9.1

OVERVIEW

As a result of unique logistical and market conditions which exist in remote rural Alaska communities, the Alaska Office of Native American Programs has developed this chapter in the Section 184 Indian Housing Loan Guarantee Program Guidebook for use by lenders in originating new construction mortgage financing. Most mortgage financing plans provide only permanent financing. That is, the lender will not usually close the loan and release the mortgage proceeds unless the condition and the value of the property provide adequate loan security. When new construction is involved, this means that a lender typically requires the construction to be complete before a long-term mortgage is made.

When a borrower wants to have a new house constructed, the borrower usually has to obtain financing to construct the new dwelling, referred as an interim loan, and a permanent mortgage when the work is complete to pay off the interim loan. Often interim financing for new construction has been difficult to obtain and is a major requisite in the delivery system for new housing in rural Alaska communities.

The Section 184 Program was designed to address this situation. Only one closing is used in the Section 184 Program. In the case of a loan that includes new construction, an estimate of construction costs, including a contingency allowance, is included in the loan. At the time of loan closing the amount allocated for construction is placed in an escrow account. The escrow account may also include funds to cover up to six mortgage payments (PITI) to assist the borrower in making monthly payments during the construction period. The construction period is generally limited to nine (9) months but a three (3) month extension may be granted.

Lenders may elect to offer separate construction and permanent loans. However, under this election, only the permanent loan would be guaranteed under Section 184. In such cases, the loan is treated as an acquisition of an existing structure after construction has been completed. Lenders may request a commitment for the borrower, prior to making the construction loan.

The permanent loan guarantee will be honored by HUD in all circumstances. Disqualification of lenders for failure to comply with requirements is addressed in Chapter 3.

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9.2

LOAN TERMS AND REQUIREMENTS

1. Firm Commitment Requirements. For approval of a loan guarantee prior to the construction period, additional documents must be submitted by the lender in addition to those specified in the processing guidelines, Paragraph 5.23c, as listed below:
1. Construction Loan Agreement — This agreement is between the lender and borrower and specifies the terms during the construction period.
2. Construction Loan Rider — This document amends the mortgagee’s Deed of Trust or Security Deed between borrower and lender which further covenant the terms of the loan.
3. Approved Builder — Name of the builder as approved by the lender. Owner/Builders are not prohibited, but it is recommended that the work be performed by a general contractor registered to work as a contractor under Alaska Statutes (AS 08.18) with experience, qualifications and a track record of similar work.
4. Architectural Exhibits — The borrower may decide to employ an architect or design consultant to prepare the proposed construction documents. The borrower must provide the lender with documents, which clearly describe the scope of work and construction schedule. The following list of exhibits are recommended:
1. Plot Plan of the Site — Shows the location of the structure with setbacks, driveways, water/sewer lines and other relevant detail. Shows the flood elevation.
2. Plans and Specifications — Shows elevations, floor plan and sufficient details of materials and finishes to direct the work. All work must be in accordance with local building codes, as applicable.
3. Schedule of Amounts for Contract Payments, form HUD-51000. Shows construction loan breakdown by the contractor in sufficient detail to guide construction drawdowns by the borrower. It may be convenient to use columns (1) Item Number and (2) Description of Item in the Period Estimate for Partial Payment, form HUD-50001 or draw request form (Appendix 4) which would be the basis for construction draws. It is important that the lender analyze the breakdown in order to avoid "front loading" of draws. (In some instances, lender may request supporting bids from subcontractors and suppliers.)
4. Construction Progress Schedule — Contractor’s planned construction schedule to cover the period of time from the starting date stipulated in the contract through the date of actual contract completion. The schedule may be computer or manual generated as long as the information is realistic and accurate in a format providing acceptable data. The lender may compare the schedule with periodic Compliance Inspection Reports to monitor progress. If the lender finds, as the work progresses, that there is or has been a slowdown of construction, he/she shall discuss the matter with the borrower and request that the borrower cause the contractor to correct the undesirable condition and, if possible, to recover the lost time.
5. Homeowner/Contractor Agreement — Is between the borrower and the contractor (optional) and specifies the terms of the construction contract and incorporating the architectural exhibits into the contract. At a minimum, the Agreement should (1) describe the work to be performed; (2) state when work will start and finish; (3) state the total amount to be paid to the contractor and terms of payment; (4) provide provision for binding arbitration on any disputes; and (5) provide a one year warranty on all work completed by the contractor. If the lender has determined the borrower has sufficient experience to do the work or act as the general contractor, the lender should obtain a Self-Help Agreement from the borrower.
2. Timing. Loan closing must occur after the receipt of a Firm Commitment and prior to the start of construction. Lenders who close the loan or allow construction to begin before receipt of the Firm Commitment, run the risk that errors could be found in the underwriting criteria and the loan would be rejected. Any funds spent on the rejected loan would not be guaranteed.
3. Interest rate. The interest rate on the loan must be a fixed rate for the term of the loan. Since the loan is fully guaranteed, the rate should reflect market rates for permanent, rather than construction financing.
4. Compliance. Secondary mortgage lenders (investors) are encouraged to be bonded, and require lenders who hold the construction escrow account to be bonded to ensure compliance with their responsibility to borrowers.
5. Valuation. Appraisal procedures will comply with industry standards by using the HUD Uniform Residential Appraisal Report (URAR) format. The market data approach to value estimation should be used where practicable. Generally, comparable sales should be closed within the last 12 months preceding the date of the appraisal, and should be within the community of the subject property. In some rural areas of the state where there is a very low inventory of housing, older sales may be used if adequately explained. When adequate market data is not available, the cost approach will be used and supported by the Marshall and Swift Handbook or other acceptable source with comments provided to explain all adjustments. For new construction, the appraisal is made from a complete set of plans and specifications, which will be incorporated into the loan as part of the Architectural Exhibits and must provide a supported and defensible estimate of value.
6. Owner/Builder wages are not an eligible construction expense. A borrower may act as his/her own general contractor; however, he/she cannot be compensated for labor. The borrower could not act as the actual trades contractor unless he/she is skilled in that area.
7. Building on own land. A homebuyer can use equity, which they have created in the past, i.e., built foundation or the on-site infrastructure, if the appraisal supports its value. If the borrower is acting as a general contractor or is having a house built on land already owned or being acquired separately, maximum financing is available if the borrower receives no cash from the settlement. (The lender must condition its approval to assure cash is not received at closing.) The appropriate loan-to-value limits are applied to the lesser of:
1. The appraised value; or
2. The acquisition cost of the property, which includes:
   1. The builder’s price or the sum of all subcontractors’ bids, materials, etc.
   2. Cost of land. If the land was owned more than six months or was received as an acceptable gift, the value may be used instead of its cost.
   3. Lender fees and other costs associated with any construction loan obtained by the borrower to fund construction of the property.
   4. Allowable closing costs.

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9.3

COSTS ELIGIBLE FOR INCLUSION IN MORTGAGE

1. Closing Costs. Allowable closing costs to be paid by the borrower must be typical, reasonable and customary for the area (as determined by HUD) and may include:
   1. Appraisal fee.
   2. Deposit verification fees.
   3. Document Preparation (if prepared by a third party not controlled by the lender).
   4. Test Certification Fees (water or environmental tests).
   5. Settlement fees.
   6. Cost of title examination and title insurance.
   7. Consultant fees to prepare architectural exhibits.
   8. Property survey.
   9. Origination fee (1% of the mortgage amount before the guarantee fee).
   10. Recording fees.
   11. Attorney fees (if the attorney is not an employee of the mortgagee).
   12. Credit report costs.
   13. Loan Guarantee fee (1 percent of the principal obligation of the loan).
2. Lender Fees. Lenders may charge borrowers for typical, reasonable, and customary fees associated with administering construction. These fees may include charging the borrower for the cost of construction inspections. In addition to the origination fee, the Department will allow lenders to charge an administration fee of up to two (2) percent for loans involving construction advances. These are cost eligible for financing in the mortgage (up to the LTV and the borrower’s debt to income ratio).
3. Contingency Reserve. The construction cost estimate must include a contingency reserve of at least 10 percent (see Paragraph 7.3(b), which is intended to be held for unforeseen circumstances during the construction period. Release of funds shall be made through an approved change order request form, Request for Acceptance of Changes in Approved Drawings and Specifications, form HUD-92577.
1. If the lender believes that a contingency reserve of more than 10 percent is needed, the lender may require the borrower to increase the amount but under no circumstances shall a contingency reserve be more than 20 percent.
2. Provided construction is progressing satisfactorily and on schedule (minimum of 95% complete), funds in the contingency reserve, which are anticipated to be remaining at completion, may be approved by the lender for items other than unforeseen circumstances (i.e., upgrades or improvements). However, lenders should ensure funds are retained in escrow (an amount equal to 1-1/2 times that estimated) for any uncompleted work before authorizing depletion of the contingency reserve.
3. Remaining funds in the contingency reserve at the Final Release Notice stage may be used to reimburse costs to the borrower for change orders, which resulted in an increase in costs where the borrower placed additional monies into the construction escrow account.
4. Unforeseen construction costs in excess of the contingency reserve must be paid by the borrower outside the mortgage agreement.
5. Less than 10 percent contingency may be approved by the Program ONAP on a case-by-case basis provided other risk sharing considerations exist. For example, a construction contract with a contractor who has obtained a materials and performance bond on the work may justify a reduction of the contingency reserve.
4. Mortgage Costs During Construction Period. An allowance for mortgage payments for up to six (6) months (including PITI) can be included in the construction escrow account to enable the borrower to make payments during the construction period.
   1. The mortgage must begin amortization with the first monthly payment, whether or not construction of the property has started.
   2. Mortgage payments may be withdrawn by the lender on a monthly basis.
   3. If the construction period extends beyond six (6) months, the borrower must begin to make mortgage payments from non-escrow funds.
   4. For approved extensions, the borrower must begin to make mortgage payments from non-escrow funds.

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9.4

CONSTRUCTION PERIOD

The construction period begins when the loan is closed. Construction will be limited to nine months; however, an additional three-month extension may be granted by the lender if the borrower and the builder can provide adequate justification for the extension. Such extensions will not affect the term of the mortgage nor can the amount of the mortgage be increased to cover any cost overruns associated with the construction delay. Extension requests should be submitted for approval to the Program ONAP office.

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9.5

ADMINISTRATION DURING CONSTRUCTION

Lenders participating in the program have a fiduciary responsibility to administer new construction activities in a manner, which limits the risks to the Section 184 program. Lenders must use due diligence in assessing the information submitted and satisfy themselves that the construction project as proposed can be met within time and budget constraints.

Due diligence, for this purpose, is defined as compliance with the processing requirements of the Section 184 Indian Loan Guarantee Program, maintaining accurate and appropriate accounting records, and using prudent contract administration judgment. Lenders who do not exhibit due diligence or have not taken active steps to prevent the occurrence of a default may be exempted from further participation in new construction loan activities.

If a builder defaults during the construction period, lenders are expected to work with the borrower and the builder to try to resolve the problems leading to default, rather than choosing the early assignment option. Because mortgage payments due during the construction period are included in the construction escrow account, the builder default should not lead to a borrower payment default, unless the builder’s default extends beyond the period for which mortgage payments have been reserved. Therefore, a lender should assign a Section 184 construction mortgage to HUD only after the borrower fails to make three mortgage payments from his or her own funds. HUD will then be responsible for the foreclosure proceedings.

Upon closing of the loan, the lender shall provide for:

1. Construction Escrow Account. Proceeds designated for construction (including the contingency reserve and the mortgage payment reserve) should be deposited in an interest-bearing account insured by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA). The construction escrow account must be fully funded at loan closing. The interest income earned by the Construction Escrow Account must be paid to the borrower or applied to the unpaid principal loan amount. Payment is subject to agreement between the lender and the borrower.
2. Builder Insurance During Construction. The builder must have builder’s risk insurance in an amount equal to or greater than the total mortgage amount. In addition, the builder must have liability coverage against injury or death to others who may enter onto the job site and workmen’s compensation, which at a minimum will provide liability coverage for any persons working on the job site. Once the improvements have been fully completed or the borrower occupies the property (whichever comes first), the borrower must have in place hazard insurance. If applicable, the borrower must also have flood insurance. When these required policies go into effect, the builder’s risk may be cancelled.
3. Inspections During Construction. All construction inspections, including the final inspection, must be performed by a qualified inspector, who is a disinterested third party and cannot be personally or financially related to the builder, borrower or other interested party, as approved by the lender. Local Indian Housing Authority (IHA) staff may do construction inspections if they are qualified and acceptable to the lender, except when the lHA is the borrower.

Construction inspection fees are considered a construction cost and should be paid from the borrower’s loan funds by the lender and included as part of the total price of the home.

Due to high transportation costs for on-site inspections in remote locations, 60 percent of the inspections (excluding the final inspection), may be completed by video, including narrative in the format approved by the lender to ensure adequate coverage of the work completed. The video should be taken by a disinterested third party and must be fully representative of all work performed for which the purpose of the inspection is being conducted.

Improvements must be satisfactorily completed in compliance with industry standards to the satisfaction of the inspector. Any deficiencies must be expeditiously corrected and noted in the subsequent report. The inspector must confirm the percentage of completion in accordance with the approved architectural exhibits. When acceptable, the inspector completes a Compliance Inspection Report, Form HUD-92051 and sends it to the lender for review.

The lender may determine that additional compliance inspections are required throughout the construction period to ensure that the work is progressing in a satisfactory manner.

4. Release of Funds from the Construction Escrow Account. The lender may not release funds from the Construction Escrow Account until the lender has received a Compliance Inspection Report, form HUD-92051, and the draw request form, Periodic Estimate for Partial Payment, form HUD-51001, certifying that the work has been completed in compliance with the accepted plans, specifications and architectural exhibits. Allowable fees paid by the borrower or on the borrower’s behalf may be reimbursed provided they are listed and documented. Under no circumstances is a payment request to be approved for work that is not yet completed, with the exception of a payment for materials and shipping costs. It is the responsibility of the lender to obtain written approval from the borrower before each draw payment is provided to the builder.
1. Materials and Shipping Costs. The lender may disburse payments for building materials or components to be shipped and stored on site provided satisfactory evidence that:
1. The borrower has acquired title to the material as necessary to perfect the lender’s lien;
2. Prior to shipment, the material is stored and protected from weather in a bonded-storage yard or other suitable place as may be approved by the lender;
3. The material is insured to cover its full value; and
4. The material will be used for this contract.

Before any progress payment, the lender shall obtain such documentation as required to assure the protection of the borrower’s interest in such materials. A progress payment may be made for up to 90 percent of the invoiced building materials value, including shipping costs. For approval, lenders must attach original invoices to a listing of the materials on the Schedule of Materials Stored, form HUD-51003 which corresponds to the arrangement established on the Schedule of Contract Payments, Form HUD-51000. Also, required documentation must include a Bill of Lading verifying that the materials have been accepted by the shipping agent, proof that transportation or marine insurance is sufficient to cover any loss materials in transit and execution of a Security Agreement and UCC-1 as necessary to perfect the lender’s lien.

The lender must require an acknowledgement of payment and releases of liens from the contractor, all subcontractors and suppliers. The first deed of trust on the property may serve as security on the materials. Only if the subject property is not available to use as collateral may other real or personal property be considered for use as collateral. The remaining 10 percent may be paid upon arrival of materials, once inventoried on-site. Borrowers are responsible that the materials are sufficiently protected from weather and loss once delivered on-site. Any damage or loss sustained not recoverable through insurance is the responsibility of the borrower.

2. Number of Progress Payments. Generally no more than 10 construction payments should be made, approximately one per month, on the escrow account. The lender or its agent will release escrow funds only upon satisfactory completion of the proposed construction, pursuant to the Loan Agreement.
3. Retain on Draws. A ten percent (10%) holdback is required on each release of construction funds except those approved in advance for shipping materials in d(1) above. Use of the "Computation of Balance Due This Payment" on the backside of the draw request form HUD-51001, Periodic Estimate for Partial Payment, will reduce the amount of materials stored as they are incorporated into the work. The total of all retainage may be released only after the final inspection and issuance of the Final Release Notice.
5. Change Orders. The change order request form, Request for Acceptance of Changes in Approved Drawings and Specifications, form HUD-92577, shall be prepared by the borrower or builder for all changes to the Architectural Exhibits, and must be submitted to the lender for prior approval. Work must be 100 percent complete on each change order item before the release of any monies to the borrower or builder.
1. If the change order results in an increase of costs, the borrower must place additional monies into the construction escrow account for payment upon acceptance of the change.
2. If a change order results in a decrease of costs, the difference cannot be released and will be applied to prepay the mortgage principal after completion of the work.
3. If a change order results in both an increase and decrease of costs which the offset cumulatively totals more than 10 percent of the loan, a revised appraisal must be completed to ensure the value has not decreased.
6. Extensions. If the work is not completed within the time frame, the borrower and builder must request an extension of time on the change order request form, Request for Acceptance of Changes in Approved Drawings and Specifications, form HUD-92577, and provide adequate reasons to justify the extension. If acceptable, the lender should verify the status of the work and may order an additional compliance inspection of the property.
7. Final Inspection. When all work has been completed, the borrower must submit the Periodic Estimate for Partial Payment, form HUD-51001, marked "Final" and provide a Mortgagor’s Letter of Completion, requesting a final inspection and indicating all work is satisfactorily complete. Upon receipt, the lender will schedule an inspection. The inspector must visit the site, determine whether the work was completed according to the approved architectural exhibits/changes orders and complete the Compliance Inspection Report, Form HUD-92051. The document must be accompanied with photographs representative of the work completed. Exterior photographs showing site work, all sides of the dwelling and the interior are required. If the final inspection discloses any minor punch list items that do not affect health/safety or livability and occupancy of the dwelling, and circumstances such as weather conditions prevent timely completion, the inspector will so certify and identify each item and its associated value to complete the Compliance Inspection Report and provide the report to the lender.
8. Closeout. After a review of the case file to ensure that all work has been completed, the lender will obtain from the principal contractor(s) lien releases to the date of the final payment for all work done, labor performed, and materials and equipment provided. If a Certificate of Occupancy is required by the local governmental jurisdiction, it must be submitted with the lender’s transmittal. The lender will prepare a transmittal to the HUD Program ONAP identifying any unused construction funds or contingency reserves to be applied to the principal balance of the mortgage along with a copy of the "Final" Compliance Inspection Report, form HUD-92051. If the "Final" Compliance Inspection Report lists any punch items the lender will be required to retain in the escrow account an amount equal to 1-1/2 times that estimated to complete the work. The lender must complete the Mortgagee’s Assurance of Completion, form HUD-92300, and submit PART 1 and PART 2 to HUD. This work is normally limited to 180 days and may be verified by videotape or photographs. Once all work is completed the lender will complete PART 4, certifying all items have been completed in a satisfactory manner.
9. Final Release Notice. If the HUD Program ONAP accepts the "Final" Compliance Inspection Report, a Final Release Notice will be issued which authorizes the release of all monies remaining in the Construction Escrow Account, including all retainage, with the exception of any held for uncompleted work. The lender may retain a holdback, for a period not to exceed 35 days or the period required by state law to file a lien, whichever is longer. A copy of the final inspection report and the Final Release Notice shall be given to the borrower.

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9.6

SUBMISSION AT COMPLETION OF CONSTRUCTION

Within 30 days of the issuance of the Final Release Notice, the lender shall submit the following documentation to HUD:

1. Warranty of Completion of Construction, form HUD 92544. Contractor’s one-year warranty of work and materials. Required only when a general contractor is performing the work.
2. Compliance Inspection Reports. All reports, form HUD-92051, signed by the inspector.
3. As-built drawings. A set of as-built drawings from information maintained and provided to the lender showing all approved changes noted on a set of the original plans. Also, include the as-built survey showing the house location within the lot.
4. Periodic Estimate for Partial Payments, form HUD-51001. Copies of all draw requests or Periodic Estimate for Partial Payments showing the amount(s) and to whom disbursements have been made.
5. Mortgagor’s Letter of Completion. Borrower certification that construction has been completed in a workmanlike manner in accordance with the plans and specifications and approved change orders, if any.
6. Certificate of Occupancy, as applicable.
7. Final Release Notice. Authorization for release of the final draw and all retainage, including instructions on prepaying the mortgage with any remaining escrow funds.

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9.7

UNFORESEEN CIRCUMSTANCES DURING CONSTRUCTION

Construction activities in rural Alaska communities are high-risk ventures with many pitfalls awaiting the participants. Lenders participating in the Section 184 Indian Loan Guarantee Program are expected to use due diligence and care in the administration of new construction loans. However, even with the utmost care and attempts to mitigate unforeseen circumstances, a lender may find that the construction cannot be completed with the funds available. Under such circumstances, the lender must assess all the factors and make a choice between two courses of action:

1. Occupancy of Property. A dwelling exhibiting all required living amenities may have certain areas that are unfinished or incomplete. Typically, in new construction, the owner may purposely leave the lower level of a split entry dwelling unfinished, since it is not obvious from the habitable area or the exterior of the dwelling and it would be acceptable for financing.

Notwithstanding an event where the property is less than 100 percent complete based on the plans and specifications, the contingency reserve is depleted, and the borrower has exhausted their resources and credit limits, the lender may determine that the property is habitable for possession by the borrower.

A lender-selected inspector will conduct a "final inspection" to review the property to determine its habitability. Punch list items and their value will be compiled for submission to the lender.

1. If it is determined that the property meets the minimal standards, a punch list of items required to achieve 100 percent completion is provided to the lender. Depending on the nature of the items, the lender should determine if the borrower, given additional time, has the capability or the resources of providing "sweat equity" to complete the dwelling. Notice and prior approval of the Program ONAP is required.
1. Lender must counsel the borrower about their obligations and encourage fulfillment of their responsibilities.
2. Borrower must agree to accept the mortgage amount despite the reduced value of the unfinished property.
3. Punch list items must meet the plans and specifications as originally approved and upon which the appraised value is based. Work should be completed within two years of final inspection. The lender assumes the responsibility to verify that the punch list items have been completed.
2. Minimal Habitability Standards
• There must be no health and safety hazards, which create a threat to occupants.
• Major interior and exterior work must be completed; exceptions could be work not affecting the beneficial use of the dwelling.
• Plumbing must comply with the minimal standards established by the applicable tribal, borough or state authority.
• There must be permanently installed appliances, including a range/oven and refrigerator.
• Heating systems must have the capacity to maintain a minimum temperature of 65ºF during the coldest weather in the area.
• Electrical system must supply energy requirements for lighting and operation of appliances.
2. Default and Subsequent Assignment. If the work is not started within 30 days or if the work ceases for more than 30 days or is not progressing reasonably and according to schedule, the lender may consider the loan to be in default. In the event of a default and subsequent assignment of the mortgage during the construction period, lenders must send a letter to HUD. This letter should describe, in sufficient detail, the events which led to the default, balances owing and funds remaining in the escrow account. The lender should request a final inspection of the property to compensate the contractor for all work completed through the date of assignment.
1. Final Inspection. The HUD Program ONAP will assign an inspector to review the property. The inspector will use the Compliance Inspection Report and the draw request form or Periodic Estimate for Partial Payment to document the amount or work that has been completed since the start of construction and determines the value of the completed work to authorize release of escrow funds. Additionally, the inspector will itemize the work necessary to complete construction and the estimated cost.
2. Final Release. HUD will authorize release of payments for completed work, as well as the release of any retainage. Lender should request a Final Release Notice with a claim for loan guarantee benefits. If funds remain in the escrow account, the amount of the claim must be reduced by the funds remaining.