www.hudclips.org 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: _____________________________________________________________________ 2 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. _____________________________________________________________________ 3 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): _____________________________________________________________________ 4 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% _____________________________________________________________________ 5 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 _____________________________________________________________________ 6 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 _____________________________________________________________________ 7 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. _____________________________________________________________________ 8 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 _____________________________________________________________________ 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 $_______. Beginning with your (date) payment, please pay the new amount. New payment coupons (or monthly billings) reflecting the new amount will be sent shortly. Your present interest rate was based on an Index Value of _______%. To determine your new interest rate we added the Current Index Value of _____% as of (date), to the agreed upon Margin of ____% for a total of ____% (rounded to the nearest 1/8th percent). The new Existing Interest Rate of ________% may not be more than one percent higher or lower than the prior Existing Interest Rate of __________%. The original Interest Rate of your mortgage was _________% which may not be increased beyond _____% during the life of the mortgage. _____________________________________________________________________ 2 The new monthly installment was determined by computing the monthly payment to principal and interest necessary to pay off the principal balance of the mortgage ($___________) 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. _____________________________________________________________________ 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. _____________________________________________________________________