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**U. S. Department of Housing and Urban Development**

Washington, D.C. 20410-8000

January 11, 1994

OFFICE OF THE ASSISTANT SECRETARY

FOR HOUSING-FEDERAL HOUSING COMMISSIONER

**MORTGAGEE LETTER 94-2**

TO: ALL APPROVED MORTGAGEES

SPECIAL ATTENTION: Nonprofit Agencies with Affordable Housing

Programs State Housing Finance Agencies

**SUBJECT:** Secondary Financing Provided by Nonprofit Agencies and

Transferability Restrictions Permitted for Property with

a HUD Insured Mortgage

The Department issued a final rule effective on September 10,

1993, to revise the Department\'s policy concerning secondary financing

provided by nonprofit agencies with affordable housing programs, and

to clarify the use of single family mortgage insurance for properties

that are not freely transferable by the borrower/homeowner because of

legal restrictions. This Mortgagee Letter will summarize main points

and provide additional clarification for certain issues. The rule

also includes provisions that are not discussed below, such as

procedures for release of selling mortgagors which will be addressed

in a separate issuance.

I. SECONDARY FINANCING BY NONPROFIT AGENCIES

HUD has long recognized the important role that nonprofit agencies

may play in providing affordable housing opportunities. The revised

rule will permit nonprofit agencies greater flexibility in providing

downpayment and other assistance to prospective homeowners through

secondary financing. HUD Field Offices will determine whether a

nonprofit agency meets the eligibility criteria for providing

secondary financing and will also approve the secondary financing.

An eligible nonprofit agency must be of the type described in

Section 501(c)(3) as exempt from taxation under Section 501(a) of the

Internal Revenue Code of 1986; have two years\' experience as a

provider of housing for low- and moderate-income persons; and have a

voluntary board with no part of the net earnings or contributions of

the organization benefiting any member, founder, contributor, or

individual. Eligible nonprofit agencies may be permitted to provide

secondary financing provided the borrower has made or will make at

settlement a cash investment of at least equal to three (3) percent

of the cost to acquire the property. The cash investment requirement

may also be satisfied with grant funds provided under the HOME

Investment

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Partnerships (HOME) program. The secondary financing arrangements are
also

subject to the restrictions below as well as those detailed in HUD
Handbook

[[4155.1]{.underline}](http://www.hudclips.org/sub_nonhud/cgi/nph-brs.cgi?d=HSGH&s1=4155.1%5Bno%5D&SECT1=TXTHLB&SECT5=HSGH&u=./hudclips.cgi&p=1&r=0&f=S)
REV-4, paragraph 1-13(C), as follows:

1\. The required monthly payment under both the insured mortgage and

the second mortgage or lien, plus other housing expenses and all

recurring charges, cannot exceed the borrower\'s reasonable

ability to pay;

2\. The second mortgage when combined with the first may not exceed

the estimated value of the property including all closing costs;

and

3\. The source, amount, and repayment terms must be disclosed in the

mortgage application and the borrower must acknowledge that he or

she understands and agrees to those terms.

However, a nonprofit agency meeting the additional criteria for being

considered as \"instrumentality of government\" may be permitted to
provide

secondary financing for as much as 100 percent of the borrower\'s
required

cash investment (subject to the restrictions 1 through 3 stated above).

For a nonprofit agency to be considered an \"instrumentality of
government\"

it must meet criterion \"A\" below, as well as one of either B1, B2, or
B3.

A. ESTABLISHMENT Must have been established by a governmental body

or with governmental approval or under special law

to serve a particular public purpose or designated

as an instrumentality by law (statute or court

opinion), and

B1. ORGANIZATIONAL Majority of governing board and/or principal

CONTROL officers named or approved by governmental

body/officials, or

B2. OPERATIONAL Government body approves all major decisions

CONTROL and/or expenditures, or

B3. FINANCIAL Government body provides funds through

CONTROL direct appropriations/grants/loans, with related

controls applicable to all activities of entity.

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If the secondary financing includes restrictions on transferability

under the new rule, such as occupancy requirements or resale
restrictions,

those requirements must comply with the new rule (as discussed below).

Permitted restrictions may be enforced by requiring repayment of the

secondary financing. The secondary financing itself is not a restriction

under the rule merely because it is due on sale of the home.

Federal agencies and government-sponsored enterprises (e.g., the

Federal Deposit Insurance Corporation (FDIC), the Federal National

Mortgage Corporation (Fannie Mae), the Resolution Trust Corporation
(RTC),

the Federal Home Loan Mortgage Corporation (Freddie Mac)) that
administer

affordable housing programs may also provide secondary financing under
the

terms described above.

II\. RESTRICTIONS TO TRANSFERABILITY \-- SUMMARY OF RULE

The rule states the long-standing HUD policy that a property with a

HUD-insured mortgage shall be free of restrictions that prevent the

borrower from freely transferring the property. The rule also prohibits

a lender from approving restrictions after the loan is closed. The rule

uses the term \"legal restrictions on conveyance\" to describe such

restrictions and this term is broadly defined to include provisions in
any

kind of legal instrument that would cause a conveyance (including a
lease)

by the borrower to:

o Be void, or voidable by a third party.

o Be the basis of contractual liability of the borrower.

o Terminate, or subject to termination, the borrower\'s interest in

the property.

o Be subject to the consent of a third party.

o Be subject to limits on the amount of sales proceeds a borrower can

retain.

o Be grounds for accelerating the insured mortgage.

o Be grounds for increasing the interest rate of the insured

mortgage.

If a conveyance could cause any of these things to occur, the property

is considered to be subject to legal restrictions on conveyance
(referred

to as \"restrictions\" for the remainder of this Mortgagee Letter) and
is

usually ineligible for HUD mortgage insurance.

However, the rule also describes the circumstances when restrictions

do not make the property ineligible. They are:

o HUD-required restrictions on sale to non-creditworthy persons or

persons who will not occupy the property as a principal residence.

These restrictions are contained in the standard mortgage language

required by HUD. (Handbook 4155.1 Rev. 4, paragraph 4-2; Handbook

4165.1 Rev. 1, Appendix III, paragraph 9(b); Handbook 4330.1 Rev. 4,

paragraph 6-4.)

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o Restrictions that are part of an eligible program for low- or

moderate-income housing (referred to as an \"affordable housing

program\" for the remainder of this Mortgagee Letter) and consistent

with requirements of the rule. An eligible program must be operated

pursuant to a Federal program, or operated by a State or local

government or an eligible nonprofit organization as defined in the

rule. These restrictions are discussed in greater detail below.

o Restrictions related to tax-exempt mortgage revenue bond financing.

In addition to the restrictions allowed for governmental or non-profit

affordable housing programs, the lender may use HUD\'s tax-exempt

financing rider to provide for mortgage acceleration for violation of

restrictions. (Handbook 4165.1 Rev 1, Appendix XII.)

o Restrictions for housing for the elderly. These are allowed if

consistent with Federal, State and local laws and if marketability is

not unduly affected.

o Restrictions related to the special title situations on Indian

lands, Hawaiian Homelands, the Northern Mariana Islands and American

Samoa. These will not necessarily preclude mortgage insurance.

LIMITATIONS ON RESTRICTIONS \-- AFFORDABLE HOUSING PROGRAMS

All restrictions relating to affordable housing programs that are

otherwise allowed by HUD policy 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. Merely subordinating the

restrictions to the insured mortgage is not sufficient. The restrictions

cannot come back in force upon subsequent resale by the lender or HUD

(except as provided in regulations for the HOME program).

Restrictions may not be enforced by any of the following consequences

for a violation:

o Voiding a conveyance by the borrower.

o Terminating the borrower\'s interest in the property.

o Accelerating the insured mortgage.

o Increasing the interest rate for the insured mortgage.

o Subjecting the borrower to contractual liability.

The prohibition against contractual liability covers liability for

damages, specific performance or injunctive relief. It does not prevent

a requirement for the borrower to

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repay with reasonable interest any assistance received in connection
with

the borrower\'s home purchase. The effect of these prohibitions is that

the borrower must have the legal ability to sell his or her home. The

borrower does not have to be allowed to retain the benefit of any
financial

assistance and, as provided below, the borrower does not have to be
allowed

to retain all sales proceeds. The borrower also may be required to sell
to

the holder of an option or right of refusal designed to continue the

property as affordable housing.

The prohibition against terminating the borrower\'s interest means that

the borrower must have fee simple absolute title instead of title that
is

dependent on subsequent events such as fee simple determinable or fee

simple subject to a condition or a limitation. For example, a program in

which the borrower may lose title if the borrower fails to occupy the

property for a specified number of years is not allowed. One exception

permits such an arrangement for a Section 203(k) rehabilitation loan as

long as the other holder of interests in title also executes the
mortgage.

An affordable housing program must be designed to serve borrowers with

a household income not to exceed 115% of the median area income, unless
the

local HUD Office with the concurrence of HUD Headquarters has approved a

higher income in writing (not to exceed 140% of the median area income).

Currently, the only area with an approved higher income limit is Hawaii,

with a limit of 140%.

SPECIFIC RESTRICTIONS ALLOWED FOR AFFORDABLE HOUSING

HUD\'s regulation permits a variety of types of restrictions including

limits to the resale price of the property or recaptures of equity. A

maximum sales price may be imposed or the sales proceeds due the
borrower

may be limited (with any excess payable to a governmental body or
nonprofit

organization for reuse in an affordable housing program). In either
case,

when the homeowner sells the property, he or she must be permitted to

recover at least the original purchase price, sales commission, cost of

capital improvements, and any accrued negative amortization if the
property

was financed with a graduated payment mortgage. In addition, homeowners

must be permitted to recover a reasonable amount of appreciation as

determined by HUD. Appreciation is measured by the difference between
the

original purchase price and the actual price at which the property is

resold. If the program permits the homeowners to sell the property at

market value but recaptures part of the equity, HUD considers a
reasonable

share of appreciation to be at least 50 percent. HUD does not object to

affordable housing schemes whereby the homeowner\'s share of
appreciation is

on a sliding scale beginning at zero, provided that within 2 years the

homeowner would be permitted to retain 50 percent of the appreciation.

If the program sets a maximum sales price restriction, the borrower must

be permitted to retain 100 percent of the appreciation. The Department

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recognizes that other arrangements for sharing appreciation may be

acceptable. HUD Field Offices may determine the reasonableness of the

appreciation share in local programs without specific written approval

from HUD Headquarters.

One method commonly used to ensure that housing remains part of an

affordable housing program is for the program sponsor or administrator
to

hold a right of first refusal or an option right that can be exercised
when

the borrower proposes to sell the home to a purchaser not eligible for
the

program benefits. This is permitted by HUD policy if: (a) the rights are

held only by a governmental body or eligible nonprofit organization and

exercised by them or someone they have identified as an eligible
purchaser,

\(b\) any right is exercised within 45 days after the holder of these
rights

may exercise them (for example, the rights are often triggered by a
notice

of sale from the borrower), and (c) any option price allows the borrower
to

recover his or her investment plus a reasonable share of appreciation as

explained above. The rule permits HUD Headquarters to approve option

rights to be held and exercised by another person or entity on a

case-by-case basis.

Other permissible restrictions for affordable housing programs are

described in the rule. Restrictions that are not described in the rule

are not allowed, unless HUD approved the restriction in writing before
the

rule took effect.

EFFECT OF PREVIOUS APPROVAL

Previous written approval of restrictions is not affected by the new

rule as long as the approval is restricted to property that was

identifiable at the time of approval. Endorsement of a mortgage for

insurance does not constitute written approval of restrictions
applicable

to the mortgaged property. Thus, a letter from the jurisdictional HUD

Office approving restrictions intended for a particular community,

neighborhood, subdivision or condominium project can still be relied
upon

by a lender even if the restrictions do not conform to the new rule. The

restrictions cannot be applied to a different location unless they are

modified to conform to the new rule. If restrictions were approved
without

a specific property identified, the approval will not excuse the lender

from compliance with the new rule.

RELATIONSHIP TO OTHER FEDERAL PROGRAMS

Restrictions are required by some other Federal programs, such as the

Homeownership and Opportunity for People Everywhere (HOPE) and HOME

programs and the Affordable Housing Disposition Programs of the
Resolution

Trust Corporation (RTC) and the Federal Deposit Insurance Corporation

(FDIC). Because the policies stated in the rule are designed to protect

the financial interests of the FHA insurance funds, there may be some

instances when restrictions designed to carry out the purposes of a
Federal

affordable housing program conflict with the rule. The rule recognizes

some conflict with HOPE and HOME requirements in areas such as rights of

first refusal, and

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HUD will attempt to apply its rule to minimize any conflict between

programs, including consideration of requests for appropriate rule

waivers.

The RTC has developed a model land use restriction agreement for

lower-income households (LURA, form no. SFLURA-1 Version 2.0) containing

restriction on conveyance which has been approved by HUD Headquarters.

This model LURA may be used in connection with the RTC Affordable
Housing

Disposition Program and may serve as a model for other state and local

affordable housing programs. However, lenders, HUD Field Offices and

program sponsors are cautioned that the language in the RTC SFLURA-3 and

the CONDOLURA and other restriction agreements issued by the RTC prior
to

the SFLURA-1 do not have HUD approval. Restrictions contained in

documents other than the SFLURA-1 must be reviewed for compliance with
HUD

requirements.

The FDIC also has developed deed recapture language (revised 6-18-93)

for its Affordable Housing Program which has been approved by HUD.

RESTRICTIONS SHOULD BE UNDERSTANDABLE

The Departmental policy is to discourage restrictions that are not

simply stated and understandable to the typical homebuyer. Sometimes

restrictions must be contained in complex legal documents. If it is not

feasible to simplify the legal documents, a simplified explanation or

disclosure of applicable restrictions should be provided to the
borrower.

This is particularly important when the restrictions are contained in

complex legal documents originally drafted to apply to the owner of a

multifamily property such as a condominium developer. A simplified

explanation helps the lender determine whether the required
certification

of compliance with regulations can be made.

DE CERTIFICATION

The lender will be responsible for determining that the property is

free of restrictions except as permitted by the rule. The following

certification is added to the list of Direct Endorsement (DE)

certifications in Appendix 4 of Handbook 4000.4 Rev. 1, Chg. 1:

(5A) The property is free of legal restrictions on conveyance

as required by 24 CFR 203.41, 203.512 or 234.66, except

for restrictions specifically permitted by those regulations.

This certification will be in effect for all mortgages executed on or

after 30 days from the date of this Mortgagee Letter.

The Department recognizes that restrictions relating to affordable

housing programs are often complex and that it may be difficult for
lenders

to determine whether

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the programs comply with HUD policies. The Department also recognizes
that

governmental or nonprofit program sponsors may develop the restrictions

before specific lenders are identified. The Field Offices will assist

lenders and program sponsors in determining whether proposed
restrictions

are acceptable. Field Offices are not responsible for approving specific

restrictions or for determining whether they will be enforceable under

applicable law. Unusual or difficult questions should not be submitted

directly to HUD Headquarters by lenders or program sponsors, but Field

Offices may seek the assistance of the Office of Insured Single Family

Housing, Mortgage Credit Branch at 202-708-2700 regarding policy matters

or the Office of General Counsel, Home Mortgage Division at 202-708-1272

regarding legal matters.

Lenders that are working with the sponsors of affordable housing

programs should make sure that the sponsors have a copy of the rule and

this Mortgagee Letter.

III\. LEASE TERMINATION

Any lease must meet the requirements of Handbook 4010.1 Chg 10,

paragraph 3-1 (September 10, 1981) and 4150.1 Rev-1, paragraph 6-32, as

well as the new rule. The handbooks require a lease to provide the
lender

a right to correct lessee (borrower) defaults upon receipt of a notice
of

intent to terminate the lease. In order for this lender\'s right to be

meaningful, a lease should not be terminable due to a violation the
lender

cannot correct.

The handbooks and the rule should be interpreted together. The rule

will prohibit restrictions that could result in lease termination if the

restrictions are violated. For example, the lessor should not be able to

terminate a lease if the lessee/borrower fails to continue to occupy a

property. Such a termination provision would violate the handbook
because

the lender could not correct the violation, and it would violate the
rule

because even occupancy requirements generally permitted for affordable

housing programs cannot be the basis for terminating the borrower\'s

interest in the property.

Ordinarily, lease terminations unrelated to affordable housing

restrictions and correctable by the lender, such as termination for

nonpayment of rent, are permitted and are not affected by the rule. The

Department does not intend to prevent affordable housing programs such
as

community land trusts that depend on ground leases, but standard
documents

for such programs should be reviewed carefully for compliance with the
rule

and modified as needed.

IV\. CONDOMINIUM POLICIES

A. Rights of First Refusal. Previous HUD policy allowed HUD to

approve an existing condominium project with a right of first

refusal held by the condominium association. The rule changes

this policy. Condominiums

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approved by HUD Offices before the rule took effect are not

affected by the change in policy. HUD offices will refuse a new

request for approval for a project with rights of right refusal

if a condominium association holds the rights; other right of

first refusal arrangements are acceptable only as permitted for

affordable housing programs.

B. Leases of Less than 6 Months. Restrictions on leasing generally

are allowed only to the extent that the rule allows restrictions

on sale. HUD will continue to approve condominium projects which

restrict leases to six months or longer, and such HUD-approved

restrictions will not be considered restrictions in violation of

the rule.

If you have questions concerning this Mortgagee Letter, please contact

the Mortgage Credit Branch at your local HUD Field Office.

Sincerely yours,

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Nicolas P. Retsinas

Assistant Secretary for Housing

\- Federal Housing Commissioner