www.hudclips.org 


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  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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                                   3
 
     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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                                   4
 
     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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                                   5
 
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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                                   6
 
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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                                   7
 
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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                                   8
 
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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                                   9
 
          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,
 

Nicolas P. Retsinas
Assistant Secretary for Housing
- Federal Housing Commissioner