March 17, 1994                  

                  U.S. Department of Housing and Urban Development

                                Washington, D.C. 20410-8000





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) 


   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.


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


   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


   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


   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



   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.




   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.



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



   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