The pre-foreclosure sale (“PFS”) option allows a borrower in default to sell his or her home and use the sale proceeds to satisfy the mortgage debt even if the proceeds are less than the amount owed. This option is appropriate for borrowers whose financial situation requires that they sell their home, but who are unable to sell without FHA relief, because the value of the property has declined to less than the amount owed on the mortgage.

Borrowers must make a commitment to actively market their property for a period of 4 to 6 months, during which time the lender delays foreclosure action. Owner-occupant borrowers who successfully sell to a third party within the required time, are paid a cash consideration up to $1,000. Lenders also receive a $1,000 incentive for successfully avoiding the foreclosure. If the property does not sell, borrowers are encouraged to convey the property to FHA through a deed-in-lieu of foreclosure.

Since PFS was introduced in 1994, it has helped thousands of borrowers in default avoid foreclosure and make a smooth transition to more affordable housing. The changes described below are intended to increase the number of borrowers who can take advantage of the PFS option.

In an effort to open PFS eligibility up to more borrowers, this Mortgagee letter changes two critical ratios used to determine property eligibility and minimum acceptable proceeds. Where Section E(4) of Mortgagee letter 94-45, HUD's Nationwide Pre-foreclosure Sale Procedure, established the minimum ratio of appraised value to outstanding mortgage indebtedness at 70%, effective February 1, 2000 the minimum ratio of appraised value to outstanding mortgage indebtedness is 63%. Where Section G(4) of Mortgagee letter 94-45, required minimum acceptable net sales proceeds of 87%, effective February 1, 2000 minimum acceptable net sales proceeds are 82%. Concurrent with these changes there will be no variances from the above stated ratios.

Unlike other options, borrowers wishing to participate in the PFS program must submit an Application to Participate HUD-90036, along with the financial information required by the lender. The lender will also obtain a recent FHA appraisal and preliminary title report. After reviewing all relevant information, the lender will notify borrowers whether or not they meet the program requirements described below. Acceptance into the program is indicated by issuance by the lender of an Approval to Participate HUD-90045.

  The forms associated with the PFS program, Information Sheet HUD-90035, Application to Participate HUD-90036, Approval to Participate HUD-90045, and Variance Request HUD-90041, are currently being revised to incorporate the ratio changes, provide the disclosure language described above, and to delete references to the assignment program. These forms will be released in a subsequent mortgagee letter. In the meantime, lenders may continue to use current versions of the forms.

  A. Loan Default

At the time the pre-foreclosure sale is closed, the loan must be in default (delinquent more than 30 days). Lenders may exercise their discretion to accept applications from borrowers who are facing imminent default, but by the time the pre-foreclosure sale is completed, the loan must be in default. Lenders should document this decision in the claim review file. Under no circumstances shall PFS be available to borrowers who have abandoned their mortgage obligation despite their continued ability to pay.

Home Equity Conversion Mortgages are not eligible pre-foreclosure sale.

  B. Borrower Qualifications

The PFS option may be extended to borrowers who satisfy the following requirements:

•  Are in default due to a verifiable increase in living expenses or decrease in income.

•  Have negative equity of not more than 63% of the outstanding mortgage balance including unpaid principal and accrued interest. (PFS may be considered if the property's appraised value slightly exceeds the mortgage payoff figure, but net proceeds, after deducting the costs of the sale, will fall short of the amount needed to discharge the mortgage by more than $1,000.)

•  Occupy the property as a primary residence. Lenders are authorized to grant reasonable exceptions to non-occupant borrowers when it is verifiable that the need to vacate was related to the cause of the default (job loss, transfer, divorce, death), and the subject property was not purchased as a rental investment, or used as a rental for more than 12 months .

  C. Application to Participate

Any borrower in default who expresses interest in the pre-foreclosure sale program should be sent a copy of the PFS Information Sheet , and Application to Participate . Additionally, lenders are encouraged to proactively solicit participation by borrowers who are in default on an FHA insured first mortgage and are unable to cure the default through reinstatement.

By signing and returning the application with the required financial information, borrowers are acknowledging that they have received housing counseling, and are agreeing to:

•  List the property with a licensed real estate broker, unrelated to the borrower. The listing agreement must include a specific cancellation clause in the event the terms of a sale are not acceptable to HUD.

•  Make a good faith effort to aggressively market the property.

•  Perform all normal property maintenance and repairs until closing of the pre-foreclosure sale.

  D. Property Value

The lender must obtain a standard FHA appraisal from an appraiser who does not share any interest with the mortgagor or mortgagor's agent. The appraisal must contain both “As Is” and “As Repaired” values for the property, and will be valid for six months. A copy of the appraisal must be shared with the homeowner or sales agent, if requested. Appraisals or opinions of value provided by the borrower, or borrower's real estate agent are not acceptable. The lender must review the appraisal and satisfy itself that the opinion represents the fair market value of the subject property.

  E. Property Condition

Properties which have sustained serious damage (fire, flood, earthquake, tornado) are not eligible for PFS if the cost of repair exceeds 10% of the As Repaired appraised value. Lenders may exercise their discretion to accept or reject damaged properties when repair costs are less than the 10% threshold, but should document their decision in the claim review file.

  F. Condition of Title

The property must have marketable title. Prior to execution of the Approval to Participate , the lender must obtain a title search or preliminary report to verify that the title is not impaired with un-resolvable title problems, or junior liens that cannot be discharged as allowed by HUD. If the lender determines that junior liens and other title issues can be resolved, the borrower may be accepted into the PFS program and resolution of the title issues can be pursued concurrent with marketing.

It is frequently in HUD's interest to aid in the discharge of secondary liens in order to facilitate the sale. Lenders are expected to provide such assistance to the borrower. In some cases junior lien creditors will release a lien in return for a partial cash payment or a promissory note from the borrower. Where the amount required to satisfy or release the lien(s) is in line with the borrower's ability to pay, the borrower should be required to do so. The incentive consideration payable to the borrower should first be applied toward the discharge of liens. If this is not sufficient, the lender can obligate an additional amount not to exceed $1,000 from sale proceeds towards the discharge of liens or encumbrances, if that will result in clear title and allow the sale to proceed. If the borrower has a HUD Title I loan secured by the property, the lender must negotiate a release of the Title I lien in order to proceed with a PFS.

  G. 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 and use good business judgment to determine that the borrower is unable to support the mortgage debt.

  H. Approval to Participate

When an application is accepted, the Approval to Participate form must be used. The date of this form becomes the starting date of PFS participation. The Approval to Participate must include the date by which a signed contract for sale must be obtained, and the minimum acceptable net sales price.

  I. Timing of Initiation

The lender must either issue an Approval to Participate , commence foreclosure, or initiate another loss mitigation option within 6 months of the date of default, unless the lender qualified for an extension by trying another loss mitigation option.

If the PFS follows a failed special forbearance agreement, the Approval to Participate must be granted, or foreclosure or other option initiated within 90 days of the failure. If the PFS follows any other option, the Approval to Participate must be granted, or foreclosure or other option initiated within 9 months of the date of default.

  J. Duration of the Pre-Foreclosure Sale Period

The pre-foreclosure sale period shall be three months beginning upon lender approval (automatically extended two months for lenders scoring in the top 25 th percentile). The lender should review marketing efforts with the mortgagor on a monthly basis. After 90 days without a scheduled closing, the lender must discuss the likelihood of a sale with the real estate broker and make a determination to either end the pre-foreclosure sale period, or extend it for an additional 30 days if a sale is likely. Documentation for this decision should be retained in the claim review file.

If the property is under contract at the end of the marketing period, the lender may extend the PFS period for 60 days not to exceed a total of 6 months (8 months for lenders in the top 25th percentile).

  K. Other Lender Responsibilities

The lender is responsible for inspection, protection, and preservation of the property between the 45th day of default and the date of the Approval to Participate . Funds expended for preservation and protection will be reimbursed.

  L. Early Termination

  Borrower participation in the PFS program may be terminated at the discretion of the lender, for any of the following reasons:

•  Un-resolvable title problems.

•  Determination that the borrower is not acting in good faith to market the property.

•  Voluntary withdrawal by the borrower.

  M. Failure

Within 90 days of the expiration of the pre-foreclosure sale period (or 6 months of the date of default, whichever is later), if no closing of an approved PFS has occurred, the lender must commence foreclosure or obtain a deed-in-lieu. If the borrower's financial condition has improved to the point that reinstatement is a viable option, the lender may undertake one of the reinstatement loss mitigation tools. However, the lender must fully justify this decision in the claim review file, and must complete the action within the 90 day period.

  N. Lender Incentives

FHA will pay lenders an incentive fee of $1,000 for each successful pre-foreclosure sale.

  O. Borrower Consideration

Borrowers who successfully sell their properties using this option are relieved of their mortgage obligation, and are entitled to receive consideration in the amount of $750. If the closing occurs within three months of the Approval to Participate, the borrower will be entitled to $1,000. Unless the borrower's consideration is required to release junior liens, the borrower may elect to accept cash paid at closing, or may apply some or all of the amount to offset sales costs not paid by FHA, including home warranty plans, optional repairs, and seller's closing expenses.

  Borrowers who become good-faith participants in the PFS program shall not be pursued for deficiency judgments by either the lender or the Department in the event that the PFS is unsuccessful and foreclosure occurs.

  P. Contract Approval

The lender will have 5 working days from receipt of a signed Contract for Sale, to respond using the Sale Contract Review form HUD-90051. The transaction must be an outright sale of the premises. No sale by assumption, regardless of provisions for release of liability, may be considered.

Lenders may approve a sale contract in which the net sales proceeds are at least 82% of As Is appraised value. “Net Sales Proceeds” is defined as the contract price less:

•  Sales commission (usually 6% or less).

•  Consideration paid to the seller ($750 or $1,000).

•  Discharge of junior liens not to exceed $1,000.

•  Property repairs required by the appraisal.

•  Local/state transfer tax stamps and other customary closing costs including the seller's costs for a title search and title insurance.

Examples of settlement costs which may not be included in the net sales proceeds calculation are:

•  Tax service fees and other property transfer costs normally paid by the buyer.

•  Home warranty fees.

•  Repairs not stipulated in the appraisal.

•  Survey costs.

•  Lawyer's fees for representing the seller (apart from conducting the settlement or review of documents).

There must not be any hidden terms or special understandings that exist between any of the parties involved in the transaction: buyer, seller, appraiser, sales agent, closing agent, and lender.

  Q. Closing and Post Responsibilities

Prior to closing, the lender will provide the closing agent with a C losing Worksheet, HUD-90052, which lists all amounts payable out of sale proceeds. Before giving final approval for a closing, the lender must review the HUD-1 to ensure that it complies with earlier closing cost estimates.

A pre-foreclosure sale must be reported to national credit bureaus as a “short sale.” Lenders will be responsible for filing information return Form 1099-A with the IRS and reporting any discharge of indebtedness, in accordance with the Internal Revenue Code.

  R. Claim Filing

The claim for insurance benefits must be submitted to HUD within 30 days after the date of the PFS closing. HUD will reimburse the lender for reasonable and customary costs of the appraisal, title search (if not included in the settlement statement), and the allowable percentage of legal fees for a foreclosure postponed pending completion of PFS. Disbursements for taxes, assessments, hazard insurance, and other allowable items payable before the date of the PFS closing are reimbursable. FHA will not pay costs related to the property which were incurred after the closing date.

The consideration paid to the borrower and allowable amounts, not to exceed $1,000,paid to release all junior liens should be reflected on the HUD-1 and not included on the claim. The mortgagee's incentive fee shall still be reflected on line 129 of the claim form HUD-27011. (See Mortgagee letter 94 - 45, Pre-Foreclosure Sale Program .)