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.



     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) 


     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.


     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.



     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


	   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


	   3)    an outline of current and future housing


	   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.]


     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. 



     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