July 13, 2022
by Bob Incollingo
Whether you are the borrower or a contractor hired by the borrower, be on guard before you sign an outdated FHA 203k loan package contract for home improvement. The old contract form for the rehabilitation and repair of single family properties is likely to be illegal under New Jersey law.
If you are a 203(k) Consultant, do not recommend an unsupported and outdated FHA form contract to a New Jersey homeowner. Such an endorsement could expose you to serious civil liability.
The Federal Housing Administration (FHA), overseen by the Office of Housing in the U.S. Department of Housing and Urban Development (HUD), is the largest mortgage insurer in the world. Section 203(k) of the National Housing Act allows the FHA to provide mortgage insurance on loans made by FHA-approved lenders for the rehabilitation and repair of single family properties. A 203k rehabilitation loan gives borrowers the ability to finance the price of their purchase along with the costs to repair and upgrade in a single loan.
In a standard 203(k) loan, the HUD-approved lender will assign the borrower an FHA-approved 203(k) consultant selected from the FHA online 203(k) Consultant Roster to assist the borrower in planning the needed construction and completing the related paperwork. The consultant will inspect the property, identify needed repairs or improvements, and provide a work write-up and cost estimate to the borrower for use in completing the loan application. The write-up and estimate will identify the scope of work and reasonable price in what will later be the rehabilitation construction contract.
The process for lender approval of a 203k loan involves a detailed review of the completed application pursuant to underwriting standards set out in Handbook 4000.1, the FHA Single Family Housing Policy Handbook. The Handbook was revised and updated on June 29, 2022, effective September 26, 2022, and requires the lender to obtain and review a written agreement between the borrower and the general contractor, or if there is no general contractor, for each contractor on the rehabilitation project. The Handbook states that as a condition of loan approval, the contractor must agree in writing to complete the work in the write-up for the amount of the cost estimate within the allotted time frame fixed by the 203k consultant.
Over time, banks and mortgage companies approved by the FHA to make 203k program loans have developed packages of forms which they use in selling and processing insured loans. The proprietary lender forms are mainly based on approved FHA model forms which are now or formerly were published online. One form commonly included in the loan file by 203k lenders is (or was) FHA Form 2420, the Homeowner/Contractor Agreement. However, despite being mandated by certain lenders for use by their borrowers, Form 2420 is no longer supported by the FHA, and does not appear on the current list of FHA forms online. Inquiry made to the FHA Resource Center confirms that the form Homeowner/Contractor Agreement is no longer in FHA’s system and that HUD no longer offers a standard remodeling contract to be used for the 203(k) loan program as state law requirements may be different.
State law requirements in New Jersey are indeed different. The outdated FHA Form 2420 Homeowner/Contractor Agreement comes up short under the New Jersey Door-to-Door Home Repair Sales Act of 1968,1 willful violations of which constitute disorderly person offenses subject to a fine of not more than $500.00 for each offense. As drafted, Form 2420 also fails to comply with the Home Improvement Practices Regulations2 of the New Jersey Administrative Code, and the Home Improvement Contractor Registration Act Regulations.3 With respect to these administrative regulations, contractual shortcomings constitute per se violations of the Consumer Fraud Act,4 by the home improvement contractor, while violation of the Contractors’ Registration Act5 is an unlawful practice and a violation of the Consumer Fraud Act, and a knowing violation is a crime of the fourth degree.
Just as the standard form of agreement used by New Jersey real estate brokers for the sale of one to four-family residential properties inserts commission-related clauses that have nothing to do with the terms of sale,6 so too does the outdated 203k rehabilitation contract cater to 203k lenders and their underwriting approval process. For example, the change order procedure prescribed in the FHA Form 2420 flows between the lender and the homeowner, rather than between the homeowner and the contractor, and makes no mention of the contractor’s adoptive signature as New Jersey law requires. For another, the Form 2420 definition of the contract documents – a mainstay of any construction contract – incorporates attachments gathered for the lender’s underwriting process: “The contract documents consist of the architectural exhibits7 listed in the Rehabilitation Loan Agreement between the Owner(s) and the Lender, or as described below (or on an attached sheet):…” FHA Handbook 4000.1 (page 530, Last Revised: 06/29/2022). The homeowner and remodeling contractor, when presented with an outdated FHA Form 2420 Homeowner/Contractor Agreement, will likely accept without question the lender-centric contract of adhesion, for fear of losing the loan, the project, or both.
Banks and mortgage companies have some catching up to do in this context. In the opinion of the author, a lender who conditions loan approval on the use of an illegal and ultimately unenforceable form rehabilitation contract is soliciting a lawful act to be done in an unlawful manner – nothing less than a civil conspiracy by definition, and consumer fraud in context.
- N.J.S.A. 17:16C-97 to -103
- N.J.A.C. 13:45A-16.1 et seq.
- N.J.A.C. 13:45A-17.1 et seq.
- N.J.S.A. 56:8-1 et seq.
- N.J.S.A. 56:8-136 et seq.
- New Jersey Realtors® Form 118-Statewide 4/17 , clauses 27 through 34, inclusive
- The phrase “architectural exhibits” is a term of art defined in the FHA 203k program loan insurance regulations, and is not one commonly used in NJ residential construction or found in local home improvement contracts. Under the Architectural exhibits may include, but are not limited to, the following:
- well certification;
- septic certification;
- termite report (including all outbuildings);
- proposed plot plans for new additions;
- foundation certification by a licensed structural engineer if:
- the existing Structure will be moved to a new foundation;
- the Structure is being reconstructed on the existing foundation; or
- the existing Structure will be elevated.
- cabinetry plans and elevations;
- New Construction exhibits to obtain a building permit for an addition;
- grading and drainage plans; or
- engineering and soil/geotechnical reports.
Cherry Hill construction attorney Robert J. Incollingo practices law across the State of New Jersey, focusing on litigation and transactions related to construction, real estate and related business matters. He is a member of the Camden, Burlington, and New Jersey State Bar Associations, as well as the unified State Bar of California. He is a past co-chair of the New Jersey State Bar Association Construction Law Section, and a member of the Builders League of South Jersey and the NJ Builders Association. A graduate of Temple University and its School of Law, South Jersey construction lawyer Bob Incollingo is a frequent speaker at professional conferences on construction and real estate law topics, and serves as a commercial arbitrator by appointment of the Superior Court in Camden and Burlington Counties.