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Processing Guidelines February 2003


Chapter 1:
Program Overview

Chapter 2:
Tribal Legal And Administrative Framework

Chapter 3:
Lender Participation

Chapter 4:
Eligible Activities And Properties

Chapter 5:
Loan Processing And The Firm Commitment

Chapter 6:
Loan Closing And Endorsement

Chapter 7:
Administering Construction Loans

Chapter 8:
Loan Servicing

Chapter 9:
Alaska Processing Guidelines For Construction Loans

Chapter 10:
Direct Guarantee

Chapter 11:



Chapter 7: Administering Construction Loans

7.1 Overview
7.2 Loan Terms And Requirements
7.3 Costs Eligible For Inclusion In Mortgage
7.4 Mortgages That Include Acquisition And Rehabilitation Financing
7.5 Construction/Rehabilitation Period
7.6 Construction/Rehabilitation Process Requirements
7.7 Submission At Completion Of Construction
7.8 Foreclosure Of Construction Loans



Only one closing is used in the Section 184 Program. In the case of loans that include construction or rehabilitation, an estimate of construction and rehabilitation costs, including a contingency allowance, are included in the loan. At the time of loan closing the amount allocated for construction or rehabilitation is placed in an escrow account and is drawn down as the construction proceeds. 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/rehabilitation period. The building period is limited to six months, unless the Program ONAP approves an extension.

If lenders elect to offer separate construction and permanent loans, only the permanent loan may 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, however, request a commitment for the borrower, prior to making the construction loan.

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  1. Firm Commitment Requirements. As specified in Chapters 4 and 5, lenders must submit plans and specifications for the construction or the rehabilitation work.
  2. Timing. Loan closing must occur after the receipt of a firm commitment and prior to the start of construction or rehabilitation.
  3. Interest Rate. The interest rate on the loan must remain fixed throughout the term of the loan. Since the loan is fully guaranteed, the interest should reflect current market rates for permanent, rather than construction financing.
  4. Compliance. Investing (secondary) mortgage lenders are encouraged to be bonded, and require lenders who hold the escrow account to be bonded to ensure compliance with their responsibility to borrowers, employees and the general public.

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  1. Lender Fees. Lenders may charge borrowers for typical, reasonable, and necessary costs to the lender associated with administering a construction loan. This includes charging the borrower for the cost of construction and rehabilitation inspections. These are eligible closing costs that may be financed in the mortgage up to the LTV and the borrower’s debt-to-income ratio. In addition, lenders may charge a loan origination fee of up to two and one-half (2-1/2) percent of the mortgage amount for mortgages that include construction draws. This loan origination fee may be included in the mortgage, up to the borrower’s ability to pay and the loan to value ratio.
  2. Contingency Reserve. The contingency reserve is intended to be held for unforeseen circumstances during the construction period. A 10 percent contingency reserve is required on all rehabilitation and new construction loans except under the following conditions:
    1. A 5 percent contingency (at the discretion of the lender and borrower) is acceptable on new construction loans for manufactured housing and modular housing.
    2. If the borrower and lender agree the scope of work is well defined and/or uncomplicated and foresee no use of contingency reserve funds AND the rehabilitation cost is less than $7,500, the lender may waive the requirement for a contingency reserve. If the contingency reserve is waived, the Waiver of Contingency Reserve (Appendix 4) must be executed by the borrower, lender and construction/rehabilitation contractor (if applicable).

    In all other instances, the 10% contingency reserve can be held in one of the following manners:

    1. The contingency reserve funds are used in the computation of the maximum mortgage amount (reference the Maximum Mortgage Calculation Worksheet in Appendix 4): and are included in the construction escrow account. Upon completion of the construction/rehabilitation and the Final Release Notice executed by the Program ONAP, the remaining contingency funds must be used to pay down the unpaid principal balance.
    2. The contingency reserve funds are not included in the mortgage. Funds for the contingency reserve may come from the borrower or from any acceptable gift source (i.e., IHA/TDHE, Tribe, TDHE, relative, etc.) The eligibility of the donor and transfer of funds must be documented by the lender. The contingency reserve funds are placed into a separate escrow account that is specifically held for unforeseen circumstances during the construction period. Upon completion of the construction/rehabilitation and the Final Release Notice executed by the Program ONAP, remaining funds in the contingency reserve account may be returned to the borrower and/or gift donor.
    3. If the lender believes that a contingency reserve of more than 10 percent is needed, the lender must request an exception to this policy from the Program ONAP and clearly justify the reasons for the exception. Under no circumstances will HUD approve a contingency reserve of more than 20 percent of the construction cost.
    4. Costs in excess of the contingency reserve must be paid by the borrower outside of the mortgage agreement.
    5. The borrower may use excess contingency reserve funds to make additional improvements to the building when (1) it is unlikely that any deficiency that may affect the health and safety of the property will be discovered; and (2) the project is at least 90% complete. Prior to doing the work, a request for use of the remaining contingency reserve funds shall be made via the Change Order Request (Form HUD 92577). The Program ONAP must approve the work.
    6. Funds remaining in the contingency reserve at the time of the Final Release Notice will be used to pay down the principal balance of the mortgage. However, all or a portion of such funds may be used to reimburse the borrower if unforeseen change orders required the borrower to place additional monies into the escrow account.
  3. Mortgage Costs During Construction Period. An allowance for mortgage payments for up to six months may be included in the construction escrow to enable the borrower to make payments during the construction period if the house is not habitable during construction/rehabilitation. If payments are not placed in the escrow account, the lender must document borrower’s ability to make the mortgage payments during the construction period and borrower must sign a statement acknowledging the requirement to make mortgage payments during the construction period.
    1. Mortgage payments may be withdrawn by the lender on a monthly basis.
    2. If the construction period extends beyond six months, the borrower must make mortgage payments from non-escrowed funds.
    3. The mortgage must begin to fully amortize with the first monthly payment, whether or not the construction has actually begun.
  4. Rehabilitation Inspection Fees. For each draw request, the lender is required to obtain the inspector’s signature stating that the work for that draw has been satisfactorily completed.
    1. Inspection fees should be placed in the interest bearing escrow account.
    2. Inspection fees cannot exceed what is reasonable and customary for the area.
    3. Any unused inspection fees (escrowed) will be used to pay down the principal once the rehabilitation is complete; or they can be used for additional improvements.
    4. If the inspection fees exceed the amount of the escrow, the borrower will be responsible for payment outside the escrow account.
    5. An inspector may charge for mileage. The fee for mileage should be reasonable and customary for assignments, which require 30 or more round trip miles from the inspector’s place of business to the subject property. The mileage charge applies only to mileage in excess of 30 miles round trip.
  5. Title Update Fees. In order to ensure that the mortgage position remains in tact on the title, a lien waiver or title update is required.
    1. Title update fees cannot exceed what is reasonable and customary for the area.
    2. Any unused title fees (escrowed) will be used to pay down the principal once the rehabilitation is complete.
    3. If the title updates exceed the amount of the escrow, the borrower will be responsible for payment outside the escrow account.

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When purchasing a house in need of repair or modernization, the homebuyer usually has to obtain financing first to purchase the dwelling; additional financing to do the rehabilitation construction; and a permanent mortgage when the work is completed to pay off the interim loans with a permanent mortgage. With the 184 loan program, the borrower can get one loan, at a long-term fixed rate to finance both the acquisition and the rehabilitation of the property.

The amount of acquisition and rehabilitation must not exceed the value of the property once the work has been completed. An appraiser will arrive at a value by reviewing the current value with the proposed changes (i.e., the specification of repairs worksheet that has been approved by the lender and the borrower) and arrive at an after improved value.

  1. Rehabilitation Loans. For loans that include acquisition and rehabilitation costs, the borrower completes a Loan Application and submits copy of the contract to purchase. Using the Specification of Repair Form (or other comparable worksheet), the borrower and the contractor complete the work write up and arrive at a cost breakdown of all the work to be done on the property. Estimates must include labor and material sufficient to complete the work if it were to be done by a licensed contractor. The cost of improvement(s) should be transferred to the Draw Request Form. The lender reviews the work write-up to ensure that the work is acceptable. An appraisal is ordered. The appraiser must arrive at an after improved value based on the existing property and the completed specifications of repairs.
  2. Eligible Improvements. A minimum of $2,500.00 in repairs must be required in order to include rehabilitation expenses in the financing of a 184 loan. Minor or cosmetic repairs by themselves are impractical and unacceptable.
  3. The rehabilitation must include one or more of the items listed below, with a cumulative total of $2,500.00 or more.

    1. Structural alterations and reconstruction (i.e., additions to the structure, finished attics, repair of termite damage and the treatment against termite infestation, etc.).
    2. Changes for improved functions and modernization (i.e., remodeled kitchens and bathrooms).
    3. Elimination of health and safety hazards (including the resolution of defective paint surfaces and/or lead based paint problems on homes built prior to 1978).
    4. Changes for aesthetic appeal and elimination of obsolescence (i.e., new exterior siding).
    5. Reconditioning or replacement of plumbing (including connecting to public water and/or sewer system), heating, air conditioning and electrical systems.
    6. Roofing, gutters and downspouts.
    7. Flooring, tiling and carpeting.
    8. Energy conservation improvements (i.e., new double pane windows, insulation, solar domestic hot water systems, etc.).
    9. Major landscape work and site improvement, patios and terraces that improve the value of the property equal to the dollar amount spent on the improvements or required to preserve the property from erosion.
    10. Improvements for accessibility to the handicapped.
    11. When basic improvements (above) are involved, the following costs can be included in addition to the minimum $2,500 requirement for the existing structure:

      1. New cooking ranges, refrigerators, and other appurtenances (used appliances are not eligible).
      2. Interior or exterior painting.
  4. Unacceptable Rehabilitation/Repair Items. Luxury items and improvements that do not become a permanent part of the real property are not eligible as a cost rehabilitation. The following items are examples of items that are NOT acceptable repairs: barbecue pits; bathhouses; dumbwaiters; exterior hot tubs; saunas; spas and whirlpool baths; outdoor fireplaces or hearths; photo murals; swimming pools; television antennas and satellite dishes; tennis courts; tree surgery. etc.
  5. Calculating the Maximum Mortgage Amount for an Acquisition and Rehabilitation Loan. The Mortgage Credit Analysis Worksheet (MCAW) does not allow the originating lender to calculate the maximum mortgage for loans that require the financing of acquisition and rehabilitation, and single close new construction. Accordingly, the Rehabilitation and Single Close Maximum Worksheet (Appendix 4) is designed to assist the lender when calculating the mortgage amount for single close construction or rehabilitation loans. The worksheet totals are transferable to the MCAW.

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  1. Length of Construction/Rehabilitation Period. The construction period begins when the mortgage loan is closed. The length of the construction period will be no longer than six months. On a property using modular construction that is built in the factory and moved to the site, the construction period will also be no longer than six months.
  2. Extensions. If the work is not completed within six months, the borrower and builder must request an extension of time on Change Order Request Form (HUD–92577), and provide adequate reasons to justify the extension. Extensions may be granted by the Program ONAP for up to six months. Such extensions will not affect the term of the mortgage. The mortgage cannot be increased to cover any cost over-runs associated with the construction delay.

    If the work is not completed within the specified time period, the lender should verify the status of the work, order a compliance inspection of the property, and notify HUD. The Program ONAP must approve time extensions (over the initial six-month period). Requests must be submitted and approved on a Change Order Request Form. An extension can be granted only if the loan is current.

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  1. Architectural Exhibits.The borrower must provide the lender with documents, which clearly describe the scope of work and construction schedule. The list of recommended exhibits are contained in Chapter 4, Paragraph 4.8.
  2. Construction Loan Agreement. A construction/rehabilitation loan agreement must be executed between the lender and the borrower (see Appendix 4). This agreement sets the conditions of the construction advances as well as other terms of the loan.
  3. Construction Loan Rider. The Section 184 Construction Loan Rider must be executed (see Appendix 4). This Rider amends the Deed of Trust, security deed or general mortgage and further describes the terms of the loan.
  4. 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 (see Paragraph 6.6c). When these required policies go into effect, the builder’s risk may be cancelled.
  5. Establishing an Escrow Account. When the guaranteed loan is closed, the proceeds designated for construction/rehabilitation (including the contingency reserve, mortgage payment reserve, inspection fees and title update fees) are to be placed in an interest bearing, trust, or escrow account insured by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA). Evidence of this escrow account must be provided with the guarantee package. A copy of a deposit slip or bank statement is acceptable evidence. This account is not an escrow for the paying of insurance premiums, ground rents or assessments, and is not to be treated as such. The construction escrow account will cease paying interest to the borrower when (1) the loan payments are delinquent for more than 30 days, or (2) the completion date (or an approved extension) has expired. If the borrowers cure the delinquent or default status, and/or the completion date has not expired or an extension has been approved, then the interest on the escrow account will begin.
  6. Interest Income. The interest income earned by the Construction/Rehabilitation Escrow Account must be paid to the borrower or applied to the unpaid principal loan amount as the borrower has indicated on the Section 184 Applicant Acknowledgment (see Appendix 4) signed at closing. The method of payment is subject to agreement between the lender and the borrower.
  7. Release of Funds (Draws) from the Account. Under no circumstances is a construction draw request to be approved for work that is not completed (except as indicated in Paragraph 7.6h below regarding shipping). The lender may not release funds for work from the Construction Escrow Account until the lender has received a Compliance Inspection Report (Form HUD-92051) and the Draw Request form, certifying that the work has been completed in compliance with the accepted plans, specifications, and architectural exhibits.
  8. Shipping and Material Costs. With prior HUD approval, the lender may make one initial draw for building components to be shipped and stored on site. A progress payment may be made for up to 90 percent of the invoiced building materials value, including 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;
    2. 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 ensure the protection of the borrower’s interest in such materials. 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. A Summary of Materials Stored, Form HUD-51004 is attached to Form HUD-51000 and used to summarize the value of all material stored. 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 release of liens from the contractor, all subcontractors and suppliers. As security, the lender may make a first deed of trust on the property. 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. Lenders, contractors, and borrowers must ensure that the shipped materials are stored safely on-site. Contractors are responsible for any materials lost while stored at the building site and contractors must be insured for such losses.

  9. Number of Draws. No more than six construction draws should be made on the escrow account (four draws for manufactured housing). However, if approval of a longer construction period is given by HUD, additional draws are permitted. The schedule for draws should be negotiated between the borrower, contractor, lender, and HUD at the time the construction period is established or extended. The lender or its agent will release escrowed funds only upon satisfactory completion of the proposed construction, pursuant to the Loan Agreement and a Draw Request.
    1. Initial Draw. The initial draw may be released one day after loan closing. Allowable fees paid by the borrower, or on borrower’s behalf, may be reimbursed provided they are listed on a separate letter. A holdback of 10 percent will be made on all draws. The total of all holdbacks may be released only after the final inspection of the construction and issuance of the final release notice.
    2. Intermediate Draws. Intermediate draws are inspected by the lender-selected inspector, who visits the site with the approved architectural exhibits. A construction draw request can occur only for each stage of construction as shown on the form. It is the responsibility of the lender to obtain written approval from the borrower before each draw payment is provided to the builder. At the lender’s option, the holdback is not required when a subcontractor is 100 percent complete with a work item, the work completed is acceptable to the inspector, and the subcontractor provides the necessary waivers.
    3. Improvements must be satisfactorily completed in compliance with industry standards, local practices, and to the satisfaction of the inspector. If acceptable, the inspector completes a Compliance Inspection Report and the Draw Request, and sends it to the lender for review.

    4. Other Inspections. The lender or HUD may determine that additional compliance inspections are required throughout the construction period to ensure that the work is progressing in a satisfactory manner.
  10. Inspector Qualifications. All construction inspections must be performed by a State/local licensed and/or Program ONAP approved and qualified inspector who is approved by the lender. The inspector must be a disinterested third party and cannot be personally or financially related to the builder, borrower, or other interested party, as approved by the lender. IHA/TDHE staff may do the construction inspections if they are qualified and acceptable to the lender. As noted elsewhere in this guide, IHA/TDHE inspectors may not charge the cost/time for Section 184 inspections to other HUD housing programs. Lenders that choose to use staff inspectors must notify the Program ONAP. The Program ONAP retains the right to reject inspectors based on poor quality of work.
    1. Inspector fees may not exceed what is reasonable and customary for the area per draw and may not exceed the maximum number of draw requests. Payment of fees will be included with the draw request.
  11. Mechanics’ and Material Lien Waivers. Lenders are responsible for ensuring the validity of the first lien on the property. Lenders are advised to obtain legal counsel and should obtain lien waivers at the time of any construction disbursement of funds from the escrow account. All disbursements should be made by check or money order, through the lender (or its agent). The lien waivers acknowledge payment in full of any and all claims, which the payee has and specifically releases all rights to claim a mechanic’s lien for material furnished and/or labor performed upon the property. Lenders may request a list of subcontractors from the general contractor. At a minimum, lenders should perform two updates, an initial and a final. The maximum number of updates should not exceed the number of draws.
  12. Change Orders. The Change Order Request (form HUD 92577) is prepared by the borrower or builder and is submitted to the lender for acceptance and approval of the Program ONAP. Work must be 100 percent complete on each change order item before the release of any monies will be made to the borrower or builder. If the change order results in an increase of costs above and beyond the amount supported by the contingency reserve, the borrower must place additional monies into the construction escrow account for payment upon acceptance of the change. 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. See Paragraph 6.3 for more information about post commitment changes to the mortgage.
  13. Final Inspection. This step will be approved when all work has been satisfactorily completed in compliance with industry standards, local practices, and to the satisfaction of the fee inspector. The borrower must provide a letter to the lender requesting final inspection and indicating that the work is satisfactorily complete (see Mortgagor’s Letter of Completion — Appendix 4).
    1. Upon receipt of the borrower’s letter, the lender will schedule an inspection with the inspector. The inspector returns the report to the lender. The inspector visits the site, makes the inspection to determine whether the construction has been completed according to the accepted exhibits and completes the Compliance Inspection Report and the Draw Request marked "final".
    2. The final inspection report must be accompanied with photos representative of the work completed. Exterior photos showing site work, all sides of the dwelling, and the interior are required.
    3. 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 lender will be required to retain escrow account funds equal to one and one-half (1-1/2) times the amount estimated to complete the work and a Mortgagor’s Assurance of Completion must be executed by the lender. Completion of this work is normally limited to 90 days and may be verified by video tape or photos.
  14. Final Release Notice. The Final Release Notice is issued by the lender and approved by the Program ONAP after it reviews the case file to ensure that all work has been completed (see Post Endorsement Checklist in Appendix 4). If an occupancy permit is required by the local jurisdiction, it must be provided prior to the issuance of the final release notice. Acceptance of the final inspection report will trigger the release of all monies remaining in the Construction Escrow Account, including all holdbacks from previous draws. However, the lender may retain the holdback for a period not to exceed 35 days (or the same time period received by law to file a lien, whichever is longer) to ensure compliance with state lien waiver laws or other state requirements. A copy of the final inspection report and Final Release Notice will be given to the borrower.
  15. Excess Funds Remaining in Escrow Account. If there are unused construction funds, inspection fees, mortgage payments, contingency funds or title update fees in the account, the lender must apply the funds to prepayment on the principal balance of the mortgage.
  16. Unforeseen Circumstances During Construction. In unusual circumstances, unforeseen problems during construction can cause the cost to complete the home to rise above the borrower’s ability to pay. If the borrower cannot obtain the needed cash to complete (i.e., from other sources, gifts from the tribe or family members, sale of personal property, etc.), the lender should contact the Program ONAP for further instructions.

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Within 30 days of completion of the construction or rehabilitation, the lender must submit the following information to the Program ONAP for inclusion in the case binder:

  1. Warranty of Substantial Completion (HUD 92544). Contractor’s warranty of work and materials extended one year from the date of acceptance for occupancy.
  2. Compliance Inspection Reports (HUD 92051). All reports must be signed by the inspector. Include a copy of the Certificate of Occupancy (if applicable) and all other approvals necessary for occupancy by the local regulatory body, as applicable.
  3. Plans and Specifications. If changes to the original plans and specifications were made and approved by HUD/lender provide a set of plans and specifications showing all approved changes noted.
  4. Draw Requests. Copies of all draw requests showing the amount and to whom disbursements have been made and copies of corresponding checks for disbursement. Copies of all change order requests, if applicable.
  5. Final Pictures.Final pictures of the completed property.
  6. Mortgagor’s Letter of Completion (sample in Appendix 4). Borrower certification that construction has been completed in a workman like manner in accordance with the plans and specifications and approved change orders, if any.
  7. Final Release Notice (sample in Appendix 4 prepared for HUD’s signature). Authorization for release of the final draw and all holdbacks, including instructions on prepaying the mortgage with any remaining escrowed funds.
  8. Contingency Release Notice (sample in Appendix 4). Copies of all contingency releases, HUD authorized.
  9. Mortgagee’s Assurance of Completion (HUD 92300). Where an escrow has been established for incomplete items.
  10. Specific conditions clearance documentation. Such as any needed occupancy permits or termite inspections. The lender may contact the Program ONAP to identify a contact person at the tribe/lHA/TDHE.

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  1. Effective Date of the Guarantee. The guarantee is effective as of the date of closing and upon receipt of the complete guarantee package. If default occurs (as indicated in Chapter 8), the lender must make and document a good faith effort to cure the default. If the default cannot be cured, the lender should follow the process described in Paragraphs 8.6. The lender may either foreclose or assign to the department for 100 percent payment. See Chapter 8 for a description of the default process.
  2. Notice. In the event that a default occurs during the construction period, in addition to the general default requirements listed in Chapter 8, lenders must send a letter to the Program ONAP. This letter should describe, in sufficient detail, the events, which led to the default, balances owing and funds remaining in the escrow account.
  3. Default. If work is not started within 30 days of closing, or if work ceases for more than 30 days, or if work is not progressing reasonably during the construction period, the lender may consider the loan to be in default unless an approved extension has been granted by the Program ONAP.
  4. Final Inspection. In the event of a default during the construction period, lenders must request a final inspection to compensate the contractor for all work completed through the date of assignment.
  5. The lender will assign an inspector to review the property. The inspector will use the Compliance Inspection Report and the Draw Request to document the amount of work that has been completed since the start of construction. HUD will determine the value of the completed work and authorize the release of escrowed funds. Additionally, the inspector will itemize the work necessary to complete construction and the estimated cost.

  6. Authorization of Payment. Using a similar format to the Final Release, HUD will authorize release of payment for completed work, as well as the release of holdbacks on advances previously released. The lender is to submit a copy of the Final Release Notice with the claim for loan guarantee benefits. If funds remain in the construction escrow account, the amount of the claim (the unpaid principal balance) must be reduced by the unexpended funds remaining in the account.

U.S. Department of
Housing and Urban Development

1999 Broadway, Suite 3390
Denver, CO 80202

(303) 675-1600

Section 184 Home

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