Financing Energy Efficiency: An EEM Handbook

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

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

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

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:

IV. LOAN QUALITY ASSURANCE REVISIONS.

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 down payment. 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.

Housing Provider Documentation Requirements. To obtain HUD approval, the non-profit agency must provide the local HUD office with the following:

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 home buyers, 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 credit worthiness:

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.

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).

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 write-up 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.

Please refer to Mortgagee Letter 93-13 for details.

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):

VII. CONDOMINIUMS.

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: