Servicing FHA single-family loans.

This article provides guidance on FHA's loss-mitigation procedures and other servicing requirements, including the most recent changes and additions.

The Federal Housing Administration (FHA) provides insurance for private lenders against loss on mortgages that finance homes, multifamily projects, property improvements and other properties. During fiscal year 1995, FHA acquired 55,960 single-family properties (one- to- four-family dwellings) through foreclosure, and incurred an average loss of $26,555 on the resale of each of these properties. Losses under FHA's Mortgage Assignment Program were substantially higher, averaging about $47,000 per assigned mortgage. The intent of the Mortgage Assignment Program was to offer qualified borrowers an opportunity to avoid foreclosure by transferring the mortgage from the lender to HUD, which then owned the mortgage and worked directly with the borrower to cure the default. Assigned mortgages cost the FHA $1.5 billion more between 1989 and 1994 than if the assignment program had not existed. And according to the General Accounting Office (GAO), more than half of these assigned mortgages ended in foreclosure anyway.

On April 25, 1996, Congress passed legislation terminating the Mortgage Assignment Program. The new law also gave the FHA the authority to implement new loss-mitigation procedures and enhance existing ones. FHA will base lender-performance rankings on how effectively lenders use these loss-mitigation tools to avoid foreclosure claims. Lenders who demonstrate superior performance in loss mitigation, as determined annually by FHA, will be rewarded through cash payments.

Conversely, as previously provided in HUD Handbook 4330.1 REV-5, "Administration of Insured Home Mortgages," dated September 29, 1994, failure to follow these procedures could result in curtailment of insurance claims. Lenders are required to document monthly evaluations of borrowers in default to determine which loss-mitigation tools are appropriate. The lender is responsible for determining which loss mitigation tools are appropriate for the borrower at that time considering FHA's guidance and the borrower's particular circumstances. Lenders are required to maintain documents supporting loss mitigation in loan files, including special forbearance plans, credit reports, income verifications and broker's price opinions.

Loss-mitigation procedures designed to keep the borrower in the home include housing counseling, forbearance, refinancing, mortgage modification and partial claims. When the borrower cannot remain in the home, loss-mitigation procedures to avoid foreclosure include preforeclosure sale and deed-in-lieu of foreclosure.

Housing counseling

HUD is required to ensure the availability of homeownership counseling throughout the United States, with priority given to areas experiencing high rates of foreclosure. HUD may provide the counseling, or the agency may contract with public or private organizations to provide the counseling. Any homeowner whose principal residence is subject to a home loan secured by a mortgage or lien and who cannot make payments or cure an existing default because of an involuntary loss or reduction in income is eligible for housing counseling, except for a homeowner receiving federal financial assistance on farm housing. The loan does not have to be insured by HUD for the homeowner to be eligible for counseling.

The counseling agency interviews the homeowner to confirm eligibility and determine the nature of the problem, designs a counseling plan, makes appointments with community agencies offering assistance, contacts the lender for help in devising a plan to cure the default, and monitors the implementation of the plan. Lenders are required to notify homeowners of the availability of housing counseling within 45 days from the due date for any amount unpaid for both conventional loans and loans insured by HUD. The lender must notify the homeowner of any counseling it offers. It must also tell the homeowner about either the counseling available in the homeowner's area or the HUD toll-free telephone number for assistance in locating housing counseling.

According to Mortgagee Letter 96-61, "FHA Loss-Mitigation Procedures - Special Instructions," dated November 12, 1996, future mortgagee letters will address housing counseling. Clearly, however, housing counseling will remain an important FHA loss-mitigation tool.

Forbearance

FHA grants the lender substantial authority to extend forbearance relief to deserving borrowers. FHA classifies forbearance agreements as informal, formal and special.

* Informal forbearance. Informal forbearance plans are oral agreements. They may be used when the arrearage is small and/or the duration of the agreement will be three months or less.

* Formal forbearance. Formal forbearance plans are written agreements. A formal forbearance plan lasts less than 18 months.

* Special forbearance. Special forbearance provides for a continuation of lender forbearance beyond time frames when foreclosure should be initiated. Borrowers are eligible for special forbearance if they have recently experienced an involuntary reduction in income or an increase in living expenses and the lender determines that the borrower has a reasonable ability to pay under the terms of the forbearance plan to eliminate the arrearage.

Special forbearance provides for a period of reduced or suspended payments that may result in an arrearage not to exceed the equivalent of 12 months of principal, interest, taxes and insurance premiums (PITI) over a period of up to 18 months from the date of the oldest unpaid installment. Lenders may establish a plan that extends beyond 18 months, but after that time the payments must equal or exceed the monthly mortgage installment under the note. Special forbearance plans may not include late charges or foreclosure costs, but foreclosure costs may be collected from the borrower before special forbearance is initiated.

For lender eligibility for incentive payments, a written special forbearance plan must be executed no earlier than four missed payments (120 days from the due date of the oldest unpaid installment) and no later than seven missed payments (210 days from the date of the oldest unpaid installment). FHA will pay lenders $100 for each special forbearance agreement executed, regardless of the outcome of the plan. Lenders whose overall loss-mitigation performance is ranked in the top 25 percentile, beginning March 1997, will become eligible for incentive payments of $200 for all special forbearance agreements executed during fiscal year 1997 based on their 1996 scores.

If the default is not cured and a conveyance claim results, the lender receives unpaid mortgage note interest, including all amounts accrued before the execution of the forbearance computed to the earliest of the date of institution of foreclosure, the date of the deed-in-lieu, or a date 90 days (or fewer if approved by the HUD field office) following the date the borrower fails to meet the requirements of the forbearance agreement. This contrasts with the payment of interest at the debenture rate from the date of default for cases where no special forbearance was used.

Partial claim

FHA will pay a partial claim to cure a default if the loan is at least four months delinquent, but the arrearage does not exceed 12 months PITI. A partial claim may not include late charges or foreclosure costs, but lenders are permitted to collect foreclosure costs from borrowers to terminate forelosure. A partial claim may not be used if the loan is in foreclosure or in default for more than 18 months.

An administrative fee of $250 will be paid to lenders for processing a partial claim. This administrative fee is to include recordation costs. If a final insurance claim is subsequently filed, only the amount of the partial claim that was applied to principal will be deducted from the final claim.

To secure repayment of the partial claim, a promissory note must be executed by the lender in the name of the secretary of HUD. Also, a subordinate mortgage must be obtained, which will include the arrearage due on the loan and will carry no note interest. The lender must use HUD's model form of note and subordinate mortgage. FHA will assume responsibility for servicing this note upon payment of the partial claim. The lender must send the original mortgage to HUD after the documents have been recorded.

Mortgagee Letter 97-17, "FHA Loss Mitigation-Clarification of Procedures," dated May 1, 1997, eliminated the requirement imposed in Mortgagee Letter 96-61 that lenders establish a repayment plan. Instead, the partial claim will be secured by a subordinate loan requiring a balloon payment that is due as specified in Mortgagee Letter 97-17.

To be eligible for a partial claim, the borrower must occupy the property as a principal residence, must have overcome the financial difficulties that caused the default and be able to make the mortgage payments. The borrower must also meet the debt-to-income ratio requirements. The lender must obtain a credit report and an income verification on the borrower. A broker's price opinion must also be obtained.

Mortgagee Letter 96-61, "FHA Loss-Mitigation Procedures Special Instructions," dated November 12, 1996, which introduced the use of partial claims, provides detailed instructions on filing a partial claim using existing claim form HUD-27011. A partial claim may be used by itself or in conjunction with a special forbearance plan.

Refinancing

A refinance transaction involves repayment of an existing real estate debt from the proceeds of a new mortgage that has the same borrowers and the same property. The borrower must have legal title to the property being refinanced.

* Streamline refinancing. FHA permits streamline refinancing of mortgages that are no more than two months delinquent at the time of the refinance. Delinquent mortgages are generally not eligible for streamline refinancing until the loan is brought current. However, if the mortgage is delinquent by no more than two monthly payments, the refinancing lender may pay the borrower's mortgage to bring the payments current provided no obligation is placed on the borrower to repay the funds used to bring the mortgage current.

Streamline refinances are designed to lower the monthly principal and interest payments on a current FHA-insured mortgage and must involve no cash back to the borrower except for minor adjustments at closing not exceeding $250. Streamline refinances can be insured with or without an appraisal.

Streamline refinancing is currently addressed in HUD Handbook 4155.1 REV-4, CHG-1, "Change 1 to Handbook 4155.1 REV-4, Mortgage Credit Analysis for Mortgage Insurance on One-to-Four-Family Properties." According to Mortgagee Letter 96-61, "FHA Loss-Mitigation Procedures - Special Instructions," dated November 12, 1996, future lender letters will address streamline refinancing.

* Refinancing of seriously delinquent mortgages. FHA allows lenders to refinance in a new FHA mortgage arrearages of three months or more if the borrower has resolved the temporary financial hardship that has caused the default. Mortgagee Letter 94-30, "Refinances of Delinquent Mortgages - Special Instructions," dated June 28, 1994, provides detailed instructions for refinancing seriously delinquent mortgages. FHA recognizes there are situations where borrowers more than two months behind in their payments, and thus not eligible for streamline refinancing, could cure their delinquency if they could refinance that mortgage and also retire any arrearage on the mortgage.

Under this program, the lender is required to provide an amount equal to one month's mortgage payment (PITI) of the mortgage being refinanced. The arrearage above the one month that the lender will pay as well as closing costs may be included in the new mortgage amount, paid through the funds generated from a premium interest rate or paid through a secondary lien held by the lender or through any combination of the three.

To be eligible for a refinance under this program, the borrower must occupy the property as a principal residence, the mortgage must be at least three months delinquent, and the default must have been the result of a temporary hardship. The underwriter must assess the reasons for the default, which must have been temporary, and extenuating circumstances that affected the borrower's ability to pay. The underwriter also must assess the borrower's current financial condition and ability to make the mortgage payments on the refinanced mortgage. This assessment requires the normal verification of income, taking into account both income adequacy and stability.

Refinancing under this program may be done with or without an appraisal. If a new appraisal supports additional indebtedness, all accrued arrearage above the one month's payment to be made by the lender and closing costs may be added to the new mortgage up to normal loan-to-value ratios. Without a new appraisal, the amount of the new mortgage may not exceed the lesser of either the unpaid principal on the old mortgage plus closing costs and arrearage or the original balance of the mortgage. Any arrearage and closing costs above the maximum amount must be paid by the lender or through funds generated by a premium rate mortgage or secondary lien. Without an appraisal, the new mortgage also must result in a decrease in the monthly mortgage payment, except when an adjustable-rate mortgage is refinanced to a fixed-rate mortgage.

Mortgage modification

If a borrower is unable to perform under a forbearance plan and does not qualify for a refinance, the lender must consider whether the borrower is eligible for a mortgage modification. The intent of a modification is to eliminate the arrearage and to reduce the monthly mortgage obligation for a borrower who has recovered from a financial problem, but whose net income has been reduced to a lower level than before the default. If the arrearage can be capitalized into the loan balance, the term extended and the interest rate reduced, the monthly payment can be reduced.

Mortgagee Letter 96-32, "Loss-Mitigation - Mortgage Modification" dated June 28, 1996, states that Ginnie Mae is permitting loans modified under the loss-mitigation program to be repooled in Ginnie Mae II pools. This is allowed even if more than 24 months have elapsed since the date of the first installment due under the original mortgage as long as not more than 24 months have elapsed since the first installment was due under the modified mortgage. To be repooled, the mortgage must be modified to have a term not to exceed 360 months from the due date of the first installment required under the modification agreement. FHA expects that virtually all modifications will be repooled, but in rare instances the lender may apply for assignment of the modified mortgage to FHA.

HUD approval is not required for a modified mortgage that cures a default if the term of the modified mortgage does not exceed 10 years beyond the original maturity date. To qualify, the borrower must be an owner-occupant with adequate income to support the new mortgage payment. The lender must obtain a credit report and income verification on the borrower. The lender must also obtain a broker's price opinion and a title search and must ensure first-lien status of the mortgage.

The new principal balance includes principal, interest and escrow items, but may not include legal, administrative costs and late charges. Following modification of an eligible mortgage, FHA will reimburse lenders $500 per case for administrative processing expenses and up to $250 for a title search. Mortgage modification may not be used in conjunction with a partial claim.

Preforeclosure sale

A preforeclosure sale is a sale of property, at fair market value, in which the lender agrees to accept the proceeds of the sale in satisfaction of a defaulted mortgage, even though the amount is less than that owed on the mortgage, to avoid foreclosure. By following the preforeclosure sale procedure, the lender can then submit a claim for the difference between the proceeds received from the sale and the amount owed on the mortgage plus interest and other reimbursable costs.

Mortgagee Letter 94-45, "HUD's Nationwide Preforeclosure Sales (PFS) Procedure," dated September 30, 1994, provides instructions for a preforeclosure sale procedure. These instructions remain in force, but have been amended by Mortgagee Letter 96-61, "FHA Loss-Mitigation Procedures - Special Instructions," dated November 12, 1996.

To be eligible for the preforeclosure sale procedure, borrowers must have a verified need to sell their homes as a result of an involuntary reduction in income or increase in expenses and have negative equity in their property caused by stagnant or declining property, values that would produce insufficient sale proceeds to pay off the mortgage. The borrower must be an owner-occupant or an owner who is not an occupant but has only one FHA-insured loan. The loan must be at least two months delinquent prior to the preforeclosure sale closing date. Seriously damaged properties are not eligible.

The property must appraise "as is" at 70 percent or more of the outstanding mortgage balance. The borrower has three months from the date of lender approval for acceptance into the program to obtain a signed contract. The three-month sale period will be automatically extended two months for lenders scoring in the top 25 percentile of overall lender performance, effective upon release of lender-performance scores in March 1997. The borrower must use the services of a professional broker to sell the property. A sales contract for a gross sales price that is at least 95 percent of the "as is" appraised value is acceptable provided that customary and usual fees are assessed for sales commission, transfer taxes and other customary seller closing costs. FHA will monitor such fees using a net sales price of 87 percent of the "as is" appraised value as a benchmark.

If the sale is successful, the borrower receives $750 from the sale proceeds, and an additional $250 if the closing occurs within three months of the date of the approval to participate. If there are junior lien holders, up to $1,000 may be paid to them to obtain a release of their lien to facilitate the sale. If the sale successfully closes, the lender is entitled to an administrative fee of $1,000. This fee is included on the lender's claim to FHA.

The lender must initiate foreclosure or deed-in-lieu within 60 days of termination of an unsuccessful preforeclosure sale attempt. If the preforeclosure sale is unsuccessful, FHA strongly recommends that the lender accept a deed-in-lieu of foreclosure. In the event of foreclosure, neither the lender nor FHA will pursue a deficiency judgment.

Deed-in-lieu of foreclosure

When the borrower is in default and does not qualify for any other loss-mitigation option, a voluntary transfer or deed-in-lieu of foreclosure should be considered. As a reward to those borrowers who make a serious, but unsuccessful, effort to sell their home under the preforeclosure sale procedure, HUD strongly recommends that the lender accept a deed-in-lieu and release the borrower from further liability. Borrowers may receive an incentive payment of up to $500 to convey their property voluntarily. A deed-in-lieu also enables the borrower to avoid the adverse consequences associated with foreclosure.

The $500 incentive payment to the borrower is fully reimbursable to the lender on its claim. FHA also will reimburse the lender up to $250 for the cost of a title search. In addition, FHA will pay the lender a $250 administrative fee upon successful completion of a deed-in-lieu.

To qualify for FHA's deed-in-lieu provision, the borrower must occupy the property as a principal residence and must not have any other FHA loans in default. In addition, the lender must be able to convey good marketable title.

Partial payments

Although not a loss-mitigation tool, rules regarding acceptance of partial payments are an important aspect of servicing FHA loans because partial payments advance the date of default. In general, the servicer of an FHA-insured loan must accept a partial payment. However, there are several exceptions. A lender does not have to accept less than a full payment if the loan is not in default. A lender does not have to accept a payment on a loan in default that is less than 50 percent of the full amount due, including the late charge. A lender also does not have to accept an amount received that is less than the amount agreed to in a verbal or written repayment agreement.

Also, a lender does not have to accept a partial payment if foreclosure has commenced or if the property is occupied by a tenant paying rent and that rent is not being applied toward the mortgage payments. The lender may also return a partial payment if four or more payments are past due or a delinquency in any amount has continued for at least six months, provided the lender has notified the borrower at least 14 days prior to receipt of the partial payment that it will not accept partial payments. Partial payments from speculators or junior lien holders who acquired the property through foreclosure do not have to be accepted.

As with loss-mitigation tools, partial payment rules are intended to assist deserving borrowers. If the borrower has shown a general disregard for the mortgage obligation, the lender may return a partial payment. An example of general disregard is a borrower who has been at least six months delinquent on two occasions.

Other FHA servicing requirements

In addition to monitoring loss-mitigation procedures, FHA will continue to monitor lenders' performance in servicing FHA loans with respect to quality control, Section 235 subsidy mortgages, escrow, loans paid in full, adjustable-rate mortgages, assumptions and reporting. HUD Handbook 4330.1 REV-5, "Administration of Insured Home Mortgages," dated September 29, 1994, provides guidance on these and other FHA requirements. FHA will normally monitor lenders' performance in these areas through on-site servicing reviews.

In 1996, Congress acted to rein in losses on mortgage insurance that the FHA had been incurring on single-family dwellings. By giving the FHA lenders new loss-mitigation tools and strengthening existing ones, the hope is that more people will be able to keep their homes.

Alexis M. Stowe, CPA CISA, CFE, CGFM, is a principal and vice president of Gardiner, Kamya & Associates, P.C., Washington, D.C., providing management consulting, auditing and accounting services to government, nonprofit and commercial entities, including the FHA.