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

Washington, D.C. 20410-8000

July 26, 2000

OFFICE OF THE ASSISTANT SECRETARY

FOR HOUSING-FEDERAL HOUSING COMMISSIONER

> **MORTGAGEE LETTER** 00-25

**TO:** ALL APPROVED MORTGAGEES

ALL 203(k) CONSULTANTS

**SUBJECT:** 203(K) Rehabilitation Mortgage Program- Single Family Loan
Production

This Mortgagee Letter announces changes to the 203(k) procedures
relating to mortgagee responsibilities, 203(k) consultant requirements,
and loan processing. Mortgagees must assure that they adhere to
requirements contained under the heading \"Responsibilities of the
Mortgagee.\" In addition, both current and prospective 203(k)
consultants will be evaluated pursuant to the standards and procedures
set forth in this Mortgagee Letter. Unless otherwise stated, the
procedures described in this Mortgage Letter and attachments are
effective on August 21, 2000, and apply to all 203(k) loans using case
numbers ordered on or after that date.

**[INFORMATION FOR CURRENT AND PROSPECTIVE 203(k)
CONSULTANTS]{.underline}**

Individuals who want to participate as 203(k) consultants must follow
FHA\'s new uniform standards for participation in the 203(k)
Rehabilitation Mortgage Insurance Program. [All current 203(k)
consultants must re-apply for placement on the FHA 203(k) Consultant
Roster (described below) by submitting application materials to an FHA
Homeownership Center (HOC). If an application package is not received
within 60 days from the date of this Mortgagee Letter, the consultant\'s
name will be removed from the Roster. Only those consultants listed on
this Roster may participate in the 203(k) program]{.underline}. Going
forward, prospective consultants can review the instructions listed
below and apply for placement on this list at any time.

**FHA 203(k) Consultant Roster**

FHA has established an FHA 203(k) Consultant Roster for individuals who
meet the criteria set forth below. FHA will initially populate this
203(k) Consultant Roster with those consultants who currently are listed
on the Homeownership Center (HOC) websites. The website for this FHA
203(k) Consultant Roster is located at the address listed below under
the \"Work Online\" Section.

> [http://www.hud.gov/lendersl.html]{.underline}

2

Those consultants who do not return application packages within 60 days
from the date of this Mortgagee Letter will have their names removed
from the FHA 203(k) Consultant Roster. Individuals who meet the criteria
will be assigned identification numbers and will be listed on the FHA
203(k) Consultant Roster. The application process is fully described
below. The duties and responsibilities of 203(k) consultants are fully
explained in Mortgagee Letter 95-40.

**Application Process**

To apply for placement on the FHA 203(k) Consultant Roster, an applicant
must submit the information listed below to the HOC in the area in which
he/she will be conducting business. Placement on the roster by one HOC
will be recognized by all HOCs. However, the 203(k) consultant must
notify the HOC if his/her primary location of business changes.

The application information should be submitted in the following format.
A list or resume documenting:

-   A minimum of three years experience as a remodeling contractor,
    general contractor or home inspector. A state license as a state
    certified engineer or architect may be submitted in lieu of the
    documentation of the three years experience;

-   Education;

-   Licensing (general contractor, home inspector, etc.). In those
    states where a Home Inspector is required to be licensed, the
    Department requires the applicant to be licensed and to provide
    proof of that licensing;

-   A narrative description of the current/prospective consultant\'s
    ability to perform home inspections, prepare architectural drawings,
    use proper methods of cost estimating and complete draw inspections;
    and,

-   The applicant must also submit a certification verifying that the
    consultant has read and fully understands the requirements of HUD
    Handbook 4240.4, REV 2 (203(k) Handbook) and all related materials
    listed in Attachment 1 of this Mortgagee Letter.

**Future Program Enhancement**

To further evaluate the 203(k) consultant\'s program knowledge, the
Department will soon develop a formal examination process similar to the
test FHA appraisers must now complete. The Department will issue
additional guidance about this examination in the near future.

[Information Collection Requirements]{.underline}

The information collection requirements referred to in this Mortgagee
Letter have been approved by the Office of Management and Budget (OMB)
under the Paperwork Reduction Act of 1995 (44 U.S.C. Chapter 35). The
OMB number issued for this requirement is OMB 2502-0527.

3

[Incomplete Application Packages]{.underline}

An individual who submits an incomplete application package (defined
above in the section entitled \"application process\") will receive a
letter indicating the information required to cure the deficiency. This
letter will give the individual 15 days to correct any deficiencies. If
the response does not satisfy the outstanding requirement in its
entirety and within the prescribed deadline, the individual must wait an
additional 90 days prior to re-applying.

[Application Approval or Denial]{.underline}

FHA will approve or deny the consultant\'s application to be listed on
the FHA 203(k) Consultant Roster, based upon the information submitted.
Inclusion of a consultant on the list means only that the consultant has
met the qualifications prescribed by FHA for placement on the Roster; it
does not create or imply a warranty or endorsement by FHA of the
consultant, nor does it represent a warranty of any work performed by
the consultant. If a consultant already on the Roster is found to not be
in compliance with requirements of the 203(k) program, the consultant
may be removed from the roster.

[Participation Letters and Consultant Identification
Numbers]{.underline}

Each applicant who meets the 203 (k) program requirements will be issued
a participation letter. This letter will contain the consultant\'s name,
business address and a consultant identification number. This number
will be needed by the consultant prior to doing any work associated with
any 203(k) loan. This consultant identification number will be used to
assist the Department in evaluating the work of consultants. Mortgagees
must enter the consultant\'s identification number on the insurance
application screen and will not be able to process 203(k) cases without
it.

Each consultant will be provided with only one participation letter.
After the letter is mailed, mortgagees, consultants and others can
verify that the consultant has been placed on the FHA Connection. The
website for this information is located at the address listed below
under the \"Work Online\" Section.

> [http://www.hud.gov/lendersl.html]{.underline}
>
> **Monitoring and Reporting Process**

FHA will perform periodic field reviews of the work performed by 203(k)
consultants. The purpose of these reviews is to ensure compliance with
FHA requirements. These reviews shall include, but not be limited to,
the cost write-up and the adequacy of the scope of work. 203(k)
consultants must provide any applicable information requested by
monitors to assist them in properly evaluating the work performed.

4

**[RESPONSIBILITIES OF THE MORTGAGEE]{.underline}**

**Mortgagees Select 203(k) Consultants from the FHA 203(k) Consultant
Roster**

Mortgagees now have the sole responsibility to select 203(k) consultants
when processing a mortgage loan application under the 203(k) Program. A
consultant must be selected from the FHA 203(k) Consultant Roster. The
cost attributed to architectural and construction engineering activities
will continue to be included in the rehabilitation cost. The mortgagee
selection of the consultant does not affect the scope of the
consultant\'s services, as described in Mortgagee Letter 95-40, but does
permit the mortgagee to exercise greater control over those services.
The Department believes that vesting full authority with mortgagees in
selecting consultants will allow the Department to hold mortgagees and
203(k) consultants fully accountable for the loan proceeds and thus
reduce the incidence of deficient work write-ups, incorrect cost
estimates and improper progress payments.

**Entering Consultant Identification Number into the FHA** **Connection
on the Insurance Application Screen**

Mortgagees will be required to enter the consultant identification
number into the FHA Connection during case number assignment; failure to
provide it will result a \'fatal error\' and preclude further
processing. The FHA Connection will automatically cross reference this
identification number entered with the national database that resides in
CHUMS of all 203(k) consultants listed on the FHA 203(k) Consultant
Roster.

**Authorizing Inspections and Draws**

Mortgagees are fully responsible for authorizing draw inspections,
managing the rehabilitation escrow account, and approving the associated
draws from the account. Consultants selected from the FHA 203(k)
Consultant Roster may perform the inspections on the mortgagee\'s
behalf, but it remains the mortgagee\'s responsibility to assure that
the inspections are completed in a quality manner and in a timely
fashion.

**Monitoring and Evaluating Quality of Services**

Mortgagees must exercise due diligence with regard to the full scope of
the 203(k) consultant\'s services. Standards for the 203(k)
consultant\'s performance must be clearly defined in the mortgagee\'s
Quality Control Plan and should be provided to each consultant that the
mortgagee relies on in the 203(k) program. Mortgagees must evaluate and
document the performance of these consultants on at least an annual
basis, to include a review of the consultant\'s actual work product.

5

Mortgagees must not use the services of consultants who have
demonstrated previous poor performance. Mortgagees are responsible for
resolving disagreements between borrowers, contractors and consultants.
Fraud or malfeasance should be documented and reported to the Department
for possible administrative action.

**[ADDITIONAL 203(k) PROGRAM CHANGES AND CLARIFICATIONS]{.underline}**

**Automated Processing of 203(k) Close-outs**

Effective August 21, 2000, the Department will require electronic
certification of closeout of 203(k) cases. The mortgagee will enter
information onto the 203(k) Close-out screen on the FHA Connection and
thereby certify, electronically, that the 203(k) loan has been properly
closed out. Mortgagees are responsible for making sure that the loan
packages are complete at close-out certification and must [still submit
the actual case binder to the HOC]{.underline}. Proper close-out means
that the mortgagee will certify that they have reviewed and verified for
accuracy the following documents without limitations: final release
notice, mortgagor\'s letter of completion, title update/lien waiver,
draw request forms (interim and final), rehabilitation inspection
reports, the lender accounting of the 203(k) rehabilitation funds,
change orders, payment ledgers, extensions for completion and
contingency release letters.

The Department will track close-out timeliness and accuracy and this
process will be reviewed during the Department\'s monitoring activities.
[Failure to **properly** close out 203(k) cases will result in the
lender being placed on pre-closing test case status for 203(k)
loans]{.underline}.

**Determining Eligible Work Items**

Although the minimum amount of improvements to be eligible for a 203(k)
loan remains at \$5,000, this threshold is no longer limited by the
eligible improvements outlined in HUD Handbook 4240.2, REV-2, Section
1.7. Luxury items and improvements that do not become a permanent part
of the real property are still [not eligible]{.underline} as a cost
rehabilitation. However, the homeowner can now use the 203(k) program to
finance such items as painting, room additions, decks and other items
even if the home does not need any other improvements. All health,
safety and energy conservation items must be addressed prior to
completing general home improvements. The work write-up must demonstrate
that, when the rehabilitation is completed, the property will meet
HUD\'s minimum property standards. Mortgagees are reminded that the
Department is particularly concerned about the value of property after
the improvements are completed. To assure that the mortgage is
adequately supported by the property value, the maximum 203(k) mortgage
amount must be based on the LESSER of the: \"as-is\" value plus the cost
of repairs (and improvements), or if an \"as-is\" appraisal is not
performed, the contract sales price on a purchase transaction plus the
repairs costs, or the existing debt on a refinance plus the repair
costs, or 110 percent of the \"after improved\" value.

6

**Processing Streamline Refinances of 203(k) Loans to 203(b) Loans**

No streamline refinance of a 203(k) can occur until the work is
complete. \"Complete\" means that the rehabilitation work is finished as
documented by a fully executed certificate of completion and that the
Rehabilitation Escrow Account has been closed with a Final Release AND
that the loan has been properly closed out and this transaction has been
certified electronically, as previously described. The new mortgage will
be subject to the appropriate insurance premium applicable to a new
Section 203(b) mortgage.

**Clarification on Chain of Title Requirement**

Mortgagee Letter 95-40 states the Direct Endorsement lender must obtain
evidence of prior ownership when a property was sold in the last year
and that prior ownership must be reviewed for undisclosed identity of
interest transactions. Lenders are reminded that this is a continuing
requirement and applies to **all** transactions. The 203(k) mortgage
must be based on the lowest sales price in the last year.

**Clarification on the Acceptance of Contractors**

Mortgagee Letter 98-11 required mortgagees to \"approve\" contractors
prior to closing and numerous questions have surfaced regarding the
intent of this requirement. The Department does not expect mortgagees to
actually approve contractors, but rather assure that an \"acceptable\"
general contractor (or specialized contractor) has been hired and by
contract agrees to complete the work described in the work write-up for
the amount of the cost estimate and within the allotted time frame. The
mortgagee must review the following items pursuant to the proposed
contractor: credentials, work experience, licensing information, type of
work performed, experience, and client references. Also, it is
**required** that borrowers and contractors complete an agreement that
outlines the rights and responsibilities of each party. Attachment 3 of
this Mortgagee Letter contains a sample Homeowner/Contractor agreement.
It is suggested that all agreements contain a provision for binding
arbitration or mediation for unresolved contract disputes.

**Approving Borrowers as General Contractors**

While not prohibited, the Department urges mortgagees to exercise
extreme caution in approving 203(k) loan applications where the borrower
wants to act as the General Contractor. Only in those cases where the
mortgagee has verified that the borrower **is** a general contractor or
can document experience in completing rehabilitation projects, may it
approve \'self-help\" arrangements. As a reminder, the borrower must
also understand that they will get paid only for materials **and not**
for their labor ("sweat equity\") on work that they perform. The
mortgagee also must make sure that the borrower understands the 203(k)
program at the construction stage and the risks inherent in
rehabilitation projects. It is recommended that the borrower sign a
Self-Help Agreement. A sample of this agreement can be found in
Attachment 3 of

7

Mortgagee Letter. In the case of a \"self-help\" arrangement, the
mortgagee should make sure that the work write-up clearly states the
cost of labor and of materials for the work items. The borrower should
maintain records documenting actual costs and lien waivers in the same
way that a General Contractor would.

**Completing Form HUD-92564-VC (Valuation Conditions)**

FHA appraisers are **not required** to complete Form HUD-92564-VC (VC
Form) when determining the \'after-improved\' value of a property
financed with a 203(k) Rehabilitation Mortgage loan because the
appraiser is relying on the 203(k) consultant\'s work write-up. However,
in preparing the valuation, the appraiser must inform lenders of any FHA
Minimum Property Requirements that the proposed scope of the repair work
(work write-up) does not address and it *may* be prudent to report this
finding on the VC Form. Using the VC Form will necessitate additional
disclosure requirements to the homebuyer. The work write-up should be
reviewed and modified by the consultant to include those additional
items noted by the appraiser.

**Verification of Proper Disbursement of Loan Proceeds**

The Department is concerned about proper disbursement of loan proceeds.
Therefore, lenders must take the following actions to assure that this
occurs. Lenders are responsible for ensuring that loan proceeds are
disbursed in the proper amount to the borrower and the seller, or in the
case of a refinance transaction, to the debt holder. The originating
lender will be required to verify the borrower\'s debts to be refinanced
to assure they were not incurred for the purpose of providing cash to
the borrower. The Department is concerned about increased insurance
risks from refinance schemes in which the borrower obtains cash from a
loan on a property, uses the cash for purposes other than property
improvements, and a short period later refinances the debt with a 203(k)
loan.

*During the rehabilitation phase,* lenders must verify that loan
proceeds from draw inspections are correctly disbursed to the proper
borrower and/or contractor (or subcontractors) to avoid mechanic liens
on the property.

**Identity of Interest Issues**

The Department wants assurance that there are no identity of interest
issues between parties participating in the 203(k) transaction.
Therefore, effective 60 days from the date of this Mortgagee Letter,
borrowers and consultants must sign certifications for all loans with
mortgage credit applications signed on or after this date. These
certifications must be placed in the case binder The required language
is listed below:

8

**Borrower\'s Identity-of-Interest Certification.** The borrower must
sign a certification stating the following:

> \"I hereby certify to the Department of Housing and Urban Development
> (HUD) and (lender), that I/We do not have an identity-of-interest with
> the seller of the property. I also Certify that I/We do not have a
> conflict-of-interest with any other party to the transaction,
> including the realtor, lender, contractor, consultant and/or the
> appraiser. In addition, I certify that I am not obtaining any source
> of funds or acting as a \"strawbuyer\" for another individual,
> partnership, company or investment club and I/We
> \_\_\_\_\_\_\_will/will not\_\_\_\_\_\_\_ occupy the residence I/We
> are purchasing or refinancing.\"
>
> ***Warning: HUD will prosecute false claims and statements. Conviction
> may result in criminal and/or civil penalties. (18 U.S.C. 1001, 1010,
> 1012; 31 U.S.C. 3729, 3802).***

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_
\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

> **Borrower\'s Signature Date**

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_
\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

> **Co-borrower\'s Signature Date**

**Consultant\'s Identity-of-Interest Certification.** All consultants
and plan reviewers are required to sign the following certification
after preparing/reviewing the work write-up and cost estimate, stating:

> \"I hereby certify that I have carefully inspected this property for
> compliance with the general acceptability requirements (including
> health and safety) in Handbook 4905.1. I have required as necessary
> and reviewed the architectural exhibits, including any applicable
> engineering and termite reports, and the estimated rehabilitation cost
> and they are acceptable for the rehabilitation of this property. I
> have no personal interest, present or prospective, in the property,
> applicant, or proceeds of the mortgage. I also certify that I have no
> identity-of-interest or conflict-of-interest with the borrower,
> seller, lender, realtor, appraiser, plan reviewer, contractor or
> subcontractor. To the best of my knowledge, I have reported all items
> requiring correction and that the rehabilitation proposal now meets
> all HUD requirements for 203(k) Rehabilitation Mortgage Insurance.\"
>
> ***Warning: HUD will prosecute false claims and statements. Conviction
> may result in criminal and/or civil penalties. (18 U.S.C 1001, 1010,
> 1012; 31 U.S.C 3729, 3802).***

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_
\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

> Consultant/Plan Reviewer\'s Signature Date

9

**REVISED 203(k) MAXIMUM MORTGAGE WORKSHEET**

The 203(k) Maximum Mortgage Worksheet (HUD-92700) was last revised in
February of 1999 to accommodate the required 3% investment by the
borrower. The revised worksheet is attached to this Mortgagee Letter as
Attachment 5 or can be downloaded electronically from HUD\'s website at:
http://www.hudclips.org. A description of the changes to the Maximum
Mortgage Worksheet can be found in Attachment 6 of this Mortgagee
Letter.

Questions regarding this Mortgagee Letter should be directed to the FHA
Homeownership Centers in Atlanta (1-888-696-4687), Denver
(1-800-543-9378), Philadelphia (1-800-440-8647) and Santa Ana
(1-888-827-5605).

Sincerely,

William C. Apgar

> Assistant Secretary for Housing-
>
> Federal Housing Commissioner

Attachments:

Attachment 1: Sample Certification form for 203(k) Consultant Approval

Attachment 2: Sample Homeowner/Contractor Agreement

Attachment 3: Sample Rehabilitation (Self-Help) Loan Agreement

Attachment 4: Revised 203(k) Maximum Mortgage Worksheet

Attachment 5: Detailed information on the Revised 203(k) Maximum
Mortgage Worksheet