Financing a Mixed-Use Property is now Easier – Is that a Good Thing?

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Financing options for mixed-use properties have greatly expanded thanks to a change in a long-standing FHA rule limiting FHA Section 203(b) mortgage insurance to properties that have non-residential portions exceeding 25% of the total floor area.

Up until September 14, 2015, a prospective borrower was able to utilize FHA Section 203(b) financing to purchase a mixed-use property under certain conditions.

Those conditions were that if the areas designed for non-residential purposes do not exceed 25% of the total floor area of the property and the non-residential use was subordinate to its residential use.

Some examples of FHA-financed properties that contain small commercial units are beauty salons, dentist offices, office space for attorneys, accountants, etc.

However, HUD’s 4000.1 Handbook (which became effective for FHA loan transactions that obtained their Case Number assignment on and after 9/14/15) states that the non-residential portion of a property can be up to 49% of the total floor area as long as the property is legally permitted and conforms to current zoning requirements.

This is a huge increase (almost double) in the amount of non-residential square footage allowed in an FHA-financed property.  This Rule change will ultimately result in FHA insuring loans on properties that have rather large commercial use and questionable owner-occupancy status.

Of course, the new Rule states that any “nonresidential use may not impair the residential character or marketability of the property”.

This will be a judgment call on behalf of the appraiser & underwriter and, no doubt, there will be inconsistent interpretations of this requirement by lenders, HUD staff, Quality Control reviewers, auditors, and maybe even HUD’s OIG or DOJ Officials in the future.

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Additional concerns that I have with this policy change include the following:

1. Will the FHA Roster Appraiser selected for the appraisal assignment be qualified to appraise a property with 49% non-residential use?
2. Are HUD’s REO Division and their Marketing & Management contractors prepared to handle properties containing larger commercial usage when they are foreclosed on and come into HUD’s REO inventory?
3. It is my belief that there will be a greater likelihood of occupancy fraud involving properties with larger commercial space.

Now that this Rule change is in effect – HUD should consider ways to identify mixed-use properties and their corresponding percentages of commercial use in order to track the default/claim rates on transactions involving such properties.

No explanation was provided by HUD in the 4000.1 Handbook as to why this policy change was made (these type of properties are not typically sought after by first-time homebuyers who are FHA’s target market) in the first place.

However, HUD should be proactive in devoting resources to studying the overall impact that this policy change will have (if any) on the FHA mortgage insurance fund going forward.

Let’s all hope that we will not be reading an article a year from now on HUD/FHA foreclosures involving large numbers of commercial properties.

Stay tuned!

About the Author

Gerry Glavey

Gerard (Gerry) Glavey is Senior Vice President / Chief Credit Officer for LoanLogics. Gerry has decades of experience working in residential mortgage credit and compliance and brings insights that few in the industry can match. In his role, he develops new services and provides support for all post close quality control and quality assurance, pre-close quality control, due diligence services, and document processing services. He spent 37 years with the US Department of Housing and Urban Development, where most recently he was the Director, Processing and Underwriting Division for the Home Ownership Center (HOC) in Philadelphia. In this capacity, Mr. Glavey was responsible for the administration of all HUD/FHA Single Family Loan Origination activities, including underwriting, appraisal and endorsement for the 16 state jurisdiction of this HOC.