www.hudclips.org U. S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT WASHINGTON, D. C. 20410-8000 OFFICE OF THE ASSISTANT SECRETARY FOR HOUSING-FEDERAL HOUSING COMMISSIONER January 29, 1986 Mortgagee Letter 86-5 TO: ALL APPROVED MORTGAGEES SUBJECT: Single Family Production - Investor Transactions In recent months, there has been an increase in the number of investor transactions which we believe circumvent the intent of our programs. As a result, we are issuing the following instruction to clarify FHA's position and to ensure that the integrity of our investor program is not violated. They are: 1. Identity of Interest Transactions. To avoid the impact of FHA's no "cash out" investor refinance policy, certain investors have begun selling properties to individuals with whom they have an identity of interest. Identity of interest includes any relationship where the purchaser and seller are related (father and son, etc.) or affiliated through a business relationship (e.g., corporation selling to an employee, partners in other projects, etc.). Where there is an identity of interest between the buyer and seller in an investor transaction, the maximum mortgage amount is limited to 75 percent of value and closing costs or acquisition cost, whichever is less. In the event that the purchaser in an identity of interest transaction plans to occupy the property, the maximum mortgage amount is limited to 85 percent of the value and closing costs or acquisition cost, whichever is less. 2. Required Leases. There has also been an increase in transactions where the investor obtains an FHA insured mortgage and then quickly sells the property on an assumption basis to a third party. While FHA will insure investor mortgages which are being held as rental properties, it was never our intent to insure investor mortgages solely for the purpose of facilitating future sales or circumventing the 7 unit limitation (no individual may have a financial interest in more than 7 units in a subdivision or contiguous area). _____________________________________________________________________ 2 FHA programs were never intended to be the financing vehicle for prearranged deals where mortgages are quickly assumed after endorsement. While It is recognized that such arrangements may be hidden from the mortgagee, we expect the mortgagee to exercise reasonable caution in processing investor transactions and to alert the local office immediately if they uncover such arrangements. To make certain that investors intend to hold properties for rental purposes, we are requiring all firm commitment applications involving investor purchases to be accompanied by a lease agreement of at least one year duration for each unit of the property. Leases with options to purchase are unacceptable as they clearly indicate that the investor is only using this transaction as a financing mechanism. This new requirement provides an additional assurance that the investor plans to use the property as it is represented in the application. Occupant purchasers of 2, 3 or 4 unit dwellings do not need leases for the other units. 3. Seven Unit Limitation. An individual is always limited to a financial interest in 7 rental units In one subdivision or units that are contiguous or adjacent. This limitation applies to any properties in which the investor may have a financial interest even if the properties are not encumbered with FHA-insured mortgage. To circumvent the 7 unit limitation, some investors have been selling properties on a sImple assumption basis to unqualified borrowers. While FHA loans are freely assumable, "churning" operations to circumvent this limitation will not be permitted, i.e., an investor indicates that properties are to be held for rental purposes when in fact he intends to sell the properties as quickly as buyers can be found and return for more "rental" properties in the investor's name. In the event a sale does occur involving an assumption, in order for the investor to obtain a firm commitment on another "rental" unit, the following documents on the assumptor must be submitted for HUD review: Copy of the Sales Contract Form 92900 Credit Report Verification of Deposit Verification of Employment Amount of Second Mortgage and Monthly Payment on that Mortgage _____________________________________________________________________ 3 Our current standards for qualifying buyers on income and credit should be applied to determine the acceptability of the assumptor. Form 2210, Request for Release of Liability, is also required to obtain additional units with respect to the 7 unit limitation. 4. Investor Refinance. In Mortgagee Letter 85-12 , FHA precluded investors from taking cash out of refinance transactions. That letter also referred to a 6-month limitation with respect to how the maximum mortgage amount is calculated. In this Letter, that period is extended to one year. Hence, supplemental obligations incurred during the last 12 months which were not related to the purchase, repair or rehabilitation of the property will not be eligible to be included as part of the existing indebtedness in determining the maximum mortgage. Also, acquisition cost will continue to be a factor on all refinancing transactions in which the purchase took place within the last 12 months. Since we are exploring additional ways to safeguard the Department's risk in these transactions, it is not expected that this change to 12 months will be permanent. Rather, it is viewed as a temporary solution until new regulations are in place which will revise the mortgagee's bidding process at foreclosure sales. This upcoming change reflects the Department's commitment to take strong action against abusive mortgagors by securing and perfecting deficiency judgements against them. Once this change is in place, we will reconsider the need for the 1 year extension outlined above. Because these instructions address ways to circumvent our investor policy, they are effective immediately. Accordingly, any firm commitment application not approved by FHA or the Direct Endorsement underwriter must be processed in accordance with these instructions. In conclusion, these instructions are designed to address abuses which have surfaced in FHA's programs. With your help, we are confident that these problems can be avoided in the future. Sincerely, Janet Hale General Deputy Assistant Secretary for Housing-Federal Housing Commissioner