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U. S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT
WASHINGTON, D. C. 20410-8000
December l7, 1984
OFFICE OF THE ASSISTANT SECRETARY FOR
HOUSING-FEDERAL HOUSING COMMISSIONER
Mortgagee Letter 84-28
TO: ALL APPROVED MORTGAGEES
SUBJECT: Adjustable Rate Mortgages (ARM)
Mortgage Servicing Procedures
Section 443 of the Housing and Urban Rural Recovery Act of
1983 added Section 251 to the National Housing Act which
authorized FHA to insure Adjustable Rate Mortgages (ARM) on
single-family properties. Reference is made to Mortgagee Letter
84-16, dated July l8, 1984, which deals with the origination
features of the ARM program. We recommend that all mortgagees
become familiar with ML 84-16, prior to their review of this
Mortgagee Letter, which considers the servicing aspects of ARMs.
An ARM provides for annual interest rate adjustments based
upon changes in the weekly average yield on U.S. Treasury
Securities adjusted to a constant maturity of one year. No
single adjustment in the interest rate can result in an increase
or decrease of more than one percentage point from the interest
rate in effect for the previous period. Adjustments in the
interest rate over the entire term of the mortgage cannot result
in an increase or decrease of more than five percentage points
from the initial contract interest rate.
The mortgagee is expected to have knowledgeable servicing
staff who can respond to questions from borrowers as to how ARMs
work and how adjustments are made. Having explanatory ARMs
literature available for distribution by loan servicing
personnel may be helpful.
Copies of the pre-loan Disclosure Statement, and each
Annual Adjustment Notice sent, should be readily available for
future reference.
1. Pre-Loan Disclosure Requirement
HUD has a prescribed form of Disclosure Statement which
must be used in the origination process to explain to the
proposed borrower the nature of the ARM obligation, which
satisfies this regulatory (24 CFR 203.49) requirement.
2. Annual Disclosure Requirements
There are two basic steps which the mortgagee must take
each year with respect to the interest rate adjustment:
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a. Make the computations to adjust the interest rate and
the monthly payments. The first adjustment to the
interest rate will become effective on the day
specified in paragraph 2 of the Adjustable Rate
Allonge to the mortgage Note (Change Date) and
thereafter each adjustment will be effective on the
same date of each succeeding year during the term of
the mortgage.
b. Notify the mortgagor of any change in the interest
rate and monthly payment.
The mortgagee's obligation to compute, adjust the interest
rate, and give notice to the mortgagor on the prescribed
dates, is not affected by delinquencies, foreclosures, or
the like, so long as the mortgage debt is existent. It is
the mortgagee's responsibility to see that its collection
actions continually update the mortgage debt pursuant to
the Annual Adjustment requirements.
3. Computing the Annual Interest Rate Adjustment
Each adjustment to the interest rate will be based on the
weekly average yield on U.S. Treasury Securities (Index)
adjusted to a constant maturity of one year. Yields are
published in the Federal Reserve Bulletin and made
available by the Federal Reserve Board in Statistical
Release H.15 (519). This release may be obtained by
writing to: Publication Services, Mail Stop 138, Board of
Governors, Federal Reserve System, Washington, DC 20551.
The following steps must be taken to determine whether the
interest rate will be adjusted and the amount of the
adjustment:
a. Determine the current Index. This is the published
interest rate for U.S. Government Securities,
Treasury Constant Maturities. 1-Year, for the week
ending on the Friday 30 days prior to the Change Date.
A sample copy of a Federal Reserve Statistical
Release, H-l5, is attached as Exhibit C and marked to
identify the pertinent Index for a mortgage having a
Change Date of October 1, 1984.
b. Determine the calculated interest rate. This is the
current Index plus the Margin (the number of
percentage points identified as "Margin" in paragraph
3(b) of the Adjustable Rate Allonge of the mortgage
Note) rounded to the nearest one-eighth of one
percentage point (0.125%). Rounding is required
unless the Adjustable Rate Allonge and Adjustable
Rate Rider have been modified to delete the provision
for rounding, as permitted by Mortgagee Letter 84-16.
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c. Compare the calculated interest rate to the existing
interest rate (the rate currently in effect) to
determine the new adjusted interest rate as follows:
(1) If the calculated interest rate is the same as
the existing interest rate, the adjusted interest
rate will not change.
(2) If the calculated interest rate is less than one
percent higher or lower than the existing
interest rate, the calculated interest rate will
become the new adjusted interest rate.
(3) If the calculated interest rate is more than one
percent higher or lower than the existing
interest rate, the new adjusted interest rate
will be limited to one percent higher or lower
than the existing interest rate.
d. In no event may any resulting Adjusted Interest Rate
be more than five percentage (5%) points higher or
lower than the initial interest rate.
e. An Adjusted Interest Rate becomes effective on the
Change Date and thereafter will be deemed to be the
existing interest rate. The new existing interest
rate will remain in effect until the next Change Date.
The following example illustrates the determination of
the Adjusted Interest Rate for a 3-year period under
each of the circumstances in paragraph c:
Assume the following facts:
Initial Interest Rate 10%
Loan Closing Date August 15, 1984
Change Date October 1
Monthly payment change date November 1
Margin l% (lOO Basis Points)
Index for week ending 8/30/85 9.05%
Index for week ending 8/29/86 8.75%
Index for week ending 8/28/87 10.20%
(1) The interest rate for the Change Date of October
1 and new monthly payment beginning November 1,
1985 (first adjustment):
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Index (week ending 8/30/85) 9.05%
(30 days prior to Change Date)
Margin 1.00%
Total 10.05%
Calculated Interest Rate 10.00%
(Rounded to nearest 1/8%)
Existing Interest Rate 10.00%
Adjusted Interest Rate 10.00%
(Effective October 1)
The sum of the Index plus the Margin must be rounded
to the nearest 1/8th which makes the Calculated
Interest Rate 10%. This is the same rate as the
Existing Interest Rate for the previous 12-month
period so the Adjusted Interest Rate does not change
for the second year.
(2) The interest rate for the Change Date of October 1 and
new monthly payment beginning November 1, 1986 (second
adjustment):
Index (week ending 8/29/86) 8.75%
Margin 1.00%
Total 9.75%
Calculated Interest Rate 9.75%
Existing Interest Rate 10.00%
Adjusted Interest Rate 9.75%
The Calculated Interest Rate is within l% of the
Existing Interest Rate for the previous 12-month
period so the Adjusted Interest Rate is the same as
the Calculated Interest Rate for the third Year.
(3) The interest rate for the Change Date of October 1 and
new monthly payment beginning November 1, 1987 (third
adjustment):
Index (week ending 8/28/87) 10.20%
Margin 1.00%
Total 11.20%
Calculated Interest Rate 11.25%
Existing Interest Rate 9.75%
Adjusted Interest Rate 10.75%
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The rounded Calculated Interest Rate is more than l%
higher than the Existing Interest Rate for the
previous 12-month period. The rate may not be
increased more than 1% in any one year so the Adjusted
Interest Rate increases l% to 10.75% for the fourth
year.
Note: The 0.5% difference between the Calculated
Interest Rate and the Adjusted Interest Rate may be
applied in the following year if the Index does not
change or changes slightly i.e., 10.20% + 1.00% =
11.25 (rounded).
Also, where the ARM is associated with an interest
rate buydown, the Note rate is the one adjusted, not
the borrower buydown rate.
4. Computation of the Monthly Installment
If the new Adjusted Interest Rate changes as a result of
the above computation, the required monthly installments
must be changed. The monthly payment attributable to
principal and interest will be computed by determining the
monthly payments necessary to amortize the unpaid principal
balance over the remaining term of the mortgage at the new
Adjusted Interest Rate. For this purpose the unpaid
principal balance shall mean the unpaid principal balance
which would be due on the Change Date if there had been no
default in any payment, but reduced by the amount of any
prepayments to principal. (Accordingly, to compute the new
monthly payment the mortgagee must credit all prepayments,
but must not debit any delinquency.) Escrow requirements
will then be added to the principal and interest
requirements to arrive at the required monthly installment.
Since interest is payable on the first day of the month
following the month in which it accrued, the recomputed
monthly installment will not be due until 30 days after the
Change Date (provided timely notice is given).
Since all ARM adjustments affect interest percentages only,
no negative amortization may occur.
5. Annual Adjustment Notice to the Mortgagor
Notice of any adjustment to the interest rate and monthly
installment, increase or decrease, must be given to the
mortgagor at least 30 days prior to the change in payment.
The Adjustment Notice must contain (a) the date the
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Adjustment Notice is given, (b) the Change Date, (c) the
new Existing Interest Rate (which is the Adjusted Interest
Rate) as adjusted on the Change Date, (d) the amount of the
adjusted monthly installment payments, (e) the current
Index, and (f) the method of calculating the adjustment to
the monthly installment payments and (g) any other
information which may be required by law from time to time.
It is suggested that the Notice be sent to the mortgagor by
Certified Mail, Return Receipt Requested. However, a
Notice addressed and mailed via first class mail to all
property owners identified on the mortgagee's records
shall be sufficient unless the mortgagor's whereabouts are
known to be elsewhere. A Notice must be given each year,
even if the interest rate does not change.
For HUD review purposes, lenders must keep some evidence
that timely notice has been given, and some evidence of the
annual adjustment computations, for the mortgage term.
However, should disputes arise as to timely notice or as to
the annual adjustment computations, compliance with our
suggested methods may not satisfy local legal
interpretations of the mortgage provisions in determining
whether the evidence was sufficient. Lenders should
therefore, be guided by the advice of counsel in matters
concerning the type and duration of record retention.
The mortgagee's collection personnel should be alerted to
the prospect of Notice not being received by the mortgagor,
and should take appropriate remedial action when necessary.
If the mortgagor's payments do not reflect the increase or
decrease recited in the Notice, a follow-up should be made
to assure that the Notice was received.
A suggested format for providing the annual Notice is
attached as Exhibit A. Additional information may be
required by other government agencies. The Notice should
contain other relevant information such as an explanation
of why a new Existing Interest Rate is less than the
Calculated Interest Rate when the 5% limitation is reached.
Our rule relating to the timing of the annual notice of
adjustment is consistent and compatible with Federal Home
Loan Bank Board (FHLBB) regulations and policy.
6. Failure to Provide Timely Notice
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If the mortgagee fails to provide notice for more than one
year, an Existing Interest Rate must be determined for each
omitted year because the calculations for each year affect
the rate for subsequent years. The l% and 5% limitations
are applicable each year and must be taken into
consideration in determining the new Existing Interest
Rate. The mortgagee's failure to provide Notice in advance
of each Change Date results in penalties (to be found in
the ARM Rider and Allonge) to the mortgagee.
Although the interest rate may change, the mortgagee is
prevented from collecting any increase in payments until
the Notice has been provided at least 30 days prior to any
new payments becoming effective. The lender forfeits its
right to collect the increased amount and the borrower is
relieved from the obligation to pay that increase.
In the event that the adjusted rate were to decline, the
failure to provide Notice would result in overpayments
until the mortgage rate was properly adjusted. In such
case, the mortgagee must refund the excess, with interest
at the Index rate in effect on the Change Date, from the
date of the excess payment to the date of repayment. The
borrower has the option of a cash refund or application of
the excess to the principal balance of the mortgage, after
application of the refund to any existing delinquency, if
any.
7. ARMs and the Assignment Program
An ARM is as freely assignable as a Section 203(b)
mortgage, and is to be considered under the 203.650
assignment program. The variation in payments may have some
effect upon the reasonable prospect criterion, but the
lender should judge eligibility based on the assumption
that the interest rate will not change. In the assignment
of an ARM to HUD, the mortgagee should plainly identify the
mortgage as an ARM and note the date when the next interest
adjustment is due.
8. Failure to Provide Accurate Notice
Should the mortgagee miscalculate the interest rate and/or
monthly payments, which errors are reflected in the Annual
Notice, HUD takes the position that the errors need to be
corrected. However, HUD takes no position as to whether an
erroneous Notice would constitute a failure to provide
notice under the terms of the mortgage contract. This is a
legal matter subject to local law and court interpretation.
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9. Sales, Assignments, Transfers of Servicing among ARMs
Mortgagees
It is the responsibility of the transferor (seller) to
provide the transferee with complete servicing records
which reflect all annual ARM requirements as having been
met. Although HUD regulations require the
transferee/assignee to assume all servicing obligations, we
do not intend that a negligent ARMs mortgagee-transferor be
permitted to avoid its disclosure obligations. In the
event that a failure of Notice or other error is
discovered, it shall be the responsiblity of the mortgagee
when the failure occurred, to reimburse the mortgagee
currently holding the loan, where any burden of refund to
the mortgagor is required.
10. Assumptions
Both borrower and lender should assume responsibility in
notifying any purchaser - assumptor about the conditions of
the ARM mortgage. Lenders should encourage mortgagors to
disclose the ARM terms in any sale.
As soon as the mortgagee is aware of any assumption sale
and has the name of the purchaser(s) it must provide the
buyer(s) with a copy of the original Disclosure Statement
with an explanatory letter relating to the ARM conditions
and request an acknowledgement from the purchaser. The
lender should also offer to provide any further ARM
information to the purchaser, if needed.
Where the assumption sale entails a substitution of
mortgagor and release of the original mortgagor, pursuant
to paragraph 94 of HUD Handbook 4330.1 , (the Form 2210
procedure), the mortgagee must prepare a new original
Disclosure Statement to assure that the purchaser is aware
of the ARM obligation. HUD processing of the substitute
mortgagor will be based on the existing interest rate in
effect at the time the 2210 package is submitted to HUD.
Il. Definitions. Exhibit B attached incorporates definitions
of some of the principal ARM terms.
If you have any questions concerning your Adjustable Rate
Mortgage Loan, you may call Richard B. Buchheit, Director,
Single Family Servicing Division, (202) 755-6672, or the local
HUD office having jurisdiction over the mortgaged property.
Sincerely,
Maurice L. Barksdale
Assistant Secretary
Attachments
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EXHIBIT A
Suggested Form of Annual Disclosure ARM Notice
Mortgagee Name Date
Address
Telephone No.
Mortgagor(s) Name
Address
Re: Annual Notice of changes in Interest Rate and Monthly
Installment Payments on Your Adjustable Rate Mortgage
Dear Mortgagor:
On (date), the interest rate on your Adjustable Rate
Mortgage (ARM) will (increase/decrease) from _____% to ____%,
and your monthly installment payments will (increase/decrease)
from $______ to $_______. Beginning with your (date) payment,
please pay the new amount. New payment coupons (or monthly
billings) reflecting the new amount will be sent shortly.
Your present interest rate was based on an Index Value of
_______%. To determine your new interest rate we added the
Current Index Value of _____% as of (date), to the agreed upon
Margin of ____% for a total of ____% (rounded to the nearest
1/8th percent).
The new Existing Interest Rate of ________% may not be more
than one percent higher or lower than the prior Existing
Interest Rate of __________%. The original Interest Rate of
your mortgage was _________% which may not be increased beyond
_____% during the life of the mortgage.
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The new monthly installment was determined by computing the
monthly payment to principal and interest necessary to pay off
the principal balance of the mortgage ($___________) over the
remaining term of the mortgage(___yrs.) at the new Existing
Interest Rate, without taking into account delinquent payments,
and crediting any prepayments to principal. The required
monthly escrow payment ($______) was then added to the required
principal and interest payment.
If you have any questions, please call _______________ at
the telephone number listed above, or your may use the toll-free
numbers previously provided.
Sincerely,
Note: If the annual ARM Notice is designed to include all
the essential factors for calculation of the new
interest rate and monthly payment, a file copy should
be sufficient to reflect the computation.
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EXHIBIT B
DEFINITIONS
Index - The weekly average yield on United
States Treasury Securities adjusted to
a constant maturity of one year
published in the Federal Reserve
Bulletin . See Exhibit C.
Current Index - The most recently available Index
published 30 days before the Change
Date.
Change Date - The effective date of an adjustment to
the interest rate. The date is
specified in paragraph 2 of the
Adjustable Rate Allonge amending the
Note. (This is not the date on which
monthly payments change.)
Margin - The agreed number of percentage points
added to the Current Index to
determine the Calculated Interest Rate.
The number is specified in paragraph 3
(b) of the Adjustable Rate Allonge
Amending the Note, and remains constant
for the life of the mortgage.
Initial Interest Rate The interest rate stated in the note
which will be in effect for l2 to l8
months from the date of the first
monthly payment.
Calculated Interest The Current Index plus the Margin,
Rate rounded to the nearest one-eighth of
one percentage point (0.125%). The
Calculated Interest Rate is used to
determine the Adjusted Interest Rate.
Adjusted Interest The new interest rate effective for the
Rate twelve month period following each
Change Date. (The Adjusted Interest
Rate will become the Existing Interest
Rate on the next Change Date.)
Existing Interest The interest rate in effect immediately
Rate prior to any adjustment on the current
Change Date.
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