Wednesday, October 24th, 2012    by attorney Chris Hacker

You may have noticed that back in August, the Federal Housing Finance Agency (“FHFA”) made an important and extensive announcement about the administration of Short sales by servicers. The FHFA is the Federal government’s department that, among other responsibilities, now controls and directs the operations of Fannie Mae and Freddie Mac since the government bailout of those two companies.

There are some substantial changes about to take effect next week when it comes to default servicing. In this post, I’m going to highlight four of those changes. In my next post, I will dive deeper into the changes to highlight a handful more.

Four Important Changes:

• Single uniform process for short sale review
• Expanded short sale eligibility
• Clarity around standards for contribution requirement
• Contribution to junior liens officially capped at $6000

Single Uniform Process

Not that long ago, Fannie Mae and Freddie Mac together had more than seven different short sale programs that servicers and borrowers had to wade through. The variations added substantial time to the evaluation process by the servicer. Starting November 1, the number of programs will be reduced to two. The primary process, shared by Fannie Mae and Freddie Mac, will be the “Standard Short Sale,” also named HAFA II. With one exception, all new submissions from borrowers will be evaluated under the HAFA II guidelines. The new HAFA II process offers some important changes, described below.

Regarding the ‘other’ process, it is an exception specific to Fannie Mae, and related to a particular subset of loans described in Fannie Mae’s Announcement as “regular servicing option MBS mortgage loans, shared-risk MBS pool for which the servicer markets the acquired property, or any other mortgage loans sold to Fannie Mae under a recourse or other credit enhancement arrangement.” As per usual, it may not be easy to determine at the outset if a given mortgage belongs to this subset; however, once you determine that a mortgage belongs to Fannie Mae, you should start inquiring with the servicer about whether this particular loan falls into those specific categories.

Expanded Eligibility

Under the HAFA II rules, a number of hardships have been given expedited status, while others have been expanded to include more cases. First, servicers can approve short sales without additional approval from Fannie Mae or Freddie Mac for borrowers with the following hardships: death, divorce, disability, distant employment transfer or relocation more than 50 miles from current home.

Additionally, HAFA II changes the requirements regarding borrower delinquency. If the borrower is current or less than 31 days delinquent, they are officially eligible for short sale consideration. If they fall under the four catagories above, they can be approved without Fannie Mae’s or Freddie Mac’s separate approval. Even if they don’t fall under those four categories, they are still eligible for consideration, pending final investor approval. However, for this category of imminent default, the property that is being short sold must be the borrower’s residence.

The second delinquency category is more than 30 days delinquent. Here the property can be any kind – residence, second home, or investment – and does not have to be occupied (as long as it has not been condemned). Additionally, the documentation requirements have been relaxed as well, which I will describe in a subsequent post.

Requiring Seller Contributions

For the first time, servicers now have an explicit formula for determining if a contribution or note will be required.

The Cash Test: If the borrower has cash reserves greater than the larger of $10,000 or 6x the monthly PITI on the loan, then they will be asking for 20% of the reserves.  For borrowers more than 30 days delinquent, the servicer can negotiate a lesser amount without approval from the investor. For borrowers eligible under imminent default, investor approval will be required for a contribution less than 20% of the reserves, unless the hardship is the death of the primary wage earner in which case no investor approval is required. For example, if a borrower’s monthly payment (PITI) was $800, 6x$800=$4800, which is less than $10,000, then the borrower will only have to contribute any funds at all if they currently have more than $10,000 sitting in their bank account. Once the original monthly payment is larger than $1,666.67, then the reserve amount could be higher without triggering a contribution requirement.

The Note Test: If the borrower’s future debt-to-income ratio (aka “back-end ratio” or “DTI”) is projected to be less than 55%, then they must be evaluated for a promissory note. The monthly payment on that promissory note will be half the difference between the projected total monthly debt payments and the amount of a monthly payment at 55% DTI. Said another way, if the back-end ratio was determined to be 45% and the borrower’s gross monthly income is $2000, then the monthly payment would be (0.55-0.45)/2 x $2000 = $100/month. The term would be initially set to five or ten years at 0%, leading to a balance of $6,000 or $12,000.

It may be apparent to you that the cash reserve test is more objective. You either have the cash or you don’t. The Note Test could be subject to more discretion regarding what to include or not as an expense or income, but the HAFA II rules also detail those. If I have time, I’ll address that in a future post as well.

Junior Lien Payoffs

I am highlighting this one not because it represents a step forward, but because it is a stumbling block. HAFA II continues the junior lien payoff cap of HAFA I: $6000. It also requires that the junior liens provide a full release of liability. And Fannie Mae explicitly prohibits junior liens from requesting contributions from the real estate agent and the borrower to provide the full release. Freddie Mac’s guidelines prohibit contributions from the borrower. As a result, we are once again in the position where Fannie Mae and Freddie Mac are playing a game of chicken with the junior liens and forcing the agents, sellers, and buyers to come along for the ride. Most junior liens will likely blink, but not until they test out the resolve and seek out any loopholes. And it appears that there is one.

The guidelines reference “allowable payments from the sales proceeds to all subordinate lienholders” (emphasis mine).  I know from experience that some junior liens will interpret that as additional payments beyond the purchase price are kosher. In other words, pay up Mr. and Mrs. Buyer. How to deal with that is a whole article in itself. Just watch out for requests to make payments that are not disclosed on the HUD.

Conclusion

These are the four items that I wanted to highlight out of the many changes that have been made. I will be posting at least one more time on this topic this week.

If you want to read the short sale guidelines yourself you can click below to get my cliff notes version of the actual announcements and regulations themselves.