Financing and Undertaking Homeowner Rehabilitation
Financing and Undertaking Homeowner Rehabilitation
This section highlights the rules related to financing and managing homeowner rehabilitation programs. It describes the partners who are typically involved in such programs, the various financing tools, eligible costs, property standards, homeowner incomes, and other Federal requirements.
There is a wide range of roles that can be played by partners in a homeowner rehabilitation program, including:
- A nonprofit or other public agency may act as a jurisdiction’s subrecipient and manage a homeowner rehabilitation program on behalf of the community.
- A partner may take on a limited administrative role for the jurisdiction, such as marketing the program in the neighborhood, or helping the jurisdiction translate materials into the language spoken by neighborhood residents.
- A partner may act as a community advocate or advisory group.
- A partner may provide counseling to owners on behalf of the jurisdiction on topics such as home repairs and maintenance.
It is important to note that homeowner rehabilitation is not an eligible CHDO set-aside activity because it does not involve the development, ownership or sponsorship of units (since these units are already owned by the homeowner).
Forms of Financial Assistance
This section highlights the various forms of financing that are common in homeowner rehabilitation projects. It also notes special provisions in CDBG for escrow accounts and lump sum draw downs.
Financial Tools. There is a wide range of options for structuring owner-occupied rehabilitation assistance. Homeowner rehabilitation programs and jurisdictions may choose to finance all of the rehabilitation cost or only a portion of the cost. Some common financial tools include:
- Grants. A grant is often necessary to provide the deep subsidy required by very low-income participants of rehabilitation programs. Grant assistance can be used to directly subsidize the cost of rehabilitation, or to write down the principal amount of a private loan, thus making the monthly loan affordable to the homeowner. The latter technique is often referred to as principal reduction.
- Deferred payment loans. Like grants, deferred payment loans are often used to provide deep subsidies to very low-income households. These are non-amortizing loans that are not repaid until some future point in time. Many jurisdictions structure these loans to be repaid upon sale of the property.
- Forgivable loans. Forgivable loans are non-amortizing loans that are typically structured so that a portion of the loan is forgiven over time. Generally, jurisdictions forgive a pro-rated share of the loan based on how long the owner has resided in the property. If the owner sells the property before the end of the loan term, then he or she would only repay the amount not yet forgiven. For instance, if the jurisdiction loans $20,000 as a ten-year forgivable loan, then each year, $2,000 would be forgiven. If the owner sells the property in year five, he or she would repay $10,000 to the jurisdiction.
- Amortizing loans. These are loans that require a monthly payment by the homeowner. When participants are able to afford monthly payments, lending funds makes sense because funds that are repaid can be reinvested to assist other low-income households. Amortizing loans can be made as principal-only loans, or funds may be lent at below-market interest rates.
If the jurisdiction chooses to finance only a part of the rehabilitation cost, it may structure its loans to be used in combination with other financing. For example, the jurisdiction and a private lender could jointly loan the funds needed for rehabilitation. The homeowner would secure one loan from the private lender and a second loan (known as a “soft second”) from the jurisdiction, usually as a deferred payment loan or one at below-market interest rate. The amount of the soft second loan is often established as the difference between the cost of rehabilitation and the amount of private loan the homeowner is able to secure. This loan is subordinate to the private lender’s.
There are several other less common forms of financial assistance that may be used in homeowner rehabilitation programs. These forms include interest subsidies and loan guarantees. Both methods enable jurisdictions to use small amounts of Federal funds to leverage private money for rehabilitation.
- Interest subsidies. Interest subsidies, also referred to as interest reduction grants or interest rate buy-downs, are similar to principal reduction grants or loans except that the HOME or CDBG funds are used to “buy down” the interest rate to an affordable level. In this case, the HOME or CDBG subsidy is paid directly to the lender and not provided to the homeowner.
- Loan guarantees. Loan guarantees are another way to leverage HOME or CDBG funds for homeowner rehabilitation. A loan guarantee can be used as a credit enhancement when a borrower otherwise eligible for a private loan is denied because of a real or perceived risk factor. In these cases, the jurisdiction could provide a loan guarantee that would ensure payment to the lender, thereby making the loan acceptable. If the jurisdiction plans to use loan guarantees for a large number of loans, it can capitalize a loan guarantee account with HOME funds. The amount of HOME funds in such accounts must be based on a reasonable estimate of the default rate on the loans guaranteed, and may not exceed 20 percent of the total outstanding principal guaranteed.
CDBG cannot be used to capitalize a loan guarantee account but it can be used for individual loan guarantees. To do this, the grantee generally retains the funds in its line of credit, to be available in the event of default unless the grantee can justify a drawdown in advance of need because no financial institution will participate based only on a payment guarantee with no funds on deposit. Further, any amount deposited as a guarantee must be reasonable—that is, the minimum amount necessary to cover anticipated defaults.
Refinancing. On occasion, a jurisdiction finds it necessary to assist a homeowner to refinance existing debt in order for an assisted property to remain affordable to the homeowner, or in the case of multifamily housing, the tenant(s). HOME and CDBG can be used to cover the cost of refinancing existing debt.
HOME can be used when the refinancing is secured by housing that is being rehabilitated with HOME funds under the following conditions:
- When HOME funds are used to rehabilitate single family (1-to-4 unit) owner-occupied housing; and
- HOME funds are loaned for rehabilitation; and
- Refinancing allows the borrower’s overall housing costs to be reduced and the housing is made more affordable.
Loans for refinancing existing debt secured by the property to be rehabilitated are eligible under CDBG if the grantee determines that this type of assistance is necessary to achieve local community development objectives. As under HOME, this refinance must be part of a rehabilitation project, to make the rehabilitation affordable—CDBG does not permit refinance-only projects.
Refinancing eligible owner-occupants’ secured debt has several implications.
- Refinancing makes overall housing costs, including rehabilitation costs, affordable to the owner.
- Refinancing will reduce the amount of funds available to other applicants, thereby reducing the number of families that can be assisted.
Mr. and Mrs. Brown are seeking HOME funds to rehabilitate their home. They have an outstanding principal balance on their first mortgage of $40,000, at 10 percent interest, with a monthly payment of $386. The cost of rehabilitation is $15,000. The PJ is offering the rehabilitation loan at 3 percent for a 20-year term, with a monthly cost of $83.19. The monthly payments for both loans total $469.19. Because the Browns are on a fixed income, the increased mortgage cost would create a financial burden, requiring them to pay well above 30 percent of their monthly income for rent. Refinancing the first mortgage along with the rehabilitation costs using HOME funds would allow them to finance the total $55,000 debt at 3 percent interest for 20 years. This results in a monthly cost of $305.03, a savings of $164.16 per month, making the rehabilitation possible for the Browns and substantially lowering their monthly housing-related expenses.
Escrow Accounts. Some grantees have difficulty making timely payments to contractors from their CDBG accounts, discouraging private businesses from participating in CDBG rehabilitation activities. In order to address this difficulty, HUD permits CDBG grantees to use program funds to establish escrow accounts for the purpose of making timely payments to program participants. The use of escrow accounts is limited to loans and grants for the rehabilitation of primarily residential properties containing no more than four dwelling units (and accessory neighborhood- scale, non-residential space within the same structure, if any, such as a store front below a dwelling unit).
- The contract between the property owner and contractor must specifically provide for the use of an escrow account;
- Account funds are only used for residential rehabilitation activities;
- Account is limited to the amount expected to be disbursed within ten working days;
- Interest earned on the account is to be returned to HUD, at least quarterly; and
- Funds in the escrow account may only pay for actual costs of rehabilitation.
Note, there are no state CDBG requirements for escrow accounts. States may use the entitlement regulations as interpretive guidance.
Lump Sum Drawdowns.x CDBG grantees may draw funds from the letter of credit in a lump sum to establish a rehabilitation fund in one or more private financial institutions for the purpose of financing the rehabilitation of privately-owned properties. The fund may be used in conjunction with various rehabilitation financing techniques, including:
- Interest subsidies;
- Loan guarantees;
- Loan reserves; or
- Other HUD-approved uses that are consistent with the objectives of the CDBG program.
The fund may also be used for making grants, but only for the purpose of leveraging non-CDBG funds for the rehabilitation of the same property.
- Written agreement with financial institution(s), with a term lasting no longer than two years.
- Use of the deposited funds must begin within 45 days of the initial drawdown and deposit. Substantial disbursements must occur from the fund within 180 days of its establishment.
- The grantee is responsible for annual review of activity progress.
- The grantee shall terminate the written agreement(s) with financial institution(s) and return all unused funds to letter of credit in the event that there is a substantial failure on the part of the financial institution(s) to live up to the terms of the written agreement. The grantee must provide HUD and the institution(s) in question with written justification for these actions.
- All unused and unobligated funds shall be returned to the grantee’s letter of credit at the end of the term of the agreement, unless the grantee renews the agreement with the financial institution(s).
- When drawdown funds are used to provide a loan guarantee for private or other non-CDBG financed loans issued to finance rehabilitation activities, these are considered to be CDBG projects, and as such are subject to CDBG requirements.
- Program income (interest, loan repayments) earned through the drawdown account is to be used to finance other CDBG-eligible rehabilitation activities.
In general, there are three types of costs for homeowner programs:
- Activity costs;
- Program or activity delivery costs; and
- Home maintenance or other related housing counseling costs.
Activity Costs. Under HOME and CDBG, both the actual cost of rehabilitating the housing and related soft costs are eligible. Table 4-1 lays out the specific eligible costs under a homeowner rehabilitation program.
Table 4-1: Eligible Homeowner Rehabilitation Costs
* Note: Lead hazard reduction costs are not counted as hard costs for the purposes of determining the level of assistance under 24 CFR Part 35 (the Lead Safe Housing Rule).
The purchase of construction equipment is generally ineligible under both HOME and CDBG. However, the purchase of tools to be used as part of a “tool lending” rehabilitation program is eligible under CDBG. Compensation for the use of construction equipment through leasing, depreciation, or other use allowances (described in applicable OMB Circulars) is allowable, provided the activity is otherwise eligible.
CDBG also allows some specific types of other soft costs, including:
- Initial homeowner warranty premium;
- Hazard insurance premium (except when the assistance is in the form of a grant);
- Flood insurance premium; and
- Inspection and testing for lead-based paint.
Program or Activity Delivery Costs. Program or activity delivery costs are those jurisdiction or subrecipient costs necessary to delivering the homeowner program, such as inspections, specifications writing, underwriting, and other project costs, including loan servicing, that are incurred by the jurisdiction and are directly related to a specific project.
As noted in the previous section, CDBG and HOME handle program delivery costs differently. Under CDBG, costs for delivery are covered under the project activity and are not counted toward the administrative cap.
Under HOME, this type of cost can be charged to the project when the cost is directly attributable to the specific project. The jurisdiction must track the costs to specific units and must include these costs within the maximum per unit subsidy limit. If the costs cannot be attributed to a specific project, they must be counted as administrative. As noted in the previous section, CDBG can pay for program delivery costs for HOME projects, including tasks such as energy auditing, work specifications, loan processing, or inspections. Since these are eligible costs under 24 CFR 570.201(k) as a housing service, they do not count toward the jurisdiction’s CDBG administrative cap.
Maintenance or Other Counseling. People often think of housing counseling as only being related to new homebuyers. However, counseling can be an important part of a homeowner rehabilitation program. In some instances, homeowners do not understand how to keep up their homes. Without proper maintenance, the benefits of the rehabilitation may be short-lived. Other homeowners may not be aware of key tips and techniques for budgeting and as a result they may find themselves unable to repay a rehabilitation loan.
Typical types of homeowner counseling include:
- Maintenance counseling. These courses focus on basic repairs and up-keep items such as changing furnace filters, regular maintenance of heating or septic systems, or weatherization tips; or
- Budgeting and finance. These courses assist the owner to manage his or her finances so that the bills get paid.
Homeowner counseling is generally an eligible cost under HOME, if the counseled homeowner resides in a HOME-assisted unit. If the homeowner does not end up receiving assistance, or if PJ records are not able to clearly assign these costs to individual units, the costs must be charged to administration.
Grantees have several options for how to set up counseling programs under CDBG. The three most common options are:
- HOME housing services. Grantees might use CDBG to pay for housing counseling related to a HOME homeowner rehabilitation program.
- Public service. Grantees can set up housing counseling programs as a public service activity. These costs will count towards the grantee’s 15 percent cap on public service expenditures.
- Program delivery for CDBG. Grantees can fund housing counseling as part of a CDBG-funded homeowner rehabilitation activity as a program delivery cost. Under this opti.on, the grantee offers housing-related counseling as part of its rehabilitation assistance program and the costs of the counseling are included in the cost of the program
Property and Rehabilitation Standards
As noted previously, HOME and CDBG differ in the application of property standards. CDBG does not mandate that units be brought up to code and does not apply a particular property standard. HUD recommends that CDBG grantees establish written property standards for units assisted with program funds to ensure that work is completed within local or state codes. Grantees are encouraged to develop guidelines for property standards and codes with CPD staff at the local HUD Field Office.
Under the HOME regulations, housing units assisted with HOME funds must meet all applicable state and local property standards, or other standards. In order to meet all applicable property standards, HOME requires that a PJ establish written rehabilitation standards for housing units that it rehabilitates with HOME. The written rehabilitation standards provide the means by which applicable property standards are met. A written rehabilitation standard defines the quality of the housing and the materials that will be used, such as specifying the type of nails to be used, the distribution of roofing tiles, or the grade of lumber to be used. Establishing such standards helps ensure that assisted units are of adequate workmanship, there is consistency among assisted rehabilitation jobs, and there is a common standard against which local contractors can base their bids.
Initial Owner Incomes
HOME and CDBG take somewhat different approaches to applicant income when it comes to rehabilitation. Under HOME, all households must be income eligible when the HOME rehabilitation assistance is provided. This means that all assisted households must be at or below 80 percent of the area median income, adjusted for household size.
With CDBG, depending on which national objective is being met, there are circumstances when each individual homeowner may or may not need to be low-income. When a homeowner rehabilitation program is undertaken to meet the low- or moderate-income housing national objective, every homeowner needs to be low- or moderate-income. In fact, no other low-and moderate-income national objective may be used for homeowner rehabilitation. Homeowner rehabilitation cannot be undertaken under the low- and moderate-income area benefit or limited clientele objectives. The statute is very clear that housing activities—if counted as a low- and moderate-income activity—must be undertaken under the housing national objective.
However, CDBG homeowner rehabilitation can be funded to meet a different national objective. For example, if the home is located in a designated blighted area, rehabilitation may be undertaken, regardless of the income of the owner, as long as it addresses conditions that contributed to the deterioration of the area. The CDBG rules stipulate that for residential rehabilitation under the area slum blight national objective, all code items must be undertaken before paying for less critical items.
If the home itself is blighted (but not necessarily located in a blighted area), the spot slum/blight national objective may be used and the income of the owner would be irrelevant. In this instance, the rehabilitation would be limited to items that are a health and safety hazard to the public. It is important to note that this does not mean that the item is a hazard to the individual but rather to the public at large. So, if an individual homeowner needs a handicapped accessibility ramp, it is not eligible because it is not a public health hazard. If the façade of a home is imminently going to fall down, with the risk of striking pedestrians on the sidewalk, it would be a public safety issue. Note that historic preservation may also be undertaken under spot blight national objective and it is not subject to the rules regarding the type of rehabilitation that can be undertaken, but rather is limited to work determined to contribute to the conservation and preservation of the structure being assisted.
CDBG also provides regulatory flexibility to support of neighborhood revitalization strategies. This flexibility is extended to both activities funded through Community Development Financial Institutions (CDFIs) and Neighborhood Revitalization Strategy Areas (NRSAs) or Community Revitalization Strategy Areas (CRSAs).
CDFIs were created under the Community Development Banking and Financial Institutions Act of 1994. CDFIs are community lenders that:
- Are primarily dedicated to the promotion of community development;
- Serve an investment area or targeted population;
- Provide development services and equity investments or loans; and
- Maintain accountability to residents within the specified investment area; and
- Are not public agencies or institutions.
CDBG grantees also have the option to develop specific Neighborhood Revitalization Strategy Areas that target program resources or specific areas within the community. States may adopt CRSAs. Regulations authorizing the development of NRSAs and CRSAs were published by HUD on January 5, 1995, and require grantees to submit NRSAs or CRSAs as either part of an original Consolidated Plan submission, or as an amendment to a previously approved Consolidated Plan (see 24 CFR 91.505).
If a CFDI is working with CDBG in a targeted low- or moderate-income neighborhood or if the grantee has an adopted NRSA or CRSA, the grantee is allowed to add up all of the CDBG units for which funds are obligated in the area in a given program year, and treat them as a single structure. Then, 51 percent of these units must be occupied by households that are low- or moderate-income. This is called creating a “virtual project” and it allows the grantee to fund some homeowner rehabilitation and rental units (49 percent) that are occupied by households that are not low- or moderate-income. This can further a grantee’s goals for mixed-income development.
If the 51 percent test is met at the end of the program year, these activities are deemed to have met the low- and moderate-income housing national objective. Note, however, that only the portion of the costs that are used to assist low- or moderate-income persons can be counted toward the grantee’s required overall program goal of 70 percent expenditure on low- or moderate-income activities.
HOME PJs and CDBG entitlement grantees have the option to choose one of three accepted methods for calculating household income. States may choose one of the following definitions or their own income definition.
- Part 5 definition of income (24 CFR Part 5.609);
- Census long form definition of income; or
- IRS 1040 definition of income.
CDBG grantees that elect to use the Part 5 definition of income may exclude the value of a homeowner’s primary residence from any calculation of net family assets if the homeowner is receiving CDBG rehabilitation assistance.
Other Federal Requirements
There are a number of other Federal requirements that are applicable to homeowner rehabilitation programs. Jurisdictions are encouraged to review the applicable regulations and HUD guidance.
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