purchase. The original
purchase price must be documented with a copy of the
HUD-1 Settlement Statement and sales agreement. Also see
Title Chain Evidence in IV below for additional instructions.
Sales of HUD-owned properties: Since each local HUD office
must adjust for local conditions in the marketing of real
estate owned, there will always be differences among the
local offices. However, to help bring about a degree of
uniformity with those elements that can be standardized, we
have adopted the following policies:
Revised loan-to-value for investor purchase of
HUD-owned properties: The minimum cash investment
for investor purchases of HUD-owned properties
using Section 203(k) financing is now uniformly set
at 15 percent nationwide. Previously, the maximum
percentage of financing on properties purchased from
HUD and repaired under Section 203(k) varied from 85
percent to 75 percent. This revision will provide
consistency on 203(k) investor downpayment requirements
throughout all office jurisdictions.
Closing costs on HUD-owned properties: Since HUD has
contractually agreed to pay up to the amount specified
in Line 5 of the Sales Contract towards the purchaser's
closing/financing expenses, a listing of allowable items,
or a price listing for those items, normally will not be
provided by HUD. The buyer is permitted to use these
funds for either financing costs or closing costs. The
buyer should indicate how these funds will be used at
the time of loan application. However, in the event
a local HUD Office does elect to specify either the
specific closing/financing items, or the maximun cost
for such items for which HUD will pay, that HUD Office
will advise the lender.
Appraisals on HUD-owned Properties: Local offices
have been instructed to provide lenders with a copy of
the appraisal report and a list of any required repairs
on HUD-owned properties. These appraisals may be used
for up to one year from the date of the appraisal.
Heat loss/Heat gain calculations: When a new heating
or cooling system is proposed, heat loss/heat gain
calculations will no longer be required. The
determination of the furnace size and type
requirements will be left to the buyer and contractor
and will not be imposed by FHA.
Additional Escrow Commitment procedures: All funds in
the rehabilitation escrow account (contingency
reserve, construction savings, unused mortgage
payments and inspection fees) that remain unspent at
the end of construction, will accrue to the escrow
commitment account in lieu of being applied to the
principal balance. If the assumption of the mortgage
does not occur within 18 months, then the escrow
commitment account will be applied to the mortgage
balance.
Occupant owners attempting to sell their home may
refinance the current mortgage with a 203(k) loan and
make repairs and improvements prior to placing the
home up for sale. If the purchaser of the
rehabilitated property is a first-time homebuyer,that
buyer can assume the property without a downpayment.
(If the home is sold to an immediate family member, the
loan-to-value will be 85 percent.) Please note that
unless the property being rehabilitated becomes
unoccupiable during construction, mortgage payments will
not be considered as a cost of rehabilitation and
therefore will not be allowed in calculating the cost
of rehabilitation.
When calculating the maximum mortgage amount for
the escrow commitment procedure on the 203(k) Maximum
Mortgage Worksheet (Attachment 4), please note a change
on line E1 that requests the input of the "Assumptor's
Estimated Closing Cost." This closing cost includes the
allowable assumption fee, title and recording fees, cost
of the credit report and attorney fees if applicable.
IV. LOAN QUALITY ASSURANCE REVISIONS. Although most of our efforts
with regard to Section 203(k) mortgages are designed to enhance
the ability of lenders to process and close these mortgages,
we are also aware that certain elements, primarily those
associated with investors and identity-of-interest transactions
may contribute to unacceptable risk. The following are
actions designed to help FHA as well as the lender manage
the risk inherent on Section 203(k) mortgages.
Partnerships: Only general partnerships will be acceptable
in this program. All partners must sign as individuals on
the note. All parties on the mortgage or deed of trust must
also sign the mortgage note.
Bulk Sales: Borrowers must reveal bulk sales to both the
lender and local HUD office. When a borrower purchases
properties through a bulk sale of more than two properties
(even if HUD is not the seller), each bulk sale must be
reviewed by the DE underwriter to assure the proper
distribution of the sales price for each property (bulk sale
amount divided by the number of properties purchased).
An as-is appraisal will be necessary to assure that the
contract sales price is not greater than the value of the
property. We do not consider it a prudent practice to
allow staff appraisers to appraise the properties in
bulk sale transactions, therefore all such transactions
will be reviewed, after closing, by the local HUD Office.
Identity-of-interest: If there is an identity-of-interest
between the buyer and the seller of the property, the parties
involved (and/or their family members) cannot use any
commission from the sale or listing of the property for the
downpayment. In addition, the loan-to-value will be limited
to 85 percent and an as-is appraisal of the property will be
required. On purchases by a partnership, there must be an
arms-length transaction between contractor and borrower
to assure no conflict of interest.
Also, there is to be no identity-of-interest between the
lender and the borrower on Section 203(k) mortgages. An
exception may be made in those situations where a mortgage
lender is rehabilitating a property from its real estate owned
inventory for resale.
Chain of Title Evidence: The DE lender must obtain evidence of
prior ownership when a property was sold in the last year.
Prior ownership must be reviewed for undisclosed identity-of-
interest transactions. The 203(k) mortgage must be based
on the lowest sales price in the last year.
V. APPROVAL OF NON-PROFIT AGENCIES. A non-profit agency, before
it can be approved as an eligible mortgagor and obtain the
same mortgage amount as available to owner occupants on
Section 203(k) mortgages, must demonstrate its experience as
a housing provider to HUD and meet all other requirements
described in HUD Handbook 4155.1 REV-4, paragraphs 1-
5. (Otherwise, the non-profit is limited to 85 percent
mortgages as any other investor.) It must also be able to
provide satisfactory evidence that it has the financial
capacity to purchase the properties.
Housing Provider Documentation Requirements. To obtain
HUD approval, the non-profit agency must provide the local
HUD office with the following:
1) complete articles of incorporation and by-laws
of the entity;
2) corporate resolution delegating signature
authority;
3) an outline of current and future housing
objectives;
4) a marketing plan describing its methodology of
renting the units or transferring properties to
homeowners through credit qualifying assumptions
or other means, if appropriate; and,
5) a detailed description of the last two years'
experience as a housing provider.
If a non-profit is approved by a HUD Office as eligible to
participate as a mortgagor based on its experience as a housing
provider, this approval is acceptable nationwide. However,
the non-profit must advise each local HUD Office of its intent
to purchase properties within that jurisdiction and provide
the local office with a copy of the acceptance letter as well
as items 2, 3, and 4 above.
With regard to housing provider experience as well as
"rehabilitation" experience, the local Office may include
alternate community-based experience (housing counseling, etc.).
HUD Offices may also allow neighborhood-based nonprofit
organizations to rehabilitate one or two properties at a time
until they are able to obtain the two years' experience
necessary to take on more units.
A non-profit using the escrow commitment procedure may exceed
the 18-month time limit for assumptions if it is offering a
lease-with-option-to-assume transaction. In this type of
transaction, non-profits are allowed a period of 36 months to
complete the assumption. We also strongly recommend that
the non-profit provide pre-purchase counseling for the
homebuyers, either in-house or from a qualified contractor.
Financial Capacity Documentation: Lenders must be capable of
analyzing a non-profit's financial capacity. Since the
application of qualifying ratios is rarely appropriate in this
analysis, the lender must be able to otherwise conclude that the
non-profit borrower will be able to support the mortgages for
which it has applied. (The individual signing the loan
application and other documents for the non-profit agency is not
personally obligated on the loan.) In addition to the documents
that must be provided to HUD to determine the non-profit agency's
eligibility, the lender must obtain the following documents to
determine creditworthiness:
1) copies of last two years' tax returns; and
2) year-end financial statements for most recent
fiscal year and most recent 90-day year-to-date
financial statement prepared by an accountant.
3) credit reports on all principals of the
non-profit organization
Unless the local HUD Office, in consultation with the mortgage
lender, has agreed that the non-profit has demonstrated its
financial capacity through alternate qualifying methods, the
following underwriting criteria must be used by the lender for
each loan application:
The non-profit agency must provide the lender financial
statements for the most recent two years' documenting
unrestricted cash flows or unrestricted and unencumbered
reserves, exclusive of rental income from the financed
properties, to meet the greater of: (a) 10% (ten percent) of
principal, interest, taxes, and insurance (PITI) payments due
each month on all mortgages for a minimum of six months; or
(b) total PITI payments for the single largest mortgage for a
minimum of six months.
[As an example of the above, a non-profit agency is considering
purchasing an inner-city property for lease to low- and
moderate-income families. The estimated monthly PITI on the
mortgage will be $1000; the agency has four other rental
properties each with mortgages of $1000 per month. To qualify
for FHA-insured financing, analysis would proceed as follows:
Sum of PITI of all properties, including the property
being purchased: $5000.
(a) $5,000 x 10% x 6 months= $3,000
(b) $1,000 x 6 months= $6,000
The non-profit agency would need to have an unrestricted cash flow
of at least $6,000 per month, or unobligated cash reserves of at
least $6,000.]
VI. ENERGY EFFICIENT MORTGAGE (EEM) PROGRAM AND SECTION 203(k).
Effective immediately, Section 203(k) loans are eligible
under the Energy Efficient Mortgages program. Refer to
Mortgagee Letter 93-13 (May 24, 1993), for instructions on the
basic program requirements for calculating an EEM. Properties
of up to four units are eligible for an EEM under
Section 203(k).
Under the FHA EEM Program, a borrower can finance into the
mortgage 100 percent of the cost of eligible energy efficient
improvements, subject to certain dollar limitations, without
an appraisal of the energy improvements and without further
credit qualification of the borrower.
To be eligible for inclusion into the mortgage, the energy
efficient improvements must be "cost effective," i.e., the
total cost of the improvements (including maintenance costs)
must be less than the total present value of the energy saved
over the useful life of the improvements. The mortgage,
subject to the specific underwriting criteria described in
ML 93-13, may include the cost of the energy efficient
improvements in addition to the usual mortgage amount
permitted by regulations. The FHA maximum loan limit for the
area may be exceeded by the cost of the eligible energy
efficient improvements. However, the entire mortgage cannot
exceed 110% of the value of the property.
The cost of the energy improvements and the estimate of
the energy savings must be determined based upon a physical
inspection of the property by a home energy rating system
(HERS) or energy consultant. For a 203(k) loan, the entire
cost of the HERS or the energy consultant can be included
in the mortgage. On new construction (an addition or new
building on an existing foundation), the energy improvements
must be over and above those required for compliance with
the current FHA energy conservation standards for new
construction. The estimate of the energy savings in
new construction must be based upon a comparison of
plans and specification of the house with the additional
energy saving improvements to those of the basic house which
complies with the current FHA energy conservation standards.
Presently, these standards are those of the 1992 CABO Model
Energy Code (MEC).
The energy inspection of the property must be performed prior
to completion of the work writeup and cost estimate to assure
there is no duplication of work items in the mortgage. After
the completion of the appraisal, the cost of the energy
improvements are calculated by the lender to determine how much
can be added to the mortgage amount.
Example:
The existing property sold for $60,000. The borrowers wish to
install $2,000 worth of energy-efficient (EE) improvements that
have a useful life of 7 years and will save $35 in monthly utility
costs. The borrowers' closing costs total $1,200, including the
$250 charge for the HERS inspection report. The interest rate on
the 203(k) mortgage is 8.00%. The cost of rehabilitation estimated
by the 203(k) consultant is $20,000. The after-improved value of
the property is $90,000.
$60,000 Sales price
20,000 Cost of rehab
+ 1,200 Closing costs
$81,200 Mortgage Basis
x97/95% Max. Loan-to-Value Ratio
$77,600 Loan Amount
Please refer to Mortgagee Letter 93-13 for details.
$2,000 Installed Cost of EE Improvements
7 Years Expected Life of Improvements
$35 Expected Monthly Savings
$420 Expected Yearly Savings
5.206 Present Value Factor (8% Interest Rate @ 7 Years)
$2,186 EE Premium (5.206PV x $420 Annual Savings)
Since the present value of the energy savings over
the expected life of the improvements (the EE premium) is
greater than the installed cost of the improvements, the
entire cost of the improvements may be added to the
mortgage amount (as shown above):
$77,600 Mortgage Amount from above
+ 2,000 Installed Cost of EE Items
$79,600 Mortgage Amount with Installed EE Items
VII. CONDOMINIUMS. The Department will now permit Section 203(k)
mortgages to be used for individual units in condominium projects
that have been approved by FHA or the Department of Veterans Affairs
under the guidelines listed below.
The 203(k) program was not intended to be a project mortgage
insurance program, as large scale development has considerably
more risk than individual single family mortgage insurance.
Therefore, condominium rehabilitation is subject to the
following conditions:
1. Owner/occupant and qualified non-profit borrowers only;
no investors;
2. Rehabilitation is limited only to the interior of the unit.
Mortgage proceeds are not to be used for the rehabilitation
of exteriors or other areas which are the responsibility of
the condominium association, except for the installation of
firewalls in the attic for the unit;
3. Only the lesser of five units per condominium association,
or 25 percent of the total number of units, can be
undergoing rehabilitation at any time;
4. The maximum mortgage amount cannot exceed 100 percent of
after improved value.
After rehabilitation is complete, the individual buildings
within the condominium must not contain more than four units.
By law, Section 203(k) can only be used to rehabilitate units
in one-to-four unit structures. However, this does not mean
that the condominium project, as a whole, can only have four
units or that all individual structures must be detached.
Example: A project might consist of 6 buildings each containing
4 units, for a total of 24 units in the project and, thus, be
eligible for Section 203(k). Likewise, a project could contain
a row of more than fou