The Department of Housing and Urban Development put out a mortgagee letter in early September that changes one fundamental part of how HUD loans function — namely, how frequently borrowers can receive surplus cash from their loans. While FHA-insured loans closed before September 7, 2022, could distribute surplus cash twice a year, loans approved on or after this date will allow monthly distributions — provided certain conditions are met.

Not all HUD loans will benefit from this change, and not all loans will benefit in the same way. Read on for more information about how these changes impact your current or future HUD-backed loan.

Requirements for Monthly Distributions

Many types of properties are eligible for the monthly distributions, but it is by no means applicable to every type of HUD financing. HUD’s letter clearly spells out which types of properties are not eligible for the new surplus cash distributions. Ineligible properties include those which:

• Have loans endorsed before the date of the letter — September 7, 2022

• Use Section 8 project-based rental assistance (e.g., housing choice voucher programs)

• Have a mortgage held by HUD itself

• Are newly constructed or sold

Beyond this, one of the primary eligibility requirements is that the regulatory agreement with HUD must include language where the borrower opts for these monthly surplus cash distributions.

Provisions for Newly Built or Purchased Properties

The HUD letter outlines some specific timeline requirements for properties which are newly constructed or acquired. For example, endorsed properties which are under construction or have recently delivered are not eligible for monthly distributions until two full fiscal years have elapsed. HUD refers to this time period as seasoning, common in many FHA-backed loans. This same seasoning period applies to substantially rehabilitated communities and those with ownership changes.

One exception in the seasoning period is for those properties with newly endorsed Section 223(f) loans. These require a wait of only one fiscal year. However, there are ways for more experienced HUD borrowers to work around this. If an investor has owned two or more HUD-backed properties for the previous five fiscal years, they can take advantage of monthly surplus cash distributions immediately. Other property owners may apply for monthly distributions if they have owned at least one FHA-insured community for three of the past five fiscal years, but this is subject to the approval of the relevant regional director.

Other Requirements for Monthly Distributions

Beyond these ownership-based requirements, a property must meet several other conditions to qualify for monthly surplus cash distributions.

Properties or borrowers which don’t comply with all relevant obligations and agreements with HUD can’t take advantage, for one. This includes keeping up with annual financial reporting and HUD audit obligations.

Another requirement relates to HUD REAC inspections. The most recent inspection carries the most weight in determining eligibility: a property’s score must be at 80 or above, so merely passing is not enough to qualify. Historical scores are also examined. If a property has received a mark under 60 — e.g., a failing score — in the past three fiscal years, it will be automatically disqualified. Beyond property scores, the borrower must also not have any APPS flags or other kinds of regulatory violations on record.

One other provision relates to debt service coverage ratio. HUD will assess a project to ensure it meets the minimum DSCR in its last annual financial statement before allowing the monthly distributions.

A New Shift for HUD?

The letter marks a new policy shift for HUD financing. While FHA loans are regularly applauded by investors for their highly competitive terms, most programs have stayed the same at their core. This major shift could elevate HUD loans even further.

While future clarification on some of the new policy may be coming in the near future, the new distributions are a welcome addition to an already-competitive financing vehicle, whether for affordable or market-rate housing across the country.

If you have any questions about how a HUD loan could work for you, fill out the form below to get in touch with one of our experienced advisors.