FHA Mortgagee Letter 2023-17 — Revisions to Rental Income Policies, Property Eligibility, and Appraisal Protocols for Accessory Dwelling Units

(b) Standard A Single Family residential one-unit Property with a single ADU remains a one-unit Property. For any Single Family residential Property with two or more units, a separate additional Dwelling Unit must be considered as an additional unit. Rental Income (TOTAL) (II.A.4.c.xii(I)) (1) Definition Rental Income refers to income received or to be received from the subject Property or other real estate holdings. (2) Rental Income Received from the Subject Property (TOTAL)

(a) Standard The Mortgagee may consider Rental Income from existing and prospective renters if documented in accordance with the following requirements. Rental Income from the subject Property may be considered Effective Income when the Property is or will be a one-unit dwelling with an ADU, a two- to four-unit dwelling, or an acceptable one- to four-unit Investment Property. No income from commercial space may be included in Rental Income calculations.

(b) Required Documentation Documentation varies depending upon the length of time the Borrower has owned the Property and must meet one of the applicable documentation requirements below: (i) Limited or No History of Rental Income Where the Borrower does not have a history of Rental Income from the subject since the previous tax filing: Two- to Four-Units The Mortgagee must verify and document the proposed Rental Income by obtaining an appraisal showing fair market rent (use Fannie Mae Form 1025/Freddie Mac Form 72, Small Residential Income Property Appraisal Report) and, if available, the prospective leases. One-Unit The Mortgagee must verify and document the proposed Rental Income by obtaining a Fannie Mae Form 1004/Freddie Mac Form 70, Uniform Residential Appraisal Report (URAR), and a Fannie Mae Form 1007/Freddie Mac Form 1000, Single Family Comparable Rent Schedule, showing fair market rent and, if available, the prospective leases. One-Unit with an Accessory Dwelling Unit The Mortgagee must verify and document the proposed Rental Income from the ADU by obtaining a Fannie Mae Form 1004/Freddie Mac Form 70, URAR, and a Fannie Mae Form 1007/Freddie Mac Form 1000, Single Family Comparable Rent Schedule, showing fair market rent and, if available, the prospective leases. (ii) History of Rental Income Where the Borrower has a history of Rental Income from the subject Property since the previous tax filing, the Mortgagee must verify and document the existing Rental Income by obtaining the Borrower’s most recent tax returns, including Schedule E, from the previous two years. For Properties owned less than two years, the Mortgagee must document the date of acquisition by providing a copy of the deed, Closing Disclosure, or other legal document.

(c) Calculation of Effective Income The Mortgagee must add the net subject property Rental Income to the Borrower’s gross income to calculate Effective Income. The Mortgagee may not reduce the Borrower’s total Mortgage Payment by the net subject property Rental Income. (i) Limited or No History of Rental Income To calculate the Effective Income from the subject Property where the Borrower does not have a history of Rental Income from the subject Property since the previous tax filing, the Mortgagee must use 75 percent of the lesser of: • fair market rent reported by the Appraiser; or • the rent reflected in the lease or other rental agreement. One-Unit with an Accessory Dwelling Unit The amount of the Rental Income from an ADU used as Effective Income must not exceed 30 percent of the total monthly Effective Income used to qualify the Borrower. (ii) History of Rental Income The Mortgagee must calculate the Rental Income by averaging the amount shown on Schedule E. Depreciation, mortgage interest, taxes, insurance, and any HOA dues shown on Schedule E may be added back to the net income or loss. If the Property has been owned for less than two years, the Mortgagee must annualize the Rental Income for the length of time the Property has been owned. (3) Rental Income from Other Real Estate Holdings (TOTAL)

(a) Standard Rental Income from other real estate holdings may be considered Effective Income if the documentation requirements listed below are met. If Rental Income is being derived from a Property being vacated by the Borrower, the Borrower must be relocating to an area more than 100 miles from the Borrower’s current Principal Residence. The Mortgagee must obtain a lease agreement of at least one year’s duration after the Mortgage is closed and evidence of the payment of the security deposit or first month’s rent.

(b) Required Documentation (i) Limited or No History of Rental Income Where the Borrower does not have a history of Rental Income for the Property since the previous tax filing, including Property being vacated by the Borrower, the Mortgagee must obtain an appraisal evidencing market rent and that the Borrower has at least 25 percent equity in the Property. The appraisal is not required to be completed by an FHA Roster Appraiser. Two- to Four-Units The Mortgagee must verify and document the proposed Rental Income by obtaining an appraisal showing fair market rent (use Fannie Mae Form 1025/Freddie Mac Form 72, Small Residential Income Property Appraisal Report) and, if available, the prospective leases. One-Unit or One-Unit with an Accessory Dwelling Unit The Mortgagee must verify and document the proposed Rental Income by obtaining a Fannie Mae Form 1004/Freddie Mac Form 70, Uniform Residential Appraisal Report (URAR) and a Fannie Mae Form 1007/Freddie Mac Form 1000, Single Family Comparable Rent Schedule, showing fair market rent and, if available, the prospective leases. (ii) History of Rental Income The Mortgagee must obtain the Borrower’s last two years’ tax returns with Schedule E.

(c) Calculation of Effective Net Rental Income (i) Limited or No History of Rental Income [Text was deleted in this section.] To calculate the effective net Rental Income from other real estate holdings where the Borrower does not have a history of Rental Income since the previous tax filing, the Mortgagee must deduct the Principal, Interest, Taxes, and Insurance (PITI) from 75 percent of the lesser of: • fair market rent reported by the Appraiser; or • the rent reflected in the lease or other rental agreement. (ii) History of Net Rental Income The Mortgagee must calculate the net Rental Income by averaging the amount shown on the Schedule E provided the Borrower continues to own all Properties included on the Schedule E. Depreciation shown on Schedule E may be added back to the net income or loss. Positive net Rental Income must be added to the Borrower’s Effective Income. Negative net Rental Income must be included as a debt/liability. If the Property has been owned for less than two years, the Mortgagee must: • annualize the Rental Income for the length of time the Property has been owned; and • document the date of acquisition by providing the deed, Closing Disclosure, or other legal document. (4) Boarders of the Subject Property (TOTAL) (a) Definition Boarder refers to an individual renting space inside the Borrower’s Dwelling Unit. A renter of an ADU is not a Boarder. (b) Standard Rental Income from Boarders is only acceptable if the Borrower has a two-year history of receiving income from Boarders that is shown on the tax return and the Borrower is currently receiving Boarder income. (c) Required Documentation The Mortgagee must obtain two years of the Borrower’s tax returns evidencing income from Boarders and the current lease. For purchase transactions, the Mortgagee must obtain a copy of the executed written agreement documenting their intent to continue boarding with the Borrower.

(d) Calculation of Effective Income The Mortgagee must calculate the Effective Income by using the lesser of the two-year average or the current lease. General Asset Requirements (TOTAL) (II.A.4.d.i) (C) Reserves (TOTAL) The Mortgagee must verify and document all assets submitted to the AUS. Reserves refer to the sum of the Borrower’s verified and documented liquid assets minus the total funds the Borrower is required to pay at closing. Reserves do not include: • the amount of cash taken at settlement in cash-out transactions; • incidental cash received at settlement in other loan transactions; • equity in another Property; or • borrowed funds from any source. (1) Required Reserves for One-Unit with an Accessory Dwelling Unit Properties If Rental Income is being used as Effective Income to qualify the Borrower, the Mortgagee must verify and document Reserves equivalent to two months’ PITI after closing for one-unit with an ADU Properties. (2) Required Reserves for Three- to Four-Unit Properties The Mortgagee must verify and document Reserves equivalent to three months’ PITI after closing for three- to four-unit Properties. Rental Income (Manual) (II.A.5.b.xii(I)) (1) Definition Rental Income refers to income received or to be received from the subject Property or other real estate holdings. (2) Rental Income Received from the Subject Property (Manual)

(a) Standard The Mortgagee may consider Rental Income from existing and prospective renters if documented in accordance with the following requirements. Rental Income from the subject Property may be considered Effective Income when the Property is or will be a one-unit dwelling with an ADU, a two- to four-unit dwelling, or an acceptable one- to four-unit Investment Property. No income from commercial space may be included in Rental Income calculations.

(b) Required Documentation Required documentation varies depending upon the length of time the Borrower has owned the Property. (i) Limited or No History of Rental Income Where the Borrower does not have a history of Rental Income from the subject since the previous tax filing: Two-to Four-Units The Mortgagee must verify and document the proposed Rental Income by obtaining an appraisal showing fair market rent (use Fannie Mae Form 1025/Freddie Mac Form 72, Small Residential Income Property Appraisal Report) and, if available, the prospective leases. One-Unit The Mortgagee must verify and document the proposed Rental Income by obtaining a Fannie Mae Form 1004/Freddie Mac Form 70, Uniform Residential Appraisal Report (URAR), and a Fannie Mae Form 1007/Freddie Mac Form 1000, Single Family Comparable Rent Schedule, showing fair market rent and, if available, the prospective leases. One-Unit with an Accessory Dwelling Unit The Mortgagee must verify and document the proposed Rental Income from the ADU by obtaining a Fannie Mae Form 1004/Freddie Mac Form 70, URAR, and a Fannie Mae Form 1007/Freddie Mac Form 1000, Single Family Comparable Rent Schedule, showing fair market rent and, if available, the prospective leases. (ii) History of Rental Income Where the Borrower has a history of Rental Income from the subject since the previous tax filing, the Mortgagee must verify and document the existing Rental Income by obtaining the existing lease, rental history over the previous 24 months that is free of unexplained gaps greater than three months (such gaps could be explained by student, seasonal or military renters, or property rehabilitation), and the Borrower’s most recent tax returns, including Schedule E, from the previous two years. For Properties owned less than two years, the Mortgagee must document the date of acquisition by providing the deed, Closing Disclosure, or other legal document.

(d) Calculation of Effective Income The Mortgagee must calculate the Effective Income by using the lesser of the two-year average or the current lease. General Asset Requirements (Manual) (II.A.5.c.i) (C) Reserves (Manual) Reserves refer to the sum of the Borrower’s verified and documented liquid assets minus the total funds the Borrower is required to pay at closing. Reserves do not include: • the amount of cash taken at settlement in cash-out transactions; • incidental cash received at settlement in other loan transactions; • gift funds; • equity in another Property; or • borrowed funds from any source. (1) Required Reserves for One-to Two-Unit Properties The Mortgagee must verify and document Reserves equivalent to one month’s PITI after closing for one- to two-unit Properties. (2) Required Reserves for Three- to Four-Unit Properties The Mortgagee must verify and document Reserves equivalent to three months’ PITI after closing for three- to four-unit Properties. (3) Required Reserves for One-Unit with an Accessory Dwelling Unit Properties If Rental Income is being used to qualify, the Mortgagee must verify and document Reserves equivalent to two months’ PITI after closing for one-unit with an ADU Properties. 203(k) Rehabilitation Mortgage Insurance Program (II.A.8.a) ii. Borrower Eligibility The Borrower must meet the eligibility requirements found in the Borrower Eligibility (II.A.1.b.ii) section, and the additional guidance provided here related to nonprofit agency Borrowers. The Mortgagee must verify and document the nonprofit agency Borrower’s caseload. The Mortgagee must review the Nonprofit List in FHA Connection (FHAC), and ensure the maximum 203(k) case load limitation is not exceeded for nonprofit Borrowers. (A) Rental Income Received from the Subject Property One-Unit with an Accessory Dwelling Unit If the subject Property is a one-unit with an Accessory Dwelling Unit (ADU) and the Borrower does not have a history of Rental Income from the subject Property since the previous tax filing, to calculate the Effective Income the Mortgagee must use 50 percent of the lesser of: • fair market rent reported by the Appraiser; or • the rent reflected in the lease or other rental agreement. Mortgagees must apply this requirement for both Mortgages underwritten through TOTAL Scorecard and manual underwriting. Standard 203(k) Eligible Improvements (II.A.8.a.vi(A)) (1) Types of Improvements Types of eligible improvements include, but are not limited to: • converting a one-family Structure to a one-family Structure with an ADU, two-, three-, or four-family Structure; • adding an Accessory Dwelling Unit (ADU) that will be attached to an existing Structure; • renovating an existing ADU that is attached or unattached to an existing Structure; • decreasing an existing multi-unit Structure to a one- to four-family Structure; • reconstructing a Structure that has been or will be demolished, provided the complete existing foundation system is not affected and will still be used; • repairing, reconstructing, or elevating an existing foundation where the Structure will not be demolished; • purchasing an existing Structure on another site, moving it onto a new foundation, and repairing/renovating it; • making structural alterations such as the repair or replacement of structural damage, additions to the Structure, and finished attics and/or basements; • rehabilitating, improving, or constructing a garage; • eliminating health and safety hazards that would violate HUD’s Minimum Property Requirements (MPR) (II.A.3.a.ii); • installing or repairing wells and/or septic systems; • connecting to public water and sewage systems; • repairing/replacing plumbing, heating, AC, and electrical systems; • making changes for improved functions and modernization; • making changes for aesthetic appeal; • repairing or adding roofing, gutters, and downspouts; • making energy conservation improvements; • creating accessibility for persons with disabilities; • installing or repairing fences, walkways, and driveways; • installing a new refrigerator, cooktop, oven, dishwasher, built-in microwave oven, and washer/dryer; • repairing or removing an in-ground swimming pool; • installing smoke detectors; • making site improvements; • landscaping; • installing or repairing exterior decks, patios, and porches; • constructing a windstorm shelter; and • covering lead-based paint stabilization costs, if the Structure was built before 1978, in accordance with the Single Family mortgage insurance lead-based paint rule (24 CFR §§ 200.805 and 200.810(c)) and the U.S. Environmental Protection Agency’s (EPA) Renovation, Repair and Painting Rule (40 CFR Part 745, especially subparts E and Q). Cash-Out Refinances (II.A.8.d.v(A)) (A) Borrower Eligibility Nonprofit agencies, state and local government agencies and Instrumentalities of Government are not eligible for cash-out refinances. Income from a non-occupant co-Borrower may not be used to qualify for a cash-out refinance. If the subject Property is a one-unit with an Accessory Dwelling Unit (ADU), rental income from the ADU cannot be used as Effective Income to qualify for a cash-out refinance. Mortgagees must apply this requirement for both Mortgages underwritten through TOTAL Scorecard and manual underwriting. New Construction (II.A.8.i) ii. Eligible Property Types [Updates to this section must be implemented for case numbers assigned on or after January 4, 2021] The following property types are eligible for New Construction financing: • Site Built Housing (one-unit, one-unit with an Accessory Dwelling Unit (ADU), or two- to four-units) • Condominium units in Approved Projects or Legal Phases • Manufactured Housing (one-unit or one-unit with an ADU) Acceptable Appraisal Reporting Forms and Protocols (II.D.3) Property/Assignment Type Acceptable Reporting Form Single Family, Detached, Attached or Semi-Detached Residential Property (One- Unit Property or a One-Unit Property with a Single Accessory Dwelling Unit (ADU)) Fannie Mae Form 1004/Freddie Mac Form 70, Uniform Residential Appraisal Report (URAR); Mortgage Industry Standards Maintenance Organization (MISMO) 2.6 Government-Sponsored Enterprise (GSE) format Single Family Comparable Market Rent Analysis Fannie Mae Form 1007/Freddie Mac Form 1000, Single Family Comparable Rent Schedule Single Unit Condominium Fannie Mae Form 1073/Freddie Mac Form 465, Individual Condominium Unit Appraisal Report; MISMO 2.6 GSE format Manufactured (HUD Code) Housing (One-Unit Property or a One-Unit Property with a Single ADU) Fannie Mae Form 1004C/Freddie Mac Form 70B, Manufactured Home Appraisal Report; MISMO 2.6 Errata 1 format Small Residential Income Properties (Two- to Four-Units) Fannie Mae Form 1025/Freddie Mac Form 72, Small Residential Income Property Appraisal Report; MISMO 2.6 Errata 1 format Update of Appraisal (All Property Types) Summary Appraisal Update Report Section of Fannie Mae Form 1004D/Freddie Mac Form 442, Appraisal Update and/or Completion Report; MISMO 2.6 Errata 1 format Compliance or Final Inspection for New Construction or New Construction for Manufactured Housing Form HUD-92051, Compliance Inspection Report, in Portable Document Format (PDF) Compliance or Final Inspection for Existing Property Certification of Completion Section of Fannie Mae Form 1004D/Freddie Mac Form 442, Appraisal Update and/or Completion Report; MISMO 2.6 Errata 1 format Characteristics of Property Improvements (II.D.3.b.vii) (E) Accessory Dwelling Unit (1) Identification of an Accessory Dwelling Unit An Accessory Dwelling Unit (ADU) is subordinate in size, location, and appearance to the primary Dwelling Unit and may or may not have separately metered utilities. The ADU must comport with zoning requirements, which may include a legal nonconforming use. (2) Required Analysis and Reporting Protocols As part of the highest and best use analysis, the Appraiser must make the determination to classify the Property as a Single Family dwelling with an ADU, or a two-family dwelling. The conclusion of the highest and best use analysis will then determine the classification of the Property and the required analysis reporting. (a) One-Unit Single Family Dwelling with an Accessory Dwelling Unit When the highest and best use analysis determines the Property to be a Single Family dwelling with an ADU, the Appraiser must: • provide a description of the ADU characteristics; • summarize the ADU’s market acceptance; • report the Gross Living Area (II.D.3.c) of the ADU separate from the primary dwelling; • state whether the ADU can be legally rented without restrictions; and • report the current ADU occupancy and the relevant details of any known lease agreements. (b) Optional Accessory Dwelling Unit Market Rent Analysis The Mortgagee may request an opinion of the ADU market rent in the scope of work. The Appraiser may provide the ADU market rent only if: • the highest and best use is determined to be a one-unit Single Family dwelling with an ADU; • the ADU is legally rentable without restrictions; and • the Appraiser determines that a non-transient (see Restriction on Investment Properties for Hotel and Transient Use (II.A.1.b.iv(A)(4))) monthly market rent can be credibly developed. The analysis of the rental data must include support for the ADU comparable rental selections, the adjustments applied, and the opinion of the ADU market rent. The Appraiser must include the ADU opinion of market rent on Fannie Mae Form 1007/Freddie Mac Form 1000, Single Family Comparable Rent Schedule, as an attachment to the appraisal and include the following supplemental statement: “This form is completed to provide FHA an opinion of the market rent of the subject’s legally rentable Accessory Dwelling Unit (ADU). Sufficient competitive market data exists to develop credible results.” Appraisers completing the optional ADU market rent analysis must comply with FHA’s Appraiser Competency Requirement (I.B.1.e.ii). The Appraiser must contact the Mortgagee if unable to fulfill a request for ADU market rent analysis. (c) Comparable Selection for Optional Accessory Dwelling Unit Market Rent Analysis The Appraiser must include a sufficient number of comparable rents to produce a credible ADU market rent estimate. The comparables used to develop the ADU market rent must not include properties rented for hotel or transient purposes, or for periods less than 30 Days. The Appraiser must include at least one comparable rental that is a Single Family dwelling with a rented ADU. If a Single Family dwelling with a rented ADU is not available, the Appraiser must supplement with the most appropriate rental available and summarize the reason for the selection and how the marketability of the ADU was determined. The policy changes amend the HECM Financial Assessment and Property Charge Guide, as follows: HECM Financial Assessment and Property Charge Guide Section 3.50, Rental Income from the Subject Property Rental income refers to income received or to be received from the subject property or other real estate holdings. The mortgagee may consider rental income from existing and prospective renters if documented in accordance with the following requirements. Rental income from the subject property may be considered effective income when the property is a one-unit dwelling with an Accessory Dwelling Unit (ADU) or a two- to four-unit dwelling. No income from commercial space may be included in rental income calculations. Required documentation varies depending upon the length of time the borrower has owned the property. Limited or No History of Rental Income Where the borrower does not have a history of rental income from the subject property since the previous tax filing: Two-to Four-Units The mortgagee must verify and document the proposed rental income by obtaining an appraisal showing fair market rent (use Fannie Mae Form 1025/Freddie Mac Form 72, Small Residential Income Property Appraisal Report) and, if available, the prospective leases. One-Unit or One-Unit with an Accessory Dwelling Unit The mortgagee must verify and document the proposed rental income by obtaining a Fannie Mae Form 1004/Freddie Mac Form 70, Uniform Residential Appraisal Report (URAR), and a Fannie Mae Form 1007/ , Single Family Comparable Rent Schedule, showing fair market rent and, if available, the prospective lease. Calculation of Rental Income Where the borrower has a history of rental income from the subject property since the previous tax filing, the mortgagee must verify and document the existing rental income by obtaining the existing lease, rental history over the previous 24 months that is free of unexplained gaps greater than three months (such gaps could be explained by student, seasonal or military renters, or property rehabilitation), and the borrower’s most recent tax returns, including Schedule E, from the previous two years. For properties owned less than two years, the mortgagee must document the date of acquisition by providing the deed, closing disclosure, or other legal document. Section 3.51, Calculating Rental Income from the Subject Property The mortgagee must add the net subject property rental income to the borrower’s gross income to calculate effective income. Limited or No History of Rental Income To calculate the effective income from the subject property where the borrower does not have a history of rental income from the subject property since the previous tax filing, the mortgagee must use 75 percent of the lesser of: • fair market rent reported by the appraiser; or • the rent reflected in the lease or other rental agreement. The amount of the rental income from an ADU used as effective income must not exceed 30% of the total monthly effective income. History of Rental Income The mortgagee must calculate the rental income by averaging the amount shown on the Schedule E. Depreciation, mortgage interest, taxes, insurance, and any HOA dues shown on Schedule E may be added back to the net income or loss. If the property has been owned for less than two years, the mortgagee must annualize the rental income for the length of time the property has been owned. Section 3.52, Rental Income – Other Real Estate Holdings Rental income from other real estate holdings may be considered effective income if the documentation requirements listed below are met. If rental income is being derived from a property being vacated by the borrower, the borrower must be relocating to an area more than 100 miles from the borrower’s current principal residence. The mortgagee must obtain a lease agreement of at least one year’s duration after the mortgage is closed and evidence of the payment of the security deposit or first month’s rent. Limited or No History of Rental Income Where the borrower does not have a history of rental income for the property since the previous tax filing, including property being vacated by the borrower, the mortgagee must obtain an appraisal evidencing market rent and that the borrower has at least 25 percent equity in the property. The appraisal is not required to be completed by an FHA Roster appraiser. • Two- to Four-Units The mortgagee must verify and document the proposed rental income by obtaining an appraisal showing fair market rent (use Fannie Mae Form 1025/Freddie Mac Form 72, Small Residential Income Property Appraisal Report) and, if available, the prospective leases. • One-Unit or One-Unit with an Accessory Dwelling Unit The mortgagee must verify and document the proposed rental income by obtaining a Fannie Mae Form 1004/Freddie Mac Form 70, Uniform Residential Appraisal Report, and a Fannie Mae Form 1007/Freddie Mac Form 1000, Single Family Comparable Rent Schedule, showing fair market rent and, if available, the prospective lease. History of Rental Income The mortgagee must obtain the borrower’s last two years’ tax returns with Schedule E. Section 3.53, Calculating Rental Income from Other Real Estate Holdings Limited or No History of Rental Income To calculate the effective net rental income from other real estate holdings where the borrower does not have a history of rental income since the previous tax filing, the mortgagee must deduct the principal, interest, taxes, and insurance payment (PITI) from 75 percent of the lesser of: • fair market rent reported by the appraiser; or • the rent reflected in the lease or other rental agreement. Calculation of Rental Income The mortgagee must calculate the net rental income by averaging the amount shown on the Schedule E provided the borrower continues to own all properties included on the Schedule E. Depreciation shown on Schedule E may be added back to the net income or loss. If the property has been owned for less than two years, the mortgagee must: • annualize the rental income for the length of time the property has been owned; and • document the date of acquisition by providing the deed, closing disclosure, or other legal document. Positive net rental income must be added to the borrower’s effective income. Negative net rental income must be included as a debt/liability. Section 3.54, Income from Boarders of the Subject Property Boarder refers to an individual renting space inside the borrower’s dwelling unit. A renter of an ADU is not a boarder. Rental income from boarders is only acceptable if the borrower has a two- year history of receiving income from boarders that is shown on the tax return and the borrower is currently receiving boarder income. The mortgagee must obtain two years of the borrower’s tax returns evidencing income from boarders and the current lease. For HECM for Purchase transactions, the mortgagee must obtain a copy of the executed written agreement documenting their intent to continue boarding with the borrower.