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Financing Energy Efficiency: An EEM Handbook


Mortgagee Letter 95-40


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) inspections.

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 down payment 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 maximum 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 balance.

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 home buyer, that buyer can assume the property without a down payment.

(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.


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 down payment. 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.


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 authority;
  3. an outline of current and future housing objectives;
  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 home buyers, 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 credit worthiness:

  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 write-up 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 


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.


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