Overhauling the Good Ship FHA HUD Mulls Multiple Reforms

By Caitlin Jones
April 12, 2010 5 min read

The U.S. Department of Housing and Urban Development (HUD) hopes to shift to priority processing of applications as part of sweeping changes to its FHA multifamily mortgage insurance programs, Department official Christopher Tawa told National Housing & Rehabilitation Association March conference attendees.

Tawa described planned and proposed HUD actions to strengthen FHA multifamily loan programs, address portfolio issues, reduce risk, accelerate processing, and make the programs friendlier to projects with federal low-income housing, historic rehabilitation, and new markets tax credits.

Catalysts are the new Administration; concerns about FHA lending practices and risk; the impact of weak real estate markets on HUD multifamily loans; and the challenges of a huge jump in FHA multifamily mortgage insurance applications with no increase in
processing staff.

“We’ve had a 400 percent increase in volume this year,” said Tawa, citing $8 billion worth of current applications received or expected. Developers and owners of market-rate and affordable rental projects are swamping HUD because of the availability and attractive features of FHA mortgages and tighter standards by conventional lenders. But the heavy volume threatens to extend an already lengthy process where it can take a year from FHA application to loan closing.

Planned Changes

Tawa described planned and proposed changes to FHA’s multifamily mortgage programs, including:

Priority Processing. Currently, HUD processes applications for FHA multifamily mortgage insurance on a first-come, first-served basis. HUD wants to shift to a system giving priority to applications for projects reflecting the Department’s policy objectives, which would cut processing times for these kinds of deals. Said Tawa, the current system “doesn’t align the activity of the insurance program with the goals of the Department, which are affordable housing, preservation, sustainable communities, transit-oriented design, green building.” He also noted that HUD wants to move to a partial electronic submission system for documents.
New Lender Qualification System. Presently, HUD licensed Multifamily Accelerated Processing (MAP) lenders can make all types of FHA multifamily loans for all types of projects, even if they lack prior experience with a particular FHA program or project type. HUD plans to begin to certify existing and new MAP lenders and limit their lending authority to FHA programs based on their experience and expertise. “This will limit the lenders who can touch a new construction or substantial rehab affordable deal to just those who have demonstrated that they can do them properly,” said Tawa.
Tighter Underwriting Standards. HUD plans to tighten certain underwriting requirements for various FHA multifamily programs, both for market-rate and affordable rental projects. For the highly popular Section 221(d)(4) new construction/substantial rehabilitation program, HUD is proposing to increase the minimum debt service coverage from 1.11 to 1.15, and the loan-to-cost cap to 87%. HUD also wants to boost required levels for the operating deficit escrow, working capital and operating reserves, and (for substantial rehab projects), the repair escrow, though these increases (other than the repair escrow) would not apply to full Section 8 preservation projects. HUD also plans to issue a standard FHA underwriting narrative to promote consistency. (For details on FHA multifamily programs and the proposed underwriting changes, see Tax Credit Advisor, March 2010, p. 26.)

Other forthcoming HUD actions:

A new standard subordination agreement, similar to one used by Fannie Mae and Freddie Mac, which will replace an existing HUD rider, plus other changes. These would remove current barriers to the use of subordinate financing for projects with FHA-insured first mortgages, such as LIHTC deals. Washington, D.C. attorney Andrew Potts, of Nixon Peabody LLP, also portrays this as a breakthrough for new markets tax credit projects, indicating this would remove the current roadblock to the combined use of NMTC-advantaged financing and FHA mortgages in mixed-use NMTC projects.
FHA multifamily loan documents, that will be updated, but will not be final and in use until early 2011.
A new subordination non-disturbance agreement (SNDA), which will enable the recruitment of major, high credit quality commercial tenants to FHA-financed mixed-use projects. A non-disturbance agreement permits a current tenant to stay under their present lease in the event of a loan default, and not face eviction. Without this protection Tawa noted FHA projects have only been able to attract lower credit quality commercial tenants.

HUD continues to implement changes directed by the Housing and Economic Recovery Act of 2008 (HERA) to make FHA programs work better with housing tax credits.

It has already eliminated a previous requirement that 100% of the equity for an LIHTC project be escrowed at the time of FHA loan closing. The recommended upfront escrow level is now 20%, which an October 2009 proposed rule would extend to historic and new markets tax credits as well. Tawa indicated that HUD will be issuing a new mortgagee letter that allows the 20% threshold only if there is proper due diligence that confirms that the tax credit syndicator or equity investor is likely to make future scheduled equity installments on time and in full, and meet all other partnership agreement obligations. HUD will also be issuing new guidance to clarify what is needed to satisfy the minimum standard under its “plans and specs rule.” Another implemented reform says that sponsors no longer have to submit final plans and specs for a tax credit project at the time of application for FHA insurance; schematic drawings are fine.

Another significant policy change by HUD has been to issue final guidelines permitting the use of master lease structures for FHA-financed housing, historic, or new markets tax credit projects.

Tawa reported, however, that HUD isn’t yet ready to roll out a housing credit pilot program mandated by HERA.

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