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December 24, 2014

Secretary Julián Castro

U.S. Department of Housing and Urban Development

451 7th

Street, SW

Washington, DC 20410

Re: Shared Equity Homeownership and HUD/FHA

Dear Secretary Castro:

The National Community Land Trust Network (“NCLTN”) is a national nonprofit membership

organization of community land trusts (“CLTs”) and other permanently affordable housing

organizations. NCLTN was incorporated in 2006, and, together with our members, we promote

strategic community development and permanently affordable housing benefiting low- and moderate-

income families through the practice of shared equity homeownership.

NCLTN provides support and leadership to over one hundred sixty organizations, including those

organizations that offer homeownership programs with lasting affordability in CLTs, Community

Development Corporations, Community Development Financial Institutions, Habitat for Humanity

affiliates, government-based inclusionary zoning programs, and deed-restricted programs. Together,

our members provide over 13,000 units of affordable homeownership units and over 20,000

affordable rental units.

While NCLTN, our members, and the Federal Housing Administration (“FHA”) seek to increase

homeownership opportunities for low- and moderate-income homeowners, our members have found

that homeowners participating in shared equity homeownership programs often cannot access FHA

programs.

We are writing to you today to request several regulatory changes that may facilitate homeowners’

access to FHA programs and, at the same time, advance your stated goal of reaching underserved

potential borrowers. We have also included proposed changes to the current Mortgagee Letter (94-2)

(the “Mortgage Letter”) that we believe will streamline the approval process for affordable housing

program participants.

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NCLTN acknowledges that HUD program staff has spent considerable time discussing many of the

issues raised in this letter. However, with no resolution on these issues to date, we are bringing these

matters your to attention at this time.

Background on Shared Equity Homeownership Programs:

Shared equity homeownership (“SEH”) is an umbrella term for programs that provide

homeownership opportunities with lasting affordability, sometimes referred to as “permanently

affordable homeownership programs” or homeownership programs with “lasting affordability”

or “long-term affordability.” (For the purposes of this letter, we will refer generally to shared

equity homeownership programs as “SEH Programs”). As described in greater detail in

Exhibit A, SEH Programs generally make a one-time investment to create homeownership

opportunities that are affordable for purchase by a low- or moderate-income homebuyer. In

return for owning a home at an affordable cost, the homeowners agree to certain restrictions

including limitations on returns upon resale or limitations on conveyances of the property. In

effect, homeowners “share” some of the proceeds from resale to pay the opportunity forward to

the next low- or moderate-income homebuyer.

Successes of SEH Programs:

Conducted by Cornerstone Partnership in 2014, the “Social Impact Report” is the most recent

national longitudinal study of 53 SEH Programs representing 3,768 homes. It found that SEH

Programs:

1) Increase access to homeownership. The average household income at the time of

purchase was 65% of the area median income, and 82% were first-time homebuyers. On

average, the homes were sold 25% below their fair market value in order to make home

purchase affordable.

2) Improve the likelihood that homeownership will be sustained. Over 93% of

households remained homeowners for at least five years. This starkly contrasts a nation-

wide longitudinal study conducted by Reid (2005), which found that less than 50% of

first-time lower-income and minority owners maintained homeownership for five years.

3) Reduce the likelihood of foreclosures. Shared equity homeowners—all of whom were

lower-income—were ten times less likely to be in foreclosure than homeowners in the

conventional market across all incomes. These results are consistent with findings from

other national studies conducted in 2009 – 2011.

4) Build wealth for homeowners. The annual rate of return on these households’

investments in homeownership was 7.97%. If they had taken the same amount of money

and invested it in the S&P 500, their annual rate of return would have only been 1.06%.

Hence, homeowners participating in shared equity homeownership build wealth.

Approximately, 62% of households went on to buy a home in the conventional market.

5) Preserve the public’s investment by keeping homes affordable resale after resale.

Delivering on the model’s promises, these programs retained the affordability of the

homes to serve the same income level resale after resale.

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FHA Regulatory Roadblocks:

Unfortunately, homeowners participating in SEH Programs have experienced difficulties in

accessing FHA programs. The below discussion details two of the most onerous regulatory

roadblocks that have prevented such access. This part of the letter requests various regulatory

changes that FHA/HUD can make to bring FHA and SEH Programs together to assist in creating

more low- and moderate-income homeownership opportunities.

I. Legal Restrictions on Conveyance

HUD regulations at 24 CFR 203.41(c) permit legal restrictions on conveyance if the restrictions

are part of a governmental or nonprofit program and if the restrictions on conveyance terminate

upon foreclosure or deed-in-lieu of foreclosure. Notwithstanding this exception, pursuant to 24

CFR 203.41(d), HUD/FHA will not insure a mortgage on property that is subject to a legal

restriction on conveyance (even if the restriction is a part of a nonprofit or governmental

program) if a violation of the restriction would be grounds for (1) accelerating the insured

mortgage, (2) voiding a conveyance of the mortgagor’s interest in the property, (3) terminating

the mortgagor’s interest in the property, or (4) subjecting the mortgagor to contractual liability

other than requiring repayment of assistance.

These regulations severely limit the effectiveness of the legal instruments SEH Programs use to

maintain affordability by restricting the remedies such programs may use to enforce restrictions

on conveyance. As described in more detail in Exhibit A, SEH Programs rely on legal

restrictions to protect the affordability of homes and promote the success of homeowners. While

the regulations permit certain restrictions, such as resale, occupancy, and purchaser-income, the

limitations on remedies effectively renders such restrictions moot.

Furthermore, the regulations (24 CFR 203.41(d)(3)) provide that a SEH Program’s legal

documents may contain a purchase option or right of first refusal whenever a homeowner choses

to sell his/her property, whether or not such sale is as a result of default or foreclosure.

However, the language of 203.41(d) discussed above limits a SEH Program’s opportunity to

actually enforce such purchase option or right of first refusal if the homeowner fails to honor

them. Without adequate remedies to enforce legal restrictions on conveyance, SEH Programs

are unable to ensure that homes will continue to serve low- or moderate-income households and

remain affordable over many sales.

NCLTN seeks a regulatory change that will remove these limitations on remedies for eligible

nonprofit and governmental programs.

Additionally, the regulations require that all legal restrictions on conveyance terminate upon

foreclosure or deed-in-lieu of foreclosure. Often in foreclosure situations, SEH Programs seek to

cure the default and find another qualified family that could purchase the home. This process

can take some time, and may not be complete before the lender takes possession of the leasehold

estate.

While we understand why HUD would require that restrictions on conveyance terminate upon

foreclosure, NCLTN requests that HUD amend the regulations to permit SEH Program’s

purchase options to survive foreclosure for a limited period of time. This is the practice of

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Fannie Mae, and NCLTN members have found that the extended cure period prevents the loss of

affordable homeownership units (while also limiting unwanted lender inventory).

Requested Regulatory Change:

To address the issues raised above, NCLTN requests that HUD revise subsections (c) and (d) of

24 CFR 203.41 as follows:

(c) Exception for eligible governmental or nonprofit programs. Legal restrictions on

conveyance are acceptable if:

(1) The restrictions are part of an eligible governmental or nonprofit program and

are permitted by paragraph (d) of this section; and

(2) Subject to any extended redemption period permitted by paragraph (d)(4) of

this section, Tthe restrictions will automatically terminate if title to the mortgaged

property is transferred by foreclosure or deed-in-lieu of foreclosure, or if the mortgage is

assigned to the Secretary.

(d) Exception for eligible governmental or nonprofit programs—specific policies. For

purposes of paragraph (c) of this section, restrictions of the following types are permitted for

eligible governmental or nonprofit programs, provided that a violation of legal restrictions on

conveyance may not be grounds for acceleration of the insured mortgaged or for an increase in

the interest rate, or for voiding a conveyance of the mortgagor's interest in the property,

terminating the mortgagor's interest in the property, or subjecting the mortgagor to contractual

liability other than requiring repayment (at a reasonable rate of interest) of assistance provided to

make the property affordable as low- or moderate-income housing:

[….]

(2) Legal restrictions on conveyance may extend beyond the term of the

mortgage, subject to paragraph (c)(2) of this section and any limitations applicable in the

jurisdiction.

(3) Except as otherwise required by the HOME and HOPE programs, rights under

an option to purchase, pre-emptive rights to purchase or rights of first refusal shall only

be held by a governmental body or eligible nonprofit organization (or their assignee who

will purchase and occupy the property), or another individual or organization approved

by the Secretary, and shall be exercised by them or their assignee (or an assignee who

will purchase and occupy the property) only within a reasonable time after the event

permitting exercise of the rights occurs, not to exceed a period of time determined by the

Secretary. The Secretary may approve another individual or organization under the

preceding sentence even if the restriction is not part of an eligible governmental or

nonprofit program.

(4) Rights under an option to purchase, pre-emptive right to purchase or rights of

first refusal permitted in paragraph (d)(3) of this section may survive foreclosure or deed-

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in-lieu of foreclosure for a reasonable redemption period, which redemption period shall

not exceed a period of time determined by the Secretary.1

[….]

(5) The mortgagor may be required to continue to be an owner-occupant.

(6) The mortgagor may be limited in his or her ability to choose a purchaser for

the property, but only to the extent necessary to ensure that the property is preserved as

low- or moderate-income housing.

(7) The mortgagor for a rehabilitation loan insured under § 203.50 of this part

may hold title subject to a condition subsequent, provided that the holder of the right of

entry for condition broken also executes the mortgage, and that the right is exercisable

only for failure by the mortgagor to complete the rehabilitation or occupy the property as

agreed by the mortgagor.

(8) Property may be subject to a legal restriction on conveyance to the extent

approved in writing by an authorized representative of the Secretary prior to September

10, 1993.

NCLTN would be happy to discuss these requested changes in more detail.

II. Resale Formulas/Fair Return

In addition to limiting legal restrictions of conveyances, HUD regulations currently limit SEH

Programs’ right to use the most effective tool to maintain affordable homeownership

opportunities: resale restrictions. As briefly discussed above, resale restrictions are an integral

part of SEH Program activities. Currently, HUD regulations generally permit restrictions on the

sales price of properties purchased under a SEH Program.2 However, the regulations go on to

prescribe that such restrictions are acceptable as long as the owner “is not prohibited from

recovering:

(i) The sum of the mortgagor's original purchase price, the mortgagor's reasonable costs

of sale, the reasonable costs of improvements made by the mortgagor, and any negative

amortization on a graduated payment mortgage insured under § 203.45 of this part; and

(ii) A reasonable share, as determined by the Secretary, of the appreciation in value

which shall be the sales price reduced by the sum determined under paragraph (d)(1)(i) of

this section.”

1 The concept of a reasonable redemption period comes from the Fannie Mae Seller Guide Section B5-5.1-04 and

B5-5.0-03.

2 “…the mortgagor may be prohibited from selling the property at a price greater than the price permitted under the

program, or the mortgagor may be required to pay a portion of the sales proceeds to a governmental body or an

eligible nonprofit organized, as long as the mortgagor is not prohibited from recovering:…” 24 CFR 203.41(d)(1).

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The regulations also note that the purchase price under a right of first refusal/purchase option

held by a nonprofit may not be less than the “sum of the mortgagor's original purchase price, the

mortgagor's reasonable costs of sale, the reasonable costs of improvements made by seller, and a

reasonable share, as determined by the Secretary, of the appreciation in value.”3

NCLTN members have found the resale formula provided in the regulations to be extremely

problematic. First, the formula seems to operate divorced from market realities: it is possible

that the value of the property is substantially lower than the original purchase price. Second,

depending upon market conditions, it cannot be guaranteed that the costs of sale will be

recuperated by the seller. Furthermore, the resale formula fails to reflect market realities that

homeowners rarely recover the full costs of capital improvements upon the sale of their property,

as the value of such improvements often does not equal the costs, since the value of such

improvements may decline over time.

Even more generally, HUD’s recitation of a specific resale formula that includes a “reasonable

share of appreciation” fails to recognize that there are many types of resale formulas that SEH

Programs use. For example, some SEH Programs use an index-based formula, whereby the

resale price is indexed to change in connection with the area median income, cost of living, or

some other metric. Other SEH Programs use a fixed-percentage formula, whereby the resale

price is determined by adding an annual percentage increase to the original purchase price.

There are other resale formulas that have proven effective in providing a fair return to

homeowners, while also protecting the public investment made by the SEH program to preserve

affordability throughout the resale process. While we know that HUD is inherently concerned

with protecting homeowners, SEH Programs use these various resale restrictions in order to help

low- and moderate-income families gain wealth from accessing and sustaining homeownership

while concurrently protecting affordability of homes to help more families in the future.

Therefore, we believe that requiring resale restrictions that stipulate a nationwide definition for

fair returns are not necessary, productive, or realistic.

The regulatory restriction requiring that the first refusal/purchase options held by nonprofits may

not be less than original purchase price, reasonable costs of sale, reasonable costs of

improvements made by seller, and a reasonable share of the appreciation in value, is also

extremely problematic. As discussed above, rights of first refusal/purchase options are

frequently used by SEH Programs to maintain unit affordability over resales. This purchase

price formula does not reflect market realities that the value of a property may drop significantly

below the original purchase price or not rise sufficiently to cover the costs of improvements and

costs of sale. In such a circumstance, rather than excising its first refusal right, a SEH provider

would be forced to let a property proceed to foreclosure, where it would attempt to buy back the

property at the a more reasonable, fair market value price. This is not in the best interest of the

mortgage lender, FHA, or the mortgagor.

Requested Regulatory Change:

To address the issues raised above, NCLTN requests that HUD remove all references to a resale

formula in section (d) of 24 CFR 203 as follows:

3 24 CFR 203.41(d)(4).

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(d) Exception for eligible governmental or nonprofit programs—specific policies. For

purposes of paragraph (c) of this section, restrictions of the following types are permitted

for eligible governmental or nonprofit programs, provided that a violation of legal

restrictions on conveyance may not be grounds for acceleration of the insured mortgaged

or for an increase in the interest rate, or for voiding a conveyance of the mortgagor's

interest in the property, terminating the mortgagor's interest in the property, or subjecting

the mortgagor to contractual liability other than requiring repayment (at a reasonable rate

of interest) of assistance provided to make the property affordable as low- or moderate-

income housing:

(1) Except as otherwise provided in the HOME Investment Partnerships (HOME) and the

Homeownership and Opportunity for People Everywhere (HOPE) programs, the mortgagor may

be prohibited from selling the property at a price greater than the price permitted under the

program, or the mortgagor may be required to pay a portion of the sales proceeds to a

governmental body or an eligible nonprofit organization, as long as the mortgagor is not

prohibited from recovering:

(i) The sum of the mortgagor's original purchase price, the mortgagor's reasonable costs of sale,

the reasonable costs of improvements made by the mortgagor, and any negative amortization on

a graduated payment mortgage insured under § 203.45 of this part; and

(ii) A reasonable share, as determined by the Secretary, of the appreciation in value which shall

be the sales price reduced by the sum determined under paragraph (d)(1)(i) of this section.

[….]

(4) In addition to the restrictions stated in paragraph (d)(3) of this section, the purchase price

under an option may not be less than the sum of the mortgagor's original purchase price, the

mortgagor's reasonable costs of sale, the reasonable costs of improvements made by seller, and a

reasonable share, as determined by the Secretary, of the appreciation in value.

To see a full cumulative mark up of our requested regulatory changes to 24 CFR 203.401(c) and

(d), please see Exhibit B.

FHA Programmatic Roadblocks:

While NCLTN would like to pursue the regulatory changes requested above, NCLTN believes

SEH Program participants and HUD can work together within the current regulatory framework

to help homeowners participating in SEH Programs access FHA programs now. One way to

achieve this goal is to resolve any confusion among HUD Field Offices and HUD Headquarters

on when and how homeowners participating in SEH Programs may be eligible for FHA

insurance. In other words, NCLTN is requesting that HUD clarify when legal restrictions on

conveyance used by SEH Programs are acceptable in order to streamline the FHA approval

process.

To effectuate this clarification, NCLTN has drafted proposed changes to the current Mortgagee

Letter (94-2) to clarify issues that routinely serve as roadblocks for our members assisting

homeowners in the FHA process. We believe these proposed change are permitted by the

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current HUD regulations, and generally our changes just seek to clarify rights already granted to

SEH Program in 24 CFR 203.41. For ease of review, attached at Exhibit C is an annotated copy

of our suggested changes to Section II and Section III of the Mortgagee Letter. As with our

requested regulatory changes, we hope to have the opportunity to discuss our proposed

Mortgagee Letter changes in more depth.

Conclusion

We appreciate your consideration of the foregoing and look forward to working with you and

your staff in achieving resolution, so that the valuable tool of SEH can continue to create

successful homeownership opportunities for those who may not otherwise have access.

Sincerely,

Melora Hiller

Executive Director

National Community Land Trust Network

Cc: Acting Assistant Secretary Biniam T. Gebre

General Counsel, Helen R. Kanovsky

Emily Thaden, NCLTN

George L. Weidenfeller, Reno & Cavanaugh, PLLC

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Exhibit A

The majority of shared equity homeownership programs (“SEH Programs”) are resale-restricted

programs, meaning that they restrict the maximum price for which the home may be resold and

restrict who may purchase the property to income-eligible households. Hence, low- or moderate-

income buyers purchase and resell homes at prices below fair market value in order to keep the

home affordable. Resale restrictions are set forth in a legal contract between the homeowner and

the SEH Program. Some SEH Programs do not restrict the price for which the home may be

sold, but instead, these types of programs allow homeowners to sell homes at fair market value,

but use legal documents to stipulate how a sale or transfer may take place to ensure the homes

remain affordable for the next low- or moderate-income buyer (such as, stipulating that the seller

receives only a portion of appreciation). Examples of these programs include limited equity

housing cooperatives, resident-owned communities, community land trusts (“CLT”), certain

types of deed-restricted programs, and shared appreciation loan (“SAL”) programs. However,

for the purposes of addressing access to FHA-insurance for single-family mortgages, only the

following types of SEH Programs are relevant: CLT, deed-restricted programs, and SAL

programs. Consequently, only these types of programs are discussed below.

Aside from resale restrictions, SEH Programs also tend to have primary residency requirements,

occasional fees owed to the SEH Program (such as ground lease payments), and/or financing

approval requirements. These requirements and restrictions all help create and maintain

affordable homeownership opportunities for low- and moderate-income persons.

A variety of legal mechanisms are used to create SEH opportunities:

1. Deed covenants: Deed covenants may be designed specifically to create shared equity

homeownership opportunities. For example, the vast majority of inclusionary housing

programs utilize deed covenants to resale-restrict inclusionary homeownership units.

Notably, deed covenants used by SEH Programs sometimes only have 30-year terms. In

these instances, affordability of the homes is preserved by ensuring the SEH Program has

the preemptive option to purchase the home and may transfer this option to an eligible

buyer. Additionally, deed-restricted programs used by SEH Programs will also have

every new homeowner sign a new deed covenant with a new term. That way, the

affordable home is preserved and serves subsequent low- or moderate-income

homebuyers.

2. Ground Leases: The vast majority of CLTs utilize renewable, 99-year ground leases to

create shared equity homeownership opportunities. The homeowner leases the land from

the CLT for a nominal monthly ground lease fee while s/he owns and obtains mortgage

financing for the improvements. Notably, sometimes the CLT provides additional

subsidy beyond the fair market value of the land in order to make the home affordable for

a low- or moderate-income household. Even though ground lease durations are longer

than most deed covenants, CLTs usually have preemptive option to purchase the home

(or to transfer this option to an eligible buyer), and they also have every new homeowner

sign a ground lease with a new term.

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3. Shared appreciation loans: Second mortgage loans that share appreciation may be used

to create shared equity homeownership opportunities (although few programs currently

utilize this legal mechanism). These types of SAL programs should not be confused with

other “shared appreciation loans” that are available in the private market, which are

profit-driven first mortgage loan products. SEH Programs that utilize SALs design them

as a way to make homeownership significantly more affordable to low- or moderate-

income buyers and to recoup the second mortgage and some portion of the appreciation

so that a subsequent SAL can be made to a subsequent low- or moderate-income

purchaser of a property. Typically, the second mortgage loan has a 30-year term with 0%

interest and is due upon sale. The nonprofit or public entity typically records a deed

covenant stipulating the program’s requirements and resale requirement along with loan

documents. Typically, the SAL program retains the preemptive option to purchase the

home (or to transfer this option to an eligible buyer) in order to keep the same home

affordable to next buyer.

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Exhibit B

Comprehensive proposed changes to 24 CFR 203.401(c) and (d)

(c) Exception for eligible governmental or nonprofit programs. Legal restrictions on

conveyance are acceptable if:

(1) The restrictions are part of an eligible governmental or nonprofit program and

are permitted by paragraph (d) of this section; and

(2) Subject to any extended redemption period permitted by paragraph (d)(4) of

this section, T the restrictions will automatically terminate if title to the mortgaged

property is transferred by foreclosure or deed-in-lieu of foreclosure, or if the mortgage is

assigned to the Secretary.

(d) Exception for eligible governmental or nonprofit programs—specific policies. For

purposes of paragraph (c) of this section, restrictions of the following types are permitted for

eligible governmental or nonprofit programs, provided that a violation of legal restrictions on

conveyance may not be grounds for acceleration of the insured mortgaged or for an increase in

the interest rate, or for voiding a conveyance of the mortgagor's interest in the property,

terminating the mortgagor's interest in the property, or subjecting the mortgagor to contractual

liability other than requiring repayment (at a reasonable rate of interest) of assistance provided to

make the property affordable as low- or moderate-income housing: …

(1) Except as otherwise provided in the HOME Investment Partnerships (HOME)

and the Homeownership and Opportunity for People Everywhere (HOPE) programs, the

mortgagor may be prohibited from selling the property at a price greater than the price

permitted under the program, or the mortgagor may be required to pay a portion of the

sales proceeds to a governmental body or an eligible nonprofit organization, as long as

the mortgagor is not prohibited from recovering:

(i) The sum of the mortgagor's original purchase price, the mortgagor's reasonable costs of sale,

the reasonable costs of improvements made by the mortgagor, and any negative amortization on

a graduated payment mortgage insured under § 203.45 of this part; and

(ii) A reasonable share, as determined by the Secretary, of the appreciation in value which shall

be the sales price reduced by the sum determined under paragraph (d)(1)(i) of this section.

(2) Legal restrictions on conveyance may extend beyond the term of the

mortgage, subject to paragraph (c)(2) of this section and any limitations applicable in the

jurisdiction.

(3) Except as otherwise required by the HOME and HOPE programs, rights under

an option to purchase, pre-emptive rights to purchase or rights of first refusal shall only

be held by a governmental body or eligible nonprofit organization (or their assignee who

will purchase and occupy the property), or another individual or organization approved

by the Secretary, and shall be exercised by them or their assignee (or an assignee who

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will purchase and occupy the property) only within a reasonable time after the event

permitting exercise of the rights occurs, not to exceed a period of time determined by the

Secretary. The Secretary may approve another individual or organization under the

preceding sentence even if the restriction is not part of an eligible governmental or

nonprofit program.

(4) Rights under an option to purchase, pre-emptive right to purchase or rights of

first refusal permitted in paragraph (d)(3) of this section may survive foreclosure or deed-

in-lieu of foreclosure for a reasonable redemption period, which redemption period shall

not exceed a period of time determined by the Secretary.4

(4) In addition to the restrictions stated in paragraph (d)(3) of this section, the purchase price

under an option may not be less than the sum of the mortgagor's original purchase price, the

mortgagor's reasonable costs of sale, the reasonable costs of improvements made by seller, and a

reasonable share, as determined by the Secretary, of the appreciation in value.

(5) The mortgagor may be required to continue to be an owner-occupant.

(6) The mortgagor may be limited in his or her ability to choose a purchaser for

the property, but only to the extent necessary to ensure that the property is preserved as

low- or moderate-income housing.

(7) The mortgagor for a rehabilitation loan insured under § 203.50 of this part

may hold title subject to a condition subsequent, provided that the holder of the right of

entry for condition broken also executes the mortgage, and that the right is exercisable

only for failure by the mortgagor to complete the rehabilitation or occupy the property as

agreed by the mortgagor.

(8) Property may be subject to a legal restriction on conveyance to the extent

approved in writing by an authorized representative of the Secretary prior to September

10, 1993.

4 The concept of a “reasonable redemption period” comes from the Fannie Mae Seller Guide Section B5-5.1-04 and

B5-5.0-03, which NCLTN members have found works well for SEH Program purposes.

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Exhibit C

Proposed draft Mortgagee Letter

Showing changes from relevant sections of Mortgagee 94-2

TO: ALL APPROVED MORTGAGEES

SPECIAL ATTENTION: Nonprofit Agencies with Affordable Housing Programs State Housing

Finance Agencies

SUBJECT: Secondary Financing Provided by Nonprofit Agencies and Transferability

Restrictions Permitted for Property with a HUD Insured Mortgage

[….]

II. RESTRICTIONS TO TRANSFERABILITY -- SUMMARY OF RULE

The rule states the long-standing HUD policy that a property with a HUD-insured mortgage shall

be free of restrictions that prevent the borrower from freely transferring the property. The rule

also prohibits a lender from approving restrictions after the loan is closed. The rule uses the term

"legal restrictions on conveyance" to describe such restrictions and this term is broadly defined

to include provisions in any kind of legal instrument that would cause a conveyance (including a

lease) by the borrower to:

Be void, or voidable by a third party.

Be the basis of contractual liability of the borrower.

Terminate, or subject to termination, the borrower's interest in the property.

Be subject to the consent of a third party.

Be subject to limits on the amount of sales proceeds a borrower can retain.

Be grounds for accelerating the insured mortgage.

Be grounds for increasing the interest rate of the insured mortgage.

If a conveyance could cause any of these things to occur, the property is considered to be subject

to legal restrictions on conveyance (referred to as "restrictions" for the remainder of this

Mortgagee Letter) and is usually ineligible for HUD mortgage insurance.

The prohibition on legal restrictions on conveyance is not meant to prohibit all restrictions or

requirements that may be placed on the property or borrower. A property or borrower subject to

requirements such as homeowner fees or ground lease payments may still be eligible for a HUD-

insured mortgage.

However, the rule also describes the circumstances when restrictions do not make the property

ineligible. They are:

HUD-required restrictions on sale to non-creditworthy persons or persons who will not

occupy the property as a principal residence. These restrictions are contained in the

standard mortgage language required by HUD. (Handbook 4155.1 Rev. 4, paragraph 4-2;

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Handbook 4165.1 Rev. 1, Appendix III, paragraph 9(b); Handbook 4330.1 Rev. 4,

paragraph 6-4.)

Restrictions that are part of an eligible program for low- or moderate-income housing

(referred to as an "affordable housing program" for the remainder of this Mortgagee

Letter) and consistent with requirements of the rule. An eligible program must be

operated pursuant to a Federal program, or operated by a State or local government or an

eligible nonprofit organization as defined in the rule. These restrictions are discussed in

greater detail below in Section II (A).

Restrictions related to tax-exempt mortgage revenue bond financing. In addition to the

restrictions allowed for governmental or nonprofit affordable housing programs, the

lender may use HUD's tax-exempt financing rider to provide for mortgage acceleration

for violation of restrictions. (Handbook 4165.1 Rev 1, Appendix XII.)

Restrictions for housing for the elderly. These are allowed if consistent with Federal,

State and local laws and if marketability is not unduly affected.

Restrictions related to the special title situations on Indian lands, Hawaiian Homelands,

the Northern Mariana Islands and American Samoa. These will not necessarily preclude

mortgage insurance.

A. LIMITATIONS ON RESTRICTIONS -- AFFORDABLE HOUSING PROGRAMS

As noted above, borrowers or properties encumbered by legal restrictions on conveyance relating

to affordable housing programs may be eligible for mortgage insurance. A more detailed

description of the restrictions permitted for affordable housing programs is provided in Section II

(B) below. All such legal restrictions on conveyance5 contained in legal instruments used by

relating to affordable housing programs that are otherwise allowed by this HUD policy must

automatically and permanently terminate upon foreclosure, deed-in-lieu of foreclosure, or

assignment of the insured mortgage to HUD. The relevant legal documents must have language

that accomplishes this result terminates any provisions relating to legal restrictions on

conveyance upon foreclosure, deed-in-lieu of foreclosure, or assignment of the insured mortgage

to HUD, however the legal documents themselves (such as ground leases or deed restrictions),

and any provisions unrelated to conveyance therein, do not have to terminate. Merely

subordinating the restrictions to the insured mortgage is not sufficient. The restrictions cannot

come back in force upon subsequent resale by the lender or HUD (except as provided in

regulations for the HOME program).

Restrictions may not be enforced by any of the following consequences for a violation:

Voiding a conveyance by the borrower.

Terminating the borrower's interest in the property.

5 NCLTN would like HUD to clarify that restrictions not pertaining to conveyances (such as lease payments or

maintenance fees) are not prohibited.

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Accelerating the insured mortgage.

Increasing the interest rate for the insured mortgage.

Subjecting the borrower to contractual liability.

The prohibition against contractual liability for violations of any legal restriction on conveyance

covers liability for damages, specific performance or injunctive relief. It does not prevent a

requirement for the borrower to repay with reasonable interest any assistance received in

connection with the borrower's home purchase. The effect of these prohibitions is that the

borrower must have the legal ability to sell his or her home. The borrower does not have to be

allowed to retain the benefit of any financial assistance and, as provided below, the borrower

does not have to be allowed to retain all sales proceeds. Upon a violation of a legal restriction on

conveyance, a The borrower also may be required to sell to the holder of an option or right of

refusal designed to continue the property as affordable housing, such as the nonprofit or

governmental entity operating the affordable housing program (or such entity’s assignee).

Notwithstanding anything to the contrary written above, HUD has waived the regulatory

prohibition on subjecting borrower to contractual liability for violations of legal restrictions on

conveyance for shared equity homeownership programs. Such affordable housing programs may

enforce legal restrictions on conveyance permitted by HUD policy by subjecting the borrower to

contractual liability for any violation of said restrictions.6

HUD acknowledges that many affordable housing programs have legal instruments, such as

ground leases or deed restrictions, which create restrictions on the property unrelated to

conveyance. Such restrictions may include penalties on homeowners for violations. These

restrictions are permitted and may survive foreclosure or deed in lieu of foreclosure, even if the

legal instruments contain restrictions on conveyance that do terminate upon foreclosure or deed

in lieu of foreclosure. An example of such restrictions would be ground lease payments.

The prohibition against terminating the borrower's interest means that the borrower must have

fee simple absolute title instead of title may not have a property interest (fee or leasehold)7 that is

dependent on subsequent events such as fee simple determinable or fee simple subject to a

condition or a limitation. For example, a program in which the borrower may lose title if the

borrower fails to occupy the property for a specified number of years is not allowed. One

exception permits such an arrangement for a Section 203(k) rehabilitation loan as long as the

other holder of interests in title also executes the mortgage. Another exception shared equity

homeownership programs which, pursuant to a HUD regulatory waiver, may terminate a

borrower’s title upon a borrower’s failure to comply with certain legal restrictions on

conveyance such as owner-occupied requirements or violations of rights of first refusal or

purchase options.8

6 NCLTN requests that HUD consider granting such a waiver while the requested regulatory change is pursued.

7 There has been some confusion in Field Office as to whether leasehold interests are eligible for FHA insurance.

They are pursuant to 24 CFR 203.37, and the regulations do not require ground lease termination upon foreclosure

so long as any restriction on conveyance contained therein terminates upon foreclosure or deed in lieu of

foreclosure.

8 NCLTN requests that HUD consider granting such a waiver while the requested regulatory change is pursued.

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An affordable housing program must be designed to serve borrowers with a household income

not to exceed 115% of the median area income, unless the local HUD Office with the

concurrence of HUD Headquarters has approved a higher income in writing (not to exceed 140%

of the median area income).

Currently, the only area with an approved higher income limit is Hawaii, with a limit of 140%.

B. SPECIFIC RESTRICTIONS ALLOWED FOR AFFORDABLE HOUSING

HUD's regulation permits a variety of types of restrictions that ensure the property is preserved

as low or moderate income housing. including limits to the resale price of the property or

recaptures of equity. For example, a borrower may be restricted to selling its property to

purchasers with certain income qualifications, or a property may be encumbered by a restriction

requiring it to be owner occupied.9

Other permitted restrictions include limits to the resale price of the property or recaptures of

equity. A maximum sales price may be imposed or the sales proceeds due the borrower may be

limited (with any excess payable to a governmental body or nonprofit organization for reuse in

an affordable housing program). In either case, when the homeowner sells the property, he or

she must be permitted to recover at least the original purchase price, sales commission, cost of

capital improvements, and any accrued negative amortization if the property was financed with a

graduated payment mortgage. Notwithstanding this requirement, HUD acknowledges that resale

formulas used by affordable housing programs must reflect market realities: a homeowner may

not actually be able to recover the original purchase price, costs of sale commission, costs of

capital improvements or accrued negative amortization if the market does not support such a sale

price. The requirement set forth by this Letter and the rule is only that a homeowner not be

prohibited from recovering the original purchase price, sales commission, cost of capital

improvements, and any accrued negative amortization if the market permits.10

In addition, homeowners must be permitted to recover a reasonable amount of appreciation as

determined by HUD. Appreciation is measured by the difference between fair market value of

the property upon purchase and the fair market value of the property upon resale.11

by the

difference between the original purchase price and the actual price at which the property is

resold. If the program permits the homeowners to sell the property at market value but

recaptures part of the equity, HUD considers a reasonable share of appreciation to be at least 50

percent. HUD does not object to affordable housing schemes whereby the homeowner's share of

appreciation is on a sliding scale beginning at zero, provided that within 2 years the homeowner

9 NCLTN members are finding that some Field Offices believe that all affordability restrictions are prohibited. This

proposed change would hopefully clarify that SEH Programs may have restrictions that protect affordability.

10 Some HUD Field Offices treat the regulatory re-sale formula as a guaranteed resale price that SEH Programs must

provide homeowners. This interpretation is not only not supported by the regulations, but also not realistic in certain

markets. We hope that this change would clarify any confusion.

11 The current definition of appreciation fails to consider that the both the original purchase price and the resale price

of an income- restricted property would be below fair market value. Any change between these numbers may be

unrelated to appreciation of the home itself.

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would be permitted to retain 50 percent of the appreciation. If the program sets a maximum sales

price restriction, the borrower must be permitted to retain 100 percent of the appreciation. The

Department recognizes that other many types of arrangements for sharing appreciation may be

acceptable, and may vary widely depending on the specific assistance provided by an affordable

housing program.12

HUD Field Offices may determine the reasonableness of the appreciation

share in local programs without specific written approval from HUD Headquarters.

Another One method restriction on conveyance commonly used to ensure that housing remains

part of an affordable housing program is for the program sponsor or administrator to hold a right

of first refusal or an option right that can be exercised when the borrower proposes to sell the

home to a purchaser not eligible for the program benefits.13

The use of such purchase options

and rights of first refusal is permitted for all sales This is permitted by HUD policy if: (a) the

rights are held only by a governmental body or eligible nonprofit organization and exercised by

them or someone they have identified as an eligible purchaser, (b) any right is exercised within

45 days after the holder of these rights may exercise them (for example, the rights are often

triggered by a notice of sale from the borrower), and (c) any option price allows the borrower to

recover his or her investment plus a reasonable share of appreciation as explained above.

Affordable housing programs may assign their right of first refusal or purchase option right to

potential homebuyers who qualify for the affordable housing program. The rule also permits

HUD Headquarters to approve option rights to be held and exercised by another person or entity

on a case-by-case basis.

Other permissible restrictions for affordable housing programs are described in the rule.

Restrictions that are not described in the rule are not allowed, unless HUD approved the

restriction in writing before the rule took effect.14

[….]

III. LEASE TERMINATION

Any lease must meet the requirements of Handbook 4010.1 Chg 10, paragraph 3-1 (September

10, 1981) and 15

4150.1 Rev-1, paragraph 6-32, as well as the new rule. The handbooks requires 12

The specificity of this appreciation share formula is problematic from NCLTN’s perspective, as the experience of

its members in implementing shared appreciation programs across the country has demonstrated a need for

flexibility in designing programs and structuring terms. While arbitrary thresholds such as these do little to shield

homeowners from over-reaching programs, they effectively bar homeowners in good programs from using FHA

financing. We believe that Field Officer should evaluate affordable housing program’s appreciation share formula

in the context of their specific market and programmatic details.

13 The regulations do not limit when (pre-foreclosure) right of first refusal or purchase options may be triggered.

Many NCLTN members rely heavily on the purchase option and right of first refusal to keep affordable housing

opportunities available for the families they are trying to serve and exercise such options whenever a buyer proposes

to sell their home. We worry that the deleted language in this section implies that such options may only be used if

a borrower’s sale violates affordability restrictions.

14 As it has been more than a decade since the rule was written place, we believe that HUD provide more flexibility

in considering legal restrictions on conveyance that are not specifically listed in the rule but that may follow the

intent behind the rule.

15 We believe this section of Handbook 4010.1 has been deleted.

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that most ground a leases to provide the lender a right to correct lessee (borrower) defaults upon

receipt of a notice of intent to terminate the lease. In order for this lender's right to be

meaningful, a lease should not be terminable due to a violation the lender cannot correct. Note,

the handbook provides an exception for ground leases made in connection with shared equity

homeownership programs: as approved by HUD, such programs may have lease provisions

permitting the termination for certain lessee defaults that lender cannot cure (such as primary

residency requirements).16

The handbooks and the rule should be interpreted together. The rule will generally prohibit

restrictions that could result in lease termination if the restrictions are violated. For example,

during the time that the property is encumbered by the mortgage, the lessor should not be able to

terminate a lease if the lessee/borrower fails to continue to occupy a property. Such a

termination provision would violate the handbook because the lender could not correct the

violation, and it would violate the rule because even occupancy requirements generally permitted

for affordable housing programs cannot be the basis for terminating the borrower's interest in the

property. However, as noted above, the handbook provides an exception for certain provisions

contained in HUD approved ground leases used by affordable housing programs, including

owner-occupancy provisions or violations of right of first refusal or purchase option. Ground

leases used by shared equity homeownership programs may include termination provisions

triggered by the failure for a borrower to occupy their home.17

Ordinarily, lease terminations unrelated to affordable housing restrictions and correctable by the

lender, such as termination for nonpayment of rent, are permitted and are not affected by the

rule. Such lease provisions, and the ground lease itself, do not need to terminate upon

foreclosure or deed-in-lieu of foreclosure. The Department does not intend to prevent affordable

housing programs such as community land trusts that depend on ground leases, and understand

that the success of such programs is related to restrictions contained within such ground leases,

but standard documents for such programs should be reviewed carefully for compliance with the

rule and modified as needed. HUD has previously approved a model ground lease rider (form

16

NCLTN would request two revisions to the Handbook 4150.1-Rev (1). First, we would request that section 6-

32(A)(6)(a) be revised as follows:

A state, including any political subdivision thereof, of the United States, an Indian Tribe, or an Indian, or a

charitable institution, a church, a university or similar public purpose institution, or an affordable housing program

(as that term is defined by the Secretary) is the lessor and or an option to purchase would not be permitted under

existing laws or regulation.

Second, we would request that the following language be inserted in Section 6-32(A)(7):

Default. Mortgagee must have the right to correct lessee's defaults within 120 days from receipt of notice of

intent to terminate lease because of such default, or such further time as may be necessary to complete foreclosure.

In cases where the ground lease is made in connection with an eligible program for low-or moderate-income

housing, HUD may approve of certain default provisions that the mortgagee may not necessarily be able to cure. An

example would be the model ground lease rider (form ____) that HUD has pre-approved for ground leases used by

affordable housing programs.

17 NCLTN requests that HUD consider granting such a waiver while the requested regulatory change is pursued.

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____) that can be used by affordable housing programs seeking to provide FHA access to their

ground lessees.18

[….]

18

NCLTN has worked with Fannie Mae to create a Ground Lease Rider that is acceptable for properties seeking

Fannie Mae assistance. We would propose working together with HUD to create a similar document for FHA, and

believe that creating such a document will help streamline FHA access for low- and moderate-income homebuyers.