Underwater borrowers – FHA mortgages

Two weeks ago, my blog post covered an overview of options for underwater borrowers. The alternatives ranged from foreclosures to short sales, with deeds in lieu of foreclosure and modifications in between.

I mentioned Federal programs such as HARP (for refinances), HAMP (for modifications), and HAFA (for short sales) and that not all struggling borrowers are eligible for all programs because applicability depends on the kind of loan the borrower has. This is because different types of loans are supervised by different Federal agencies.

Today’s topic is underwater borrowers who have FHA loans.

Because FHA (Federal Housing Administration) loans are supervised by HUD (Department of Housing and Urban Development), it stands to reason that HUD also controls how FHA loans are implemented, modified, terminated, or otherwise unwound. Keep in mind that FHA doesn’t make loans, it insures them, which is a way of inducing banks and other lenders to make loans to borrowers who have little equity.

In response to the housing crisis and economic meltdown, HUD issued a series of letters to their mortgagees (participating lenders) outlining policies and procedures. Bear with me now while I list a few citations, but if you check these out you’ll get loads of specifics, so I’ll mention a few for your reading pleasure. Mortgagee Letter 2008-43 dated December 24, 2008, outlines procedures for short sales. A second letter – this one called Mortgagee Letter 2009-23 – was issued July 30, 2009, and announced a HAMP program for FHA (appropriately called “FHA – HAMP”) addressing loan modifications. (FHA loans weren’t covered by the original HAMP.) In a follow-up on September 23, 2009, Mortgagee Letter 2009-35 clarified modification procedures. Yet another Mortgagee Letter (this one 2009-52) came out December 16, 2009, and discussed the impact of selling short. All these letters are public and available online. All you have to do is Google them and take a look.

Like all Federal agencies, HUD publishes regulations. For those who like to hear it (or in this case, read it) from the horse’s mouth, check out 24 CFR 203.355 for FHA lenders’ options on default. For short sale procedures see 24 CFR 203.370 and, for modifications, 24 CFR 203.616. Google these and you’ll get plenty of hits.

In a nutshell, here’s what you’ll find. To be eligible for an FHA modification, the borrower must be at least 4 months but not more than 12 months delinquent. If the money situation improves (but not too much), the borrower may resume making payments but must be unable to catch up the shortage or payments missed. In other words, the borrower must be suffering from changed circumstances (changed, that is, from the time the borrower originally got the FHA loan).

If the borrower qualifies and a modified loan is put in place, the arrearage isn’t forgiven. Instead, the borrower is required to sign a junior promissory note and mortgage for the arrearage which gives taxpayers hope the loan will be paid in full. This junior note and lien requirement is a problem if the borrower already has a HELOC (home equity line of credit) in place, but with most FHA borrowers putting only 3% down at date of acquisition, there shouldn’t be a HELOC. But if there is, a modification is probably out.

That’s when a short sale enters the picture.

To be eligible for a short sale, the borrower must be in default and have negative equity, but the property can’t be in foreclosure yet. The borrower also must be the owner-occupant (not an investor, although there are a few hardship exceptions) and have been actively trying to sell the property for 3 months. So, timing is critical.

Generally, for a short sale to be considered, the property must be listed for sale at its “as is” appraised value as determined by an FHA appraiser. A real estate commission up to 6% is allowed, assuming more than one sales agent is involved. Otherwise, the maximum commission is 3%. The seller may not make repairs as a seller concession (with some exceptions), the goal being to maximize the sale price and minimize the shortage to the lender (and, in turn, the cost to FHA and taxpayers).

The actual sale price allowed (compared to the loan balance) depends on a tiered pricing structure, based in part on how long the house has been on the market. As an incentive to underwater borrowers, FHA allows the seller/borrower to receive $750-$1,000 cash at closing (for first and last month’s rent since the seller/borrower won’t be buying another house). Incentives up to $1,250 go to outgoing FHA lenders too, with another $250 thrown in for title searches and recording fees. There’s more. Despite senior lenders’ not liking to pay junior liens when they’re not being paid in full themselves, FHA will allow up to $2,500 of the sale price to make junior lienholders go away. And, up to 1% of the new buyer’s loan may be used for seller’s closing costs if the buyer is obtaining a new FHA loan.

So, the FHA programs are in place, with short sales likely trumping modifications in most cases. To answer your questions – or at least to get a strong start – read Mortgagee Letter 2008-43. It contains loads of details.

- Morrie Erickson