Section 202 Preservation: Impacts of Mortgage Modifications and Re-refinancing

Regulation | September 13, 2017 | by Colleen Bloom, Gates Dunaway, Sunny Fitzgerald

Many owners have refinanced their Section 202 properties with an FHA 223(f) or FHA 221(d)4 loan. Since the refinancing, they may have been approached by their lender or another lender to “refinance” the property, or simply to lower the interest rate. There is some confusion over these options, and especially how it impacts the “re-refinancing” rules of a HUD 202 Direct Loan. Here are the differences in your options.

It's a bit like alphabet soup.  But it's important to understand the difference between an A-7, and IRRP, and a re-refinancing.

Full Refinancing

 A “full refinancing” of an existing mortgage is simply the act of going to the lender of your choice, and getting a new FHA loan to pay off the old. The new refinancing can be considered a “recapitalization” as it allows for several benefits beyond simply replacing the debt including, equity take-out, capital and accessibility repairs and improvements, and resetting the Reserve for Replacement. A recapitalization can also be maximized (ie: obtaining the largest loan possible) with at least 15 years remaining on a HAP contract.

This type of transaction would count as a “re-refinancing” if the existing mortgage is an FHA loan (typically a 223(f) or 221(d)4), and the new loan is also an FHA mortgage. When properties that were originally financed with a 202 Direct Loan refinance for a 2nd time with FHA insured loan, they will lose the “exemption” status of their Section 8 HAP contract. This means that if Option 4 rents are over-market, at renewal of the HAP contract the owner will not be able to renew under Option 4, and the rents will be marked down to market under Options 1 or 2. Marking down to market, however, may ultimately prove to be worth it when considering the other benefits of a recapitalization; therefore it is important to be strategic when considering this option.

Section 223(a)(7) Refinancing

Refinancing an existing mortgage through the “(a)7” program is simpler than a full refinancing, and allows the owner the benefit of a lower interest rate and some funding for limited repairs. Because the new(a)7 loan cannot be any larger than the original principal balance, the main benefit is most often lower debt service payment as the result of a lower interest rate.

The lender in an (a)7 transaction can be the current or a new lender, and the transaction can take as little as 2 or 3 months to close (as opposed to up to year to close on a “full refinancing”). Note that an (a)7 will also trigger the “re-refinancing” rules mentioned above. At HAP contract renewal, a transaction that has completed an (a)7 refinancing will not be able to renew under Option 4, and any over-market rents will be reduced to market. Also, be aware that when you proceed with an (a)7 with new lower debt service payments the result is likely an increase of surplus cash. Make sure that you understand the property’s rules regarding surplus cash and debt service savings to avoid having all of this extra cash being swept into the residual receipts account and then swept by HUD for payment of the Section 8 contract.

Rate Reduction Program (IRRP)

When you need to lower the interest rate on your current mortgage and do not want to trigger the “re-refinancing” rules, use the relatively simple IRRP program. This program requires you to stay with your current lender, the original loan balance cannot be adjusted, and no additional repairs or take-outs are permitted. The end result could be increased cash flow for operations. But it is important to take into account any future recapitalization goals as an IRRP also resets a prepayment and loan lockout period.

In summary, it is important to understand a few things about your FHA refinanced property to know best how to proceed with a possible refinancing or interest rate adjustment.

  • Does the property have an over-market, Option 4 Section 8 contract? In these cases, a full refinancing or an (a)7 will be considered a “re-refinancing”, and at HAP renewal those over-market rents will be reduced to market. When might this still be a good option? When there is a sizable amount of equity that has built up at the property that can be tapped for other critical purposes and the lower rents will still support operations and debt service.
     
  • Does the property have an under-market, Option 1, 2 or 4 Section 8 contract? Then a “re-refinancing” does not negatively impact the potential rents at the property, and might possibly increase the rents when renewed under Option 1 or 2 (see below). In this case you have many factors to consider when selecting a financing option that supports your overall goals.

Authors:

Gates Dunaway, The Gates Dunaway Group, LLC 

Sunny Fitzgerald, Centennial Mortgage 

 

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