HUD 221(d)(4) Construction Requirements: Bonds, Builders Risk, Insurance and Retainage

Section 3.2.7.A requires assurance of completion of construction in the form of a combined performance and payment bond or cash or a letter of credit in an amount approved by HUD. Section 8.14.C.13 then sets the amounts by building type for construction or rehabilitation costs over $500,000.

• Non-elevator buildings, or elevator buildings of 4 stories or less: corporate surety payment and performance bonds, each for 100% of HUD's estimated cost of construction or rehabilitation, or a cash deposit or letter of credit of 15% of that estimate.
• Elevator buildings of 5 or more stories: the same 100%/100% bonds, or a cash deposit or letter of credit of 25% of HUD's estimated cost.
• The cash or letter of credit route uses a Completion Assurance Agreement (form HUD-92450, and HUD-92450M at closing), which the general contractor funds with a cash deposit or an unconditional, irrevocable letter of credit.

HUD prescribes the bond forms. The Closing Guide (Sections 19.5.6.1 to 19.5.6.3) names the Performance Bond-Dual Obligee, form HUD-92452M, which must name the lender and HUD as obligees, and the Payment Bond, form HUD-92452A-M, which must name the lender, HUD and the borrower. The lender and HUD keep first priority right to call the performance bond, and no equity investor may be named as an obligee, which matters on a tax credit deal where the investor may expect bond rights.

Sureties must be on the U.S. Treasury's accredited list in Circular 570, and the bonds must not exceed the limits listed there for that surety. The surety must send power of attorney confirmation on the day of closing. A letter of credit may replace cash for completion assurance at the lender's option, and the guide says HUD will neither review the letter of credit nor render an opinion on its sufficiency.

A surety bond is credit, not insurance. If HUD or the lender calls the bond, the surety performs or pays and then typically looks to the contractor and its indemnitors for recovery, subject to the terms of the bonds issued.

Section 3.9.1 sets the construction-period casualty and liability minimums. Section 3.9.3.A then requires HUD and the lender to be named as additional insured, with the clause loss payable to the mortgagee, its successors and assigns. It also requires carriers to hold an A.M. Best Financial Strength Rating of B+ or better. A contractor whose program is written with a lower-rated carrier may need to change markets before closing.

• General liability: a Commercial General Liability form with limits of not less than $1 million per occurrence and $2 million in the aggregate, endorsed to include owners and contractors protective coverage.
• Auto: the greater of the state minimum or $300,000 for one person and $500,000 for more than one person, plus $100,000 property damage, applying to owned, non-owned and hired vehicles.
• Flood: in a Special Flood Hazard Area, flood insurance is required during construction when the property becomes insurable (see the flood section below).

HUD's Property Insurance Requirements form (the edition shown is dated 07/2005) asks for a standard Builders Risk Completed Value form for fire, extended coverage and vandalism and malicious mischief, written for 100% of the insurable value of the completed building or buildings and in force by the first insured advance. The policy shows the mortgagor as the insured; the general contractor and subcontractors may be additional insureds as their interests may appear, and the policy carries a non-contribution mortgage or mortgagee clause payable to the mortgagee and the FHA Commissioner.

The MAP Guide's cost estimating guidance adds that builders risk may be placed by either the general contractor or the borrower and that the contractor commonly places it, but the borrower must be named as an insured party under the form's requirements. Where the contractor buys the policy, the declarations, insured wording and mortgagee clause are worth checking against the form line by line before the first draw. Perils beyond those the form names, along with sublimits and deductibles, can vary by carrier guidelines and programs.

The two HUD documents state the flood amount differently, and this page does not reconcile them. The MAP Guide (March 2021, Section 3.9.1) requires flood insurance during construction in a Special Flood Hazard Area once the property becomes insurable, in an amount of at least the greater of the NFIP maximum or the replacement cost of the bottom two stories above grade.

HUD's Property Insurance Requirements form (07/2005, item 6) states the amount as at least the lesser of the outstanding principal balance or the NFIP maximum. The MAP Guide is the newer document, but which passage controls on a given loan is a question for the lender and HUD. Ask the lender to state the flood amount it will accept in writing before binding.

Section 3.2.2 states that Davis-Bacon wage requirements apply to new construction and substantial rehabilitation for both Insurance of Advances and Insurance Upon Completion. Under Section 3.2.6.A, the general contractor and all subcontractors must comply with federal wage and reporting requirements under the Davis-Bacon Act and the Copeland Act, which requires weekly certified payroll reports. The guide excludes off-site improvements, and demolition or site work done before the federal nexus (a pre-application or firm commitment application to HUD).

Section 12.15.5 provides for a 10% holdback from the contractor's monthly payments. After 50% completion, retainage may drop from 10% to 5% until 75% completion and then to 2.5% until Final Endorsement, if the contractor has no identity of interest above a 5% equity interest, the surety consents in writing in advance and HUD approves. A contractor with an identity of interest above 5% generally cannot have retainage released until Final Endorsement, with limited exceptions. Retainage held to the end is working capital the contractor's surety typically weighs when it sets the bond line.

Section 3.2.5 requires the borrower to submit a cost certification prepared by an independent Certified Public Accountant, and the final mortgage can be reduced after HUD reviews it. General contractors and subcontractors must submit their own cost certification if a cost-plus construction contract is used or there is an identity of interest with the borrower.

Latent defect assurance is stated in two passages with different bases. Section 12.16.S, for Insurance Upon Completion, requires a builder's warranty and a latent defect agreement plus either a cash escrow deposit of 2.5% of the total cost of construction held for 15 months or an irrevocable letter of credit for 2.5% of the cost of construction. The Closing Guide's list for Insurance Upon Completion closings (Section 19.6.5.4.B, item 6, Escrow Agreement for Latent Defects, form HUD-92414M) describes a cash escrow of 2.5% of the principal amount of the Security Instrument held 15 months, a letter of credit or a surety bond on form HUD-3259 from a Circular 570 surety for 10% of the construction contract, effective for two years after Project Substantial Completion. Ask the lender which base it will apply.