November 14, 2002

#### MORTGAGEE LETTER 2002-22 

**TO: ALL GOVERNMENT AGENCIES**

**ALL APPROVED MORTGAGEES**

####  ALL APPROVED NONPROFIT AGENCIES

**SUBJECT:** Downpayment Assistance Programs Operated by Governmental
Agencies and Nonprofits Using Subordinate Financing

Over the past few months, FHA has received several questions about
downpayment assistance programs operated by governmental agencies and
nonprofits. The purpose of this Mortgagee Letter is to provide technical
guidance to mortgagees about these downpayment assistance programs by
summarizing existing program rules and requirements, based on Section
528 of the National Housing Act.

# A. State and Local Governments and Nonprofit Instrumentalities of Government

Section 528 of the National Housing Act requires FHA to insure first
mortgages with second mortgages or loans made or held by any state or
local government agency or instrumentality of government, provided all
FHA requirements are met. Mortgagee Letter 94-2 describes the conditions
that a nonprofit must meet in order to be considered an instrumentality
of government and, thus, eligible to provide secondary financing for as
much as 100% of the borrower's required cash investment. To obtain this
status, according to Section 528 of the National Housing Act, the
nonprofit must be an entity "established by a governmental body or with
governmental approval or under special law to serve a particular public
purpose or designated by law (statute or court opinion)." FHA also
requires that the unit of government that *established* the nonprofit
also must either exercise organizational control, operational control,
or financial control of the nonprofit in its entirety or, at minimum,
the specific homebuyer assistance program that is using FHA's credit
enhancement. As described in ML 00-08 and ML 01-02, our Homeownership
Centers (HOCs) may review applications from nonprofits that purport to
be instrumentalities of government and make approval decisions based on
information submitted by the nonprofit.

The policies discussed in ML 94-2 have enabled state and local
governments, by themselves or through nonprofit instrumentalities
established by the governmental units, to operate successful downpayment
assistance programs. However, mortgagees must be aware that *only* the
actual units of government or their established nonprofit
instrumentalities may provide the second lien under the 100 percent
financing policies acceptable to FHA.

# B. Information Regarding the Second Lien

The second lien itself must be made or held by the eligible governmental
body or instrumentality. Neither governmental units nor their
established nonprofit instrumentalities may use "agents," including
other nonprofits or for-profit enterprises to make the second lien
regardless of the source of those funds. In other words, even if the
funds used for the secondary financing were *derived* from an acceptable
source such as HUD HOME funds or from a unit of government or the
eligible nonprofit instrumentality, the subordinate lien must be in the
[name]{.underline} of the eligible entity, i.e., the state, county, city
or eligible nonprofit instrumentality must be the lien holder. This
authority cannot be delegated to another party that is not itself
permitted to provide this level of secondary financing. These other
entities, however, may be used to *service* the subordinate lien if
regularly scheduled payments are to be made by the mortgagor.

In addition, in accordance with 24 CFR 203.41, if the subordinate lien
includes any restrictions on transferability, such as occupancy
requirements or resale restrictions, those must automatically and
permanently terminate upon foreclosure, deed-in-lieu of foreclosure, or
assignment of the insured mortgage to HUD. The relevant legal documents
must have language that accomplishes this result. It is also important
to note that "forgivable" second liens (e.g., no repayment if the
homeowner remains in the house for five years) are [not]{.underline}
*gifts* and, thus, are subject to these requirements.

The FHA-insured **mortgage amount** is calculated by applying the
maximum loan-to-value multipliers based on location of the property and
value, as described in ML 98-29, to the lesser of the sales price or
appraised value and making certain that there is at least a 3 percent
cash investment (which may be met with proceeds from the second lien).
The *combined* loan-to-value (CLTV) is limited to the amount to acquire
the property, which may include the sales price, closing costs, prepaid
expenses, and discount points, and in some cases, the costs for property
rehabilitation; this may *not,* however, result in any cash back to the
borrower. As an example, a \$100,000 sales price would yield a \$97,000
FHA mortgage amount. Combined with \$3,500 for closing costs and prepaid
expenses being paid by the nonprofit, the combined indebtedness could
equal \$103,500 with secondary financing equaling \$6,500.

In addition, the combined indebtedness may exceed the value of the
property if the governmental unit or nonprofit instrumentality of
government is supporting or engaging in a neighborhood revitalization
effort. In many cases, the combined indebtedness including the amount
spent for rehabilitation cannot be supported by the property's value
after completing the improvements; these revitalization programs are
usually designed to increase property values of in the neighborhood over
an extended period of time. Subject to approval by the HOC, the
subordinate financing, when combined with the FHA-insured first
mortgage, may exceed the value of the property even after rehabilitation
has been completed. Repayment of the subordinate lien is due only when
the property is sold or the mortgage is paid in full.

As an example, a \$100,00 sales price would yield a \$97,000 FHA
mortgage amount. Combined with \$3,500 for closing costs and prepaid
expenses being paid by the nonprofit, along with \$20,000 for
rehabilitation, the combined indebtedness could equal \$123,500 with
secondary financing equaling \$26,500. The after-rehabilitation
appraised value, however, is only \$120,000. Nevertheless, provided
there are assurances that the funds for rehabilitation are expended only
for that purpose and not given to the homebuyer, the HOC can approve
revitalization programs that result in the costs of the improvements
exceeding their effect on value.

# C. Nonprofits with FHA-Approved Affordable Housing Programs

In accordance with ML 00-08 and ML 02-01, when a nonprofit that is *not*
recognized by FHA as an instrumentality of government is providing
subordinate financing *and* that nonprofit *has* obtained FHA's approval
as a provider of subordinate financing, the nonprofit may provide
downpayment assistance that covers the gap between the FHA first
mortgage and amount to acquire the property, minus the required
homebuyer's minimum cash investment requirement of three percent.

The FHA-insured **mortgage amount** is calculated by applying the
maximum loan-to-value multipliers based on the location of the property
and value, as described in Mortgagee Letter 98-29, to the lesser of the
sales price or appraised value and making certain that there is a 3
percent cash investment (which may *not* be met with proceeds from the
second lien.) The *combined* loan-to-value (CLTV) is limited to the
amount to acquire the property, pay closing costs, prepaid expenses, and
discount points minus the statutory 3 percent investment which may come
from the homebuyer's own funds or from a legitimate gift from an
acceptable source.

As an example, a \$100,000 sales price would yield a \$97,000 FHA
mortgage amount. Combined with \$3,500 for closing costs and prepaid
expenses being paid by the nonprofit, the combined indebtedness could
equal \$100,500 with secondary financing equaling \$3,500. The 3 percent
required investment may not come from any subordinate liens.

D. [Mortgage Amount Limitations When the Downpayment Assistance Provider
is Also the]{.underline}

#  Seller of Property 

In accordance with Section 528 of the National Housing Act, the combined
loan-to-value (CLTV) or indebtedness may be affected when the
downpayment assistance provider is also the seller. All sellers are
permitted to pay the homebuyer's closing costs, prepaid expenses, and
discount points up to an amount equaling six percent of the sales price;
any amount above this threshold results in a dollar-for-dollar reduction
to the loan amount. Similarly, if a governmental unit or nonprofit is
providing a gift of equity from the sale of the property, there must a
dollar-for-dollar reduction to the sales price.

E. [Mortgagee Letter 2002-02]{.underline}

ML 2002-02 was issued on January 16, 2002 to clarify and amplify that
FHA's existing underwriting policy does not permit gifts to borrowers
from third parties when such gifts are used to pay off or reduce their
outstanding consumer debt to enable them to qualify for FHA-insured
mortgages and the third parties receive contributions from the sellers
for payment of these debts. ML 2002-02 referred to nonprofit
organizations because our experience has indicated that such entities
are the only ones that have engaged in this practice. References in ML
2002-02 to nonprofit organizations should be construed as references to
any third parties. For example, a gift for debt payoff assistance from a
family member is not ordinarily prohibited unless the family member
making the gift receives the funds from the seller or any other party
with an interest in the transaction.

Questions have arisen with regard to application of ML 2002-02 to gifts
made for downpayment assistance in situations in which donors receive
contributions from sellers. ML 2002-02 is limited to debt payoff
assistance, not downpayment assistance. ML 2002-02 does not apply to
gifts for downpayment assistance by nonprofit organizations or other
third parties that receive contributions from sellers or other parties
with interests in the transactions, provided that such contributions are
made after closing.

F. [Mortgagee Roster Verification]{.underline}

Mortgagees must verify that nonprofits providing secondary financing are
approved by HUD for that activity specifically by consulting the
Nonprofit Organization Roster, a listing of nonprofits that HUD has
determined are qualified to participate in certain specified FHA single
family activities, including providing secondary financing. HUD recently
(June 6, 2002) published final regulations governing roster placement
and removal of nonprofit entities. The rules became effective on July 8,
2002. The Roster can be accessed on HUD's web site at
*http://www.hud.gov/offices/hsg/sfh/np/np_hoc.cfm*

If you have any questions regarding this Mortgagee Letter, please
contact your Homeownership Center in Atlanta (888) 696-4687; Denver
(800) 543-9378; Philadelphia (800) 440-8647, or Santa Ana (888)
827-5605.

Sincerely,

John C. Weicher

Assistant Secretary for Housing-

Federal Housing Commissioner