Christopher Shearer
FHA 203K How is it different?
Most mortgage financing plans provide
only permanent financing. That is, the lender will not usually close
the loan and release the mortgage proceeds unless the condition and
value of the property provide adequate loan security. When
rehabilitation is involved, this means that a lender typically
requires the improvements to be finished before a long-term mortgage
is made.
When a homebuyer wants to purchase a house in need of repair or
modernization, the homebuyer usually has to obtain financing first to
purchase the dwelling; additional financing to do the rehabilitation
construction; and a permanent mortgage when the work is completed to
pay off the interim loans with a permanent mortgage. Often the
interim financing (the acquisition and construction loans) involves
relatively high interest rates and relatively short amortization
periods. The Section 203(k) program was designed to address this
situation. The borrower can get just one mortgage loan, at a
long-term fixed (or adjustable) rate, to finance both the acquisition
and the rehabilitation of the property. To provide funds for the
rehabilitation, the mortgage amount is based on the projected value
of the property with the work completed, taking into account the cost
of the work.
To minimize the risk to the mortgage lender, the mortgage loan (the
maximum allowable amount) is eligible for endorsement by HUD as soon
as the mortgage proceeds are disbursed and a rehabilitation escrow
account is established. At this point the lender has a fully insured
mortgage loan.
To be eligible, the property must be a one- to
four-family dwelling that has been completed for at least one year.
The number of units on the site must be acceptable according to the
provisions of local zoning requirements. All newly constructed units
must be attached to the existing dwelling. Condominium and
Cooperative units are not eligible.
Homes that have never been completed cannot be accepted into the
203(k) program; construction of the property must have been completed
for at least one year. Evidence of completion would be a Certificate
of Occupancy or other similar documentation from the local
jurisdiction.
Homes that have been demolished, or will be razed as part of the
rehabilitation work, are eligible provided the existing foundation
system is not affected and will still be used. The complete
foundation system must remain in place. A report from a licensed
structural engineer is required stating that the existing foundation
is structurally sound and capable of supporting the proposed
construction of the dwelling. Where the home has been completely
razed (or where only the footings remain), including the demolition
of the foundation, the property is not eligible for a 203(k) insured
loan, but could be acceptable as new construction under Section
203(b).
In addition to typical home rehabilitation projects, this program can
be used to convert a one family dwelling to a two, three, or
four-family dwelling. An existing multi-unit dwelling could be
decreased to a one- to four-family unit.
An existing house on another site can be moved onto the mortgaged
property; however, release of loan proceeds for the existing
structure on the non-mortgaged property is not allowed until the new
foundation has been properly inspected and the dwelling has been
properly placed and secured to the new foundation.
A manufactured (mobile) home that was built after June 15, 1976, and
has been on a permanent foundation for over one year, can be rehabbed
with this
program. The unit must have been delivered to the site when it was
new, prior to being occupied. The rehabilitation cannot affect the
structural components of the home that were designed and constructed
in conformance with the Federal Manufacturers Construction and Safety
Standards. Refer to HUD Handbook 4145.1 REV-2 for additional
information, especially for the licensed engineer's certification.
This program can be used to
accomplish rehabilitation and/or improvement of an existing
one-to-four unit dwelling in one of four ways:
A. To purchase a dwelling and the land on which the dwelling is
located and rehabilitate it.
B. To purchase a dwelling on another site, move it onto a new
foundation on the mortgaged property and rehabilitate it.
C. To refinance existing indebtedness and rehabilitate such a
dwelling.
D. To rehabilitate such a dwelling.
Mortgages that do not involve the insurance of
advances, the refinancing of outstanding indebtedness or the purchase
of the property need not be a first lien on the property, but will
not be junior to any lien other than a first mortgage.
For A and C in paragraph 1-5., the mortgage must be a first lien on
the property and the loan proceeds (other than rehabilitation funds)
may be available before the rehabilitation begins.
For B in paragraph 1-5., the mortgage must be a first lien on the
property; however, loan proceeds cannot be made available until the
unit is attached to the new foundation (see paragraph 1-4.).
For D in paragraph 1-5., the mortgage may be a second lien on the
property; however, no insured advances will be allowed and the
mortgage cannot be endorsed until all work is satisfactorily
completed (see paragraph 5-1.A.). The minimum mortgage amount must
exceed the limits of a loan under Title I of the National Housing
Act.
Mortgage proceeds must be used in part for
rehabilitation and/or improvements to a property. There is a minimum
$5000.00 requirement for the eligible improvements on the existing
structure on the property. Minor or cosmetic repairs by themselves
are impracticable and unacceptable; however, they may be added to the
minimum requirement (in addition to $5,000). The mortgage must
include one or more of the items listed below, with a cumulative
minimum of $5,000.
A. Structural alterations and reconstruction (e.g., additions to the
structure, finished attics, repair of termite damage and the
treatment against termite infestation, etc.)
B. Changes for improved functions and modernization (e.g., remodeled
kitchens and bathrooms).
C. Elimination of health and safety hazards (including the
resolution of defective paint surfaces and/or lead-based paint
problems on homes built prior to 1978).
D. Changes for aesthetic appeal and elimination of obsolescence
(e.g., new exterior siding).
F. Reconditioning or replacement of plumbing (including connecting
to public water and/or sewer system), heating, air conditioning
and electrical systems.
F. Roofing, gutters and downspouts.
G. Flooring, tiling and carpeting.
H. Energy conservation improvements (e.g., new double pane windows,
insulation, solar domestic hot water systems, etc.).
I. Major landscape work and site improvement, patios and terraces
that improve the value of the property equal to the dollar amount
spent on the improvements or required to preserve the property
from erosion.
J. Improvements for accessibility to the Handicapped.
When basic improvements are involved, the following costs can be
included in addition to the minimum $5,000 requirement for the
existing structure:
- Construction or rehabilitation of a detached garage or an
attached unit(s) to the existing dwelling (if allowed by the
local zoning ordinances).
- New cooking ranges, refrigerators and other appurtenances
(Used appliances are not eligible).
- Interior or exterior painting.
Luxury items and improvements that do not become a permanent part of
the real property are not eligible as a cost rehabilitation. The
items listed below (not limited to this list) are not acceptable
under the 203(k) program, including the repair of any of the
following:
Barbecue pits; bathhouses; dumbwaiters; exterior hot tubs,
saunas, spas and whirlpool baths; outdoor fireplaces or hearths;
photo murals; swimming pools; television antennas and satellite
dishes; tennis courts; tree surgery. Additions or alterations to
provide for commercial use are not eligible.
1-8. REQUIRED IMPROVEMENTS. <TOP> All rehabilitation construction and/or
additions financed with Section 203(k) mortgage proceeds must comply
with the following:
A. Cost Effective Energy Conservation Standards.
1) Addition to Existing Structure. New construction must
conform with local codes and HUD Minimum Property Standards
in 24 CFR 200.926d (HUD Handbook 4910.1, Appendix K) is
required.
2) Rehabilitation of Existing Structure. To improve the thermal
efficiency of the dwelling, the following are required:
a) Weatherstrip all doors and windows to reduce infiltration
of air when existing weatherstripping is inadequate or
nonexistent.
b) Caulk or seal all openings, cracks or joints in the
building envelope to reduce air infiltration.
c) Insulate all openings in exterior walls where the cavity
has been exposed as a result of the rehabilitation.
Insulate ceiling areas where necessary.
d) Adequately ventilate attic and crawl space areas.
For additional requirements, refer to 24 CFR Part 39,
Appendix A-1 through A-6 for standards that apply to
improvements proposed as part of the rehabilitation.
3) Replacement Systems.
a) Heating, ventilating, and air conditioning system supply
and return pipes and ducts must be insulated whenever
they run through unconditioned spaces.
b) Heating systems, burners, and air conditioning systems
must be carefully sized to be no greater than 15 percent
oversized, except to satisfy the manufacturers' next
closest nominal size.
If a new heating/cooling system is proposed, provide heat
loss/heat gain calculations for the entire house to
ensure proper sizing of heating system. Use the design
criteria developed by the American Society of Heating,
Refrigerating and Air Conditioning Engineers (ASHRAE) or
Manual J developed by the National Environmental Systems
Contractors Association.
B. Smoke detectors. Each sleeping area must be provided with a
minimum of one (1) approved, listed and labeled smoke detector
installed adjacent to the sleeping area. The detector must sense
visible or invisible particles of combustion. When activated,
the detector must provide an alarm suitable to warn occupants
within the sleeping area.
Smoke detectors may be battery powered when installed in existing
or rehabilitated dwellings. However, where new construction is
being added to an existing building, the smoke detector must
receive its primary power from the building wiring, in
conformance to local codes and ordinances.
1-9. DEFINITIONS FOR USE IN THE 203(k) PROGRAM. <TOP>
A. Insurance of advances. This refers to insurance of the mortgage
prior to the rehabilitation period.
A mortgage that is a first lien on the property is eligible to be
endorsed for insurance following mortgage loan closing,
disbursement of the mortgage proceeds, and establishment of the
Rehabilitation Escrow Account.
The mortgage amount may include funds for the purchase of the
property or the refinance of existing indebtedness, the costs
incidental to closing the transaction, and the completion of the
proposed rehabilitation. The mortgage proceeds allocated for the
rehabilitation will be escrowed at closing in a Rehabilitation
Escrow Account.
B. Rehabilitation Escrow Account. When the loan is closed and
Insurance of Advances is used, the proceeds designated for the
rehabilitation or improvement, including the contingency reserve,
mortgage payment reserve and monies retained under the Escrow
Commitment Procedure, are to be placed in an interest bearing
escrow account insured by the Federal Deposit Insurance
Corporation (FDIC) or the National Credit Union Administration
(NCUA). This account is not an escrow for the
paying of real estate taxes, insurance premiums, delinquent
notes, ground rents or assessments, and is not to be treated as
such.
1) The lender (or its agent) will release escrowed funds upon
completion of the proposed rehabilitation in accordance with
the Work Write-up (see example of a Rehabilitation Checklist
in Appendix 1) and the Draw Request (Form HUD 9746-A in
Appendix 9). Release of funds for completed work cannot
occur until one day following loan closing (see paragraph
4-9).
2) The net income earned by the Rehabilitation Escrow Account
must be paid to the mortgagor. The method of such payment is
subject to agreement between mortgagor and mortgagee.
However, payment of the interest income on the Rehabilitation
Escrow Account can accumulate and be paid in one lump sum
after completion of rehabilitation and issuance of the Final
Release Notice. When the Escrow Commitment Procedure is
used, interest on the investor's escrow account can be paid
when the loan is assumed. Provide an Applicant's
Acknowledgement shown in Appendix 4.
3) During rehabilitation the lender may not release funds from
the Rehabilitation Escrow Account until the lender has
received a Compliance Inspection Report (Form HUD 92051) and
the Draw Request (Form HUD 9746-A), certifying that the work
has been completed in compliance with the accepted
architectural exhibits.
The final release of the escrowed rehabilitation funds is to
take place only after the local jurisdiction has provided its
final acceptance of the work and the HUD or the Direct
Endorsement (DE) Underwriter has reviewed the final
Compliance Inspection Report and the Draw Request form.
The Final Release Notice (Appendix 7, as applicable) can be
issued, authorizing the final payment, which may include the
interest earned on the escrow account and the total of all
holdbacks (see paragraph 1-9.B. and E.). This Notice also
directs the prepayment of the mortgage by the amount
remaining in the contingency reserve and any unused
inspection fees or mortgage payments, when applicable.
C. Rehabilitation Loan Agreement. When the mortgage involves the
insurance of advances, a Rehabilitation Loan Agreement must be
executed by the lender and the borrower (see Appendix 2). The
Rehabilitation Loan Agreement establishes the conditions under
which the lender (or its agent) will release funds from the
Rehabilitation Escrow Account to aid the borrower in the
rehabilitation or improvement of the property. When the lender
uses the services of an agent, the lender remains responsible for
the actions of that agent. See paragraph 5-2.C. for information
on how to release funds.
D. Inspections. All inspections are performed by HUD-approved fee
inspectors assigned by the HUD Field Office (but paid by the
lender) or on the HUD-accepted staff of the DE lender (see
paragraph 5-2.C.). The fee inspector is to use the architectural
exhibits in order to make a determination of compliance or
non-compliance. The HUD accepted Plan Reviewer can be allowed to
do the fee inspections on the property, because he/she is already
familiar with the proposed improvements and can inspect the
rehabilitation knowing what was accepted in the work write-up
(see paragraph 3-2.F.).
When the inspection is scheduled due to a request for payment,
the inspector is to indicate on the Compliance Inspection Report
(Form HUD 92051) whether or not the work has been completed.
Also, the inspector must use the Draw Request form (Form HUD
9746-A, Appendix 9). The first draw must not be scheduled until
the lender has determined that the applicable building permits
have been issued.
The inspection fees are paid by the mortgagor, but, the lender is
responsible to ensure that payment is made to the inspector (see
paragraph 1-13.D.). If the inspection fee is part of the escrow,
then it can be released along with the release of the escrow
funds as a result of an acceptable Draw Request.
E. Holdback. A ten (10) percent holdback is required on each
release from the Rehabilitation Escrow Account. The total of all
holdbacks may be released only after a final inspection of the
rehabilitation and issuance of the Final Release Notice. The
lender (or its agent) may retain the holdback for a maximum of 35
calendar days unless State law allows for a longer time period to
ensure that no liens are placed on the property. At lenders
option, the holdback is not required when a subcontractor is 100%
complete with a work item, the work completed is acceptable to
the inspector and the subcontractor provides the necessary lien
waivers. Also refer to paragraph 5-2.E.
F. Contingency Reserve. At the discretion of the Field Office or
the DE Underwriter, the cost estimate may include a contingency
reserve if the existing construction is less than 30 years old or
the nature of the work is complex or extensive. A contingency
reserve is required when there is evidence of termite
damage or previous termite infestation.
For properties older than 30 years the cost estimate must include
a contingency reserve of a minimum of ten (10) percent of the
cost of rehabilitation; however, the contingency reserve may not
exceed twenty (20) percent where major remodeling is
contemplated. If the utilities were not turned on for
inspection, a minimum fifteen (15) percent is required. If the
scope of work is well defined and uncomplicated, and the
rehabilitation cost is less than $7,500, the lender may waive the
requirement for a contingency reserve. A notice about the
Contingency Reserve must be provided to the borrower prior to, or
at, the closing of the loan (see Appendix 4).
The reserve cannot be used to make additional improvements to the
dwelling that are considered luxury items; however, it may be
used to pay for added construction costs caused by deficiencies
(health, safety and necessity) discovered during rehabilitation.
Use a Request for Change, Form HUD 92577, when the scope of
rehabilitation will be affected. When adjustments to the proposed
rehabilitation (i.e., deleting a skylight from the work write-up)
are made following loan closing, the amount by which the costs
are reduced are added to the contingency reserve. Any
unused portion of the Contingency Reserve Fund remaining at the
time of issuance of the Final Release Notice must be applied to
reduce the mortgage balance. Work items cannot be deleted from
the rehabilitation if it will decrease the value of the home,
since the loan has already closed.
If the Borrower feels that the contingency reserve will not be
used and they wish to avoid having the reserve applied to reduce
the mortgage balance after issuance of the Final Release Notice,
the borrower (or any other person, organization or agency on the
borrower's behalf) may place their own funds into the contingency
reserve account. In this case, if monies are remaining in the
account after the Final Release Notice is issued, the monies may
be released back to the borrower (or other person, organization
or agency who placed the money in the contingency reserve).
If the mortgage is at the maximum mortgage limit for the area or
for the particular type of transaction, but a contingency reserve
is required, the contingency reserve must be placed into an
escrow account from other funds of the borrower at closing.
Under these circumstances, if the contingency reserve is not
used, the remaining funds in the escrow account will be released
to the borrower after the Final Release Notice has been issued.
G. Mortgage Payment Reserve. Funds not to exceed the amount of six
(6) mortgage payments (including PITI and the mortgage insurance
premium) can be included in the cost of rehabilitation and
deposited in the rehabilitation escrow account to assist a
mortgagor (whether a principal residence or an investment
property) when the property is not occupied during
rehabilitation.
On multi-unit properties, if one or more units is occupied, the
mortgage payment must be reduced accordingly. If the owner
occupies one of the units, or if the rents received are not
sufficient to cover that portion of the mortgage, then the
mortgage payment will be reduced by dividing the PITI by the
number of units in the property (i.e., the monthly mortgage
payment for a triplex is $1,248; if one unit is occupied, the
mortgage payment is reduced to $832).
The number of mortgage payments cannot exceed the completion
time frame required in the Rehabilitation Loan Agreement. The
lender must make the monthly mortgage payments directly from the
interest bearing reserve account. Monies remaining in the
reserve account after the Final Release Notice is issued, or
occupancy of the property, must be used to reduce the mortgage
principal.
1-10. MAXIMUM MORTGAGE AMOUNT. <TOP> The mortgage amount, when added to any
other existing indebtedness against the property, cannot exceed the
applicable loan-to-value ratio and maximum dollar amount limitations
described in 24 CFR 203.50. The downpayment requirements are the
same as under the Section 203(b) program (refer to HUD Handbook
4155.1, paragraph 2-4 for additional information. Also refer to
paragraph 6-1 for requirements for incentives to sell HUD-owned
properties). The Mortgage Payment Reserve is considered a part of
the cost of rehabilitation for determining the maximum mortgage
amount (see paragraph 1-9.G.).
A. Maximum Mortgage Calculation. Based on the lesser of:
1) The estimate of As-is value or the purchase price of the
property before rehabilitation, whichever is less, plus the
estimated cost of rehabilitation and allowable closing
costs; or
2) 110 percent of the expected market value of the property
upon completion of the work plus allowable closing costs.
Principal Residence (Owner-occupant)
The maximum mortgage amount is based on 97/95 percent of
1) or 2) above.
Investment Property (Non-Occupant Mortgagor or Builder/Rehabber)
The maximum mortgage amount is based on 85 percent of
1) or 2) above.
Escrow Commitment Procedure (Builder/Rehabber)
See Appendix 10 for an example for calculating the maximum
mortgage amount using the escrow commitment procedure. This
procedure cannot be used for a loan amount less than the
97/95% calculated for an owner-occupant (the loan can be
assumed by an investor, however, the mortgage principal must
be paid down to what the mortgage would be to an investor).
A mortgagor (Builder/Rehabber/Investor, not an
owner/occupant) that purchases or refinances an investment
property but intends to sell the rehabilitated property to a
mortgagor acceptable to HUD (who intends to occupy the
property as a principal residence) can obtain a mortgage
based on the loan-to-value ratio and maximum dollar amount
limitations prescribed under Section 203(b) for a principal
residence, provided:
-- The dollar difference between the maximum mortgage
amount (97/95 of the fair market value for an
owner-occupant) and the mortgage amount available to an
investor (85% of acquisition cost) will remain in escrow
with the lender until the property is assumed by an
owner-occupant acceptable to the Commissioner;
and
-- The escrowed funds will be administered under the Escrow
Commitment Procedure;
Use Form FHA-314, Escrow Commitment Certificate, for
this procedure. The commitment may be issued for the
maximum mortgage amount for the longest term
permissible, 30 years. Refer to paragraph 4-5 for
information concerning financial requirements for an
investor who uses this procedure.
To allow for maximum owner-occupant financing when the
loan is assumed (by an owner-occupant acceptable to HUD)
and to avoid the extra cost for a new mortgage, the
mortgage may be based on the market value of the
property after rehabilitation. The difference between
the maximum mortgage requirements for an owner-occupant
and an investor would be retained in an escrow account.
The investor/builder must sign a Statement of
Understanding similar to that shown in Appendix 8 and
must provide the lender an acceptable plan on how the
property will be marketed for assumption by an
acceptable owner-occupant purchaser.
The investor/builder may elect to use the escrow funds
to reduce the principal balance at any time prior to the
18th month. If the property is not sold prior the 18th
amortization payment of the mortgage, the entire escrow
amount must be applied to reduce the principal balance
and reduce the mortgage amount to an amount available as
an investment property.
The owner-occupant who assumes the loan must provide a
downpayment based on 97/95% (unless they qualify under
the first time homebuyer provision below). If the
resale price is less than the appraised value of the
property, the mortgage amount must be reduced
accordingly based on the acquisition price. If the
resale price is greater than the appraised value, the
purchaser must make a larger downpayment. Refer to the
example in Appendix 10. For mortgage calculations for
refinance transactions, see paragraph 4-7.
If the purchaser is a "first time homebuyer," the
assumption can be done with no downpayment requirement.
A "first time homebuyer" is defined as a person(s) who
has not had an ownership interest in a principal
residence within the three years preceding the date of
the execution of the mortgage loan documents. Each
borrower must certify to the above ownership interest.
To verify this requirement, the lender must obtain
certified copies of signed federal income tax returns
filed by the eligible borrower for the three tax years
immediately preceding execution of the mortgage loan
documents. If the borrower was not required by law to
file a federal income tax return for any of these three
years and did not so file and certifies to such, then
the requirement is waived.
B. Cost of Rehabilitation. Expenses eligible to be included in the
cost of rehabilitation are materials, labor, contingency
reserve, overhead and construction profit (put in each work
item), up to six (6) months of mortgage payments, plus expenses
related to the rehabilitation such as permits, fees, inspection
fees by a qualified home inspector (i.e., a member of the
American Society of Home Inspectors), licenses, inspection fees
during construction by a HUD accepted inspector, lien protection
fees for title updates and architectural/ engineering fees.
The cost of rehabilitation may also include the supplemental
origination fee which the mortgagor is permitted to pay when the
mortgage involves insurance of advances, and the discounts which
the mortgagor will pay on that portion of the mortgage proceeds
allocated to the rehabilitation.
Comments(0)