In the past two years, the Federal Housing Administration (FHA) has experienced dramatic growth and now plays an important role in the recovery of the housing market. As the current economic and housing crisis continues to evolve, we expect on-going changes affecting FHA and its loan programs as a result of FHA’s increasing market share and developments in the housing finance industry.
To assist our readers in keeping up with these changes, we plan to provide periodic reports on developments that impact FHA’s loan programs. This month’s report covers guidance from the Federal Reserve Board regarding prepayment penalty restrictions vis-à-vis certain FHA-insured loans. The report also covers recent mortgagee letters issued by FHA addressing matters related to appraisals, streamline refinance transactions, principal limits for reverse mortgages, loss mitigation incentives for loan modifications, and flood zone requirements.
Prepayment Penalty Restrictions for Higher-Priced Mortgage Loans. In last month’s Basis Points, Chuck Dodge reported on the new rules under Regulation Z and the Home Ownership and Equity Protection Act (HOEPA) for “higher-priced mortgage loans.” These rules went into effect on October 1, 2009. Among other things, the rules restrict prepayment penalties on higher-priced mortgage loans – prohibiting prepayment penalties if loan payments can change within the first four years and, otherwise, limiting prepayment penalties to the first two years of the loan.
The new restrictions on prepayment penalties raised concerns about FHA loans that use a monthly interest accrual amortization. Under the monthly interest accrual method, if prepayment in full occurs on a date other than an installment due date, the borrower must pay interest through the next installment due date. The Federal Reserve Board’s staff commentary to Regulation Z provides that prepayment penalties include any “interest charges for any period after prepayment in full is made.” As such, a loan that uses a monthly interest accrual amortization might be considered to include a prepayment penalty.
For now, this concern has been alleviated. In a letter dated September 29, 2009, the Federal Reserve Board advised HUD that lenders that use the monthly interest accrual method may continue to follow that practice and are not required to treat the interest charged from the date of prepayment until the next installment due date as a prepayment penalty for any purpose under Regulation Z. The letter also states that, over the coming months, the Federal Reserve Board’s staff expects to review the commentary and consider whether the commentary should be changed to address specifically this aspect of FHA and other lending programs, including whether the commentary should be changed to treat this feature as a prepayment penalty.
Related to this issue is the disclosure of prepayment penalties in the new form of Good Faith Estimate under RESPA. Based upon the Federal Reserve Board’s guidance, HUD updated its FAQs for the new RESPA rule to reflect that, for an FHA loan where the monthly interest accrual method is used, a loan originator completing the Good Faith Estimate should not check “Yes” to the question “Does your loan have a prepayment penalty?”
Appraisals. FHA recently issued several mortgagee letters addressing appraisal portability and appraisal validity periods, as well as appraiser independence and revised eligibility requirements for appraisers. The new requirements in Mortgagee Letters 2009-28, 2009-29 and 2009-30 will be effective for all case numbers assigned on or after January 1, 2010.
ML 2009-28 (September 18, 2009) relates to appraiser independence. The letter contains new requirements concerning the eligibility of entities that order appraisals and addresses responsibilities of lenders regarding fees paid to appraisers and appraisal management companies (AMCs). The letter also serves to reaffirm existing requirements concerning appraiser independence. The new requirements prohibit lenders from accepting appraisals prepared by appraisers who are selected, retained or compensated in any manner by a mortgage broker or any member of a lender’s staff who is compensated on a commission basis tied to the successful completion of a loan. In addition, lenders must ensure that appraisers are compensated at a market rate and that appraisers are not prohibited from disclosing the appraiser’s fee in the appraisal report. When lenders use AMCs, lenders must ensure that the fee for the actual completion of the appraisal doesn’t include a fee for the management of the appraisal process and that the fee charged by the AMC is a market-rate fee for actual services performed by the AMC.
ML 2009-29 (September 18, 2009) relates to appraisal portability when a borrower switches from one lender to another and an appraisal was ordered by and completed for the first lender. While FHA prohibits “appraiser shopping,” the letter sets forth limited circumstances under which the second lender may order a second appraisal. A second appraisal is permitted where the first appraisal contains material deficiencies, the appraiser performing the first appraisal is on the second lender’s exclusionary list of appraisers, or the first lender’s failure to timely provide a copy of the appraisal to the second lender would cause a delay in closing, posing potential harm to the borrower.
ML 2009 30 (September 18, 2009) relates to changes in appraisal validity periods to align FHA requirements with current industry practices. The validity period for all appraisals will be 120 days. This is a change from the current validity periods of six months for an appraisal of an existing property that is complete and 12 months for proposed and under construction properties.
ML 2009 36 (September 23, 2009) relates to revised eligibility requirements for FHA Roster Appraisers. FHA reminds lenders and appraisers that, as of October 1, 2009, appraisers listed on the roster who are not state certified appraisers will be removed from the roster. This action stems from the revised eligibility requirements for appraisers under the Housing and Economic Recovery Act of 2008.
Streamline Refinance Transactions. In ML 2009 32 (September 18, 2009), FHA provides revised procedures for streamline refinance transactions, effective for new case numbers assigned on or after 60 days from the date of the letter. The revised procedures include requirements concerning seasoning and payment history for the loan being refinanced, demonstration of net tangible benefit to the borrower, certification of borrower’s employment/income and verification of assets needed to close, maximum combined loan-to-value ratio, and maximum insurable mortgage amounts (discount points may no longer be included in the new mortgage for a streamline transaction with an appraisal). In addition, mortgagees may no longer use an abbreviated version of the Uniform Residential Loan Application. The revisions are intended to bring documentation standards for streamline refinance transactions in line with other FHA loan origination guidelines, ensure the borrower’s capacity to repay the new loan, and prohibit the practice of loan churning. FHA also reaffirms existing procedures for streamline refinance transactions.
Principal Limits for HECMs. In ML 2009 34 (September 23, 2009), FHA announces a new set of principal limit factors for the Home Equity Conversion Mortgage (HECM) program to assist with the viability of the program. The new principal limit factors must be used for all HECMs for which the FHA case number is assigned on or after October 1, 2009.
Loss Mitigation Incentives for Loan Modifications. In ML 2009 35 (September 23, 2009), FHA updates the conditions under which FHA will pay loss mitigation claims for modifications of loans where the current rate is 50 basis points or more over the current market rate. To qualify for the incentive payment and allowable costs, the modified loan must meet the term and interest rate requirements prescribed in the letter. Specifically, in cases where the current note rate is 50 basis points or more over the current market rate: (1) The mortgagee must reduce the loan modification note rate to the current Market Rate. For purposes of this requirement, HUD will consider the Market Rate to be no more than 50 basis points greater than the most recent Freddie Mac Weekly Primary Mortgage Market Survey Rate for 30-year fixed rate conforming mortgages (US average), rounded to the nearest one-eighth of one percent (0.125%), as of the date the modification agreement is executed. (2) The mortgagee must re amortize the total unpaid amount due over a 360 month period from the due date of the first installment required under the modified mortgage. These requirements are effective 30 days from the date of the letter.
Flood Zone Requirements. In ML 2009 37 (October 1, 2009), FHA reminds mortgagees and appraisers of their responsibility to determine if a property is located within a Special Flood Hazard Area (SFHA) and reiterates FHA’s eligibility requirements for properties located in a SFHA. The originating lender has the final responsibility for determining if a property is located in a SFHA, and FHA encourages mortgagees to obtain a flood zone certification, independent of any assessment made by the appraiser, and to purchase life-of-loan flood zone determination services for all properties securing FHA loans. Mortgagees must inform borrowers of the requirement to obtain and maintain adequate flood insurance for properties located in a SFHA and require the escrow of flood insurance premiums if escrow is required for other items such as hazard insurance and taxes. Mortgagees are required to force place flood insurance if the borrower allows the policy to lapse or if the coverage is found to be inadequate.
Sharon Bangert is a partner in the Washington, D.C., office of Hudson Cook, LLP. Basis Points readers can reach Sharon at 202-327-9703 or by email at sjbangert@hudco.com.