For a Standard 203(k) Rehabilitation Mortgage Insurance Program, the mortgagee must either make funds available for additional improvements or apply the funds towards the principal balance if the Contingency Reserve was financed. Mortgage Payment Reserves remaining in the reserve account after the Final Release Notice is issued must be used to reduce the mortgage principal.
For a Limited 203(k), the mortgagee must apply the funds towards the principal balance if the Contingency Reserve was financed.
For additional information see Handbook 4000.1 II.A.8.a.xviii.(C) at https://www.hud.gov/program_offices/administration/hudclips/handbooks/hsgh