A loan modification is a permanent change in one or more of the terms of a borrower's loan which if made, allows the loan to be reinstated, and results in a payment the borrower can afford. Modifications may include a change in the interest rate; capitalization of delinquent principal, interest or escrow items; extension of the time available to repay the loan; and/or re-amortization of the balance due.

Modification may be appropriate for borrowers who have experienced a permanent or long term reduction in income or increase in expenses, or have recovered from the cause of the default but do not have sufficient surplus income to repay the arrearage through a repayment plan. To qualify, borrowers must be able to support the monthly mortgage debt after the terms of the loan are modified.

Not all loans are appropriate for modification. Loan characteristics which best support modification include: loans with above market interest rates; lower loan to value ratios; and/or mature terms (loans paid down 10 years or more). The modification tool is valuable when the arrearage can be capitalized into the loan balance, the term extended and/or the interest rate adjusted to current market rate, so that the resulting monthly payment is at a level the borrower can afford.

Modification is most often used to reduce a borrower's payment when the cause of the default is permanent or long term. However, if a borrower has recovered from a short term financial problem and has strong income, a modification may be used to increase the monthly payment slightly, allowing the borrower to repay the arrearage gradually over the life of the loan.

Approximately 96% of all FHA insured loans are securitized in Ginnie Mae guaranteed pools. Prior to modification, but no sooner than the 90 th day of default, securitized loans must be purchased from pools. Ginnie Mae has recently streamlined its re-pooling requirements allowing almost all modified FHA loans to be quickly repooled. Details of Ginnie Mae's modification policy are found in the All Participants Letter 96-15, Pooling FHA Loans That Have Been Modified as a Result of Loss Mitigation Efforts .

FHA has recently made several changes to its modification program. First, the Department realized that borrowers with below market interest rates were being excluded from the modification program because their loans had to be re-pooled at a discount. When appropriate, lenders may now increase the note interest, not to exceed market rate as defined below in Section F, page 21. Next, to protect borrowers from future payment increases, all modifications must now result in a fully amortizing, fixed rate loan. Adjustable and other variable payment loans will be converted to fixed as a condition of the modification. Finally, the BPO requirement has been eliminated (there is no longer a BPO requirement for any of the reinstatement options). These changes are more fully described below.

A. Loan Delinquency

  To modify a defaulted mortgage under the loss mitigation program:

•  Three or more full monthly payments must be due and unpaid.
•  At least 12 months have elapsed since the origination date of the loan.
•  The loan may not be in foreclosure at the time the modification is executed, however, loans removed from foreclosure status may be modified.
•  The default must be due to a verifiable loss of income or increase in living expenses.

Note: Loans which are not delinquent but are in danger of imminent default may be modified at the discretion of the lender and insurance coverage will be increased above the original certificate amount as necessary. However, performing loan modifications do not qualify for incentives under the Loss Mitigation Program, and may not meet Ginne Mae requirements for re-pooling of modified loans, which requirements are described in Ginne Mae's All Participants Letter, 96-15.

  B. Borrower Qualifications

  Modifications may be offered to borrowers who have stabilized, surplus income which, while not sufficient to sustain the original loan and repay the arrearage, is sufficient to support the monthly payment under the modified rate and/or term.

The borrower must be an owner occupant, committed to occupying the property as a primary residence. Modification may not be used as a means to reinstate a loan prior to a sale or assumption.

  •  Property Condition

  While the modification option does not include a loan-to-value restriction, and no appraisal or broker's price opinion is required, the lender must conduct any review it deems necessary to verify that the property has no physical conditions which adversely impact the borrower's continued use or ability to support the debt.

A borrower may not be able to support payments under a modification if the property is in such a deteriorated condition that repairs drain the borrower's monthly resources. An analysis of the borrower's surplus income should consider anticipated property maintenance expenses. If the mortgagee's inspection identifies a property in extremely poor physical condition, a modification may not offer a permanent resolution to the default.

Costs to complete needed repairs may not be capitalized as part of a modification agreement, nor may a borrower receive any cash back from a modification. Borrowers who have sufficient equity and income to receive cash back should be considered for a delinquent refinance.

  D. Financial Analysis

The lender is required to assess the borrower's financial condition as described in Section H, page 10. HUD expects the lender to project the borrower's surplus monthly income for a minimum of three months, and use good business judgment to determine if the borrower has the capacity to repay the arrearage through a repayment or special forbearance plan, before considering modification. If the financial analysis determines that the borrower does not have the ability to support the modified monthly payment, the modification option may not be used.

  •  Combining Options

  Modification may be utilized as a stand alone tool, or incorporated as part of a repayment, or special forbearance agreement. For example, if a borrower needs time to resolve the default, but will eventually be able to support the debt at the modified rate but no more than that, a repayment plan or special forbearance may culminate in a loan modification. An existing repayment plan, or special forbearance may also be converted to modification if the borrower's circumstances change.

Mortgage modification may not be used in conjunction with a partial claim. If modification is appropriate, it should be used as the primary tool to bring the account current.

  F. Allowable Provisions

The following provisions apply to loan modifications:

  •  All modifications must result in a fixed rate loan. ARM, GPM and GEM mortgages may only be modified to fixed payment, fully amortizing loans.
•  The modification must fully reinstate the loan.
•  At the lender's discretion, note interest rates may be reduced below market if necessary to resolve the default. Discount fees associated with rate reductions are not reimbursable.
•  At the lender's discretion, note interest rates may be increased if supported by the borrower's ability to pay. The maximum interest allowable shall be calculated as 150 basis points above the current FHA debenture interest rate. Debenture interest rates are provided semi-annually through mortgagee letter.
•  All or a portion of the PITI arrearage (principal, interest, and escrow items) may be capitalized to the mortgage balance.
•  Foreclosure costs, late fees and other administrative expenses may not be capitalized. Lenders may collect the legal and administrative fees (resulting from the canceled foreclosure action), from mortgagors to the extent not reimbursed by HUD, either through a lump sum payment or through a repayment plan separate from, and subordinate to, the modification agreement.
•  The modified principal balance may exceed the principal balance at origination.
•  The modified principal balance may exceed 100% loan-to-value.
•  Lenders may re-amortize the total unpaid amount due over the remaining term of the mortgage, or may extend the term not more than 10 years beyond the original maturity date or 360 months from the due date of the first installment required under the modified mortgage, whichever is less.

G. Lien Status

  The lender must ensure first-lien status of the modified mortgage. In satisfying this requirement, the lender must comply with any applicable state or federal laws and regulations.

If title to the property is encumbered with an FHA Title I loan, and the lender servicing the Title II loan has determined that a subordination agreement is necessary, the lender may send a written subordination request to:

U.S. Department of Housing and Urban Development
Home Improvement Branch
451 7 th Street, SW, Room 9272
Washington, DC 20410

If title to the property is encumbered with an FHA Title I loan which has been assigned to the Secretary, and the lender servicing the Title II loan has determined that a subordination agreement is necessary, the lender servicing the Title II loan may send a written subordination request to:

HUD Albany Financial Operations Center
Asset Recovery Division
52 Corporate Circle
Albany, NY 12203
•  464-4200

  H. Required Documentation

  FHA does not dictate a specific format for documentation of the modification agreement. The lender is responsible for ensuring that the modification documentation preserves the first lien status of the FHA insured loan. The lender will have to make the determination in accordance with state law as to whether it is necessary to record the Modification Agreement to maintain the first lien requirement.

  I. Disclosures

  FHA requires lenders to comply with any disclosure or notice requirements applicable under State or Federal law.

  J. FHA Mortgage Insurance

Where the loan modification has been processed in accordance with all HUD requirements, the FHA mortgage insurance coverage will be extended to the new principal balance of the loan following modification of eligible loans. Modification has no effect on the one-time MIP or on periodic MIP payments. Monthly MIP payments must be calculated on the original insurance amount.

  K. Lender Incentives

FHA will pay lenders a $500 incentive fee for each modification and will reimburse the actual cost of the title search and/or endorsement to the title policy not to exceed $250.00. No other expenses may be included on the claim.

L. Failure

In the event the borrower becomes delinquent following modification, it shall be treated as a new default and serviced accordingly. In the event the loan is foreclosed following modification, the lender must be prepared to deliver a copy of the modification agreement to the Department when a conveyance claim is filed. The lender shall be responsible for maintaining the first lien status of the insured loan subsequent to modification. Any amount of a loan which is not in the first priority position will be considered uninsured and not subject to claim. HUD reserves the right at the time of claim submission to request documentation (legal or otherwise) establishing the first lien status.

  M. Limitations on Use

If a loan has been modified or reinstated using a partial claim within the past three years, re-default risk is presumed to increase following a subsequent modification. Prior to granting a modification in this circumstance, the lender must prepare a written justification, and retain a copy along with supporting documents in the claim review file. It is anticipated that this will be a highly unusual occurrence, and that the cause of the second default will be unrelated to the original problem.

  N. Filing For Incentive Payment

The lender must file the claim for incentive payment within 60 days of the execution date of the modification agreement. It is not necessary to send a copy of the modification agreement, however, it must be retained in the claim review file and made available to FHA upon request.

FHA will pay lenders a $500 incentive fee for each modification and will reimburse the actual cost of the title search and/or endorsement to the title policy not to exceed $250.00. No other expenses may be included on the claim.