www.hudclips.org U.S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT WASHINGTON, D.C. 20410-8000 February 20, 1987 OFFICE OF THE ASSISTANT SECRETARY FOR HOUSING-FEDERAL HOUSING COMMISSIONER Mortgagee Letter 87-9 TO: All Approved Mortgagees SUBJECT: Mortgage Prepayment Provisions For HUD-Insured and Coinsured Multifamily Projects This Mortgagee Letter supersedes Mortgagee Letter 87-4,* dated January 12, 1987, in its entirety. (The format of this letter is the same as that of Mortgagee Letter 87-4; note, however, that substantive or clarifying changes have been made to the following paragraph and Sections I-A(2), I-C(1), II-A and II-B.) This letter clarifies HUD's position with respect to the inclusion of provisions prohibiting partial or full prepayments ("lock-outs") and prepayment penalties in fully-insured and coinsured project mortgages. The policies set forth below apply to all project mortgages endorsed for full insurance under Section 207, 213, 220, 221(d)(3) or (d)(4), 223(f), 231, 232, 241 or 242 of the National Housing Act, or endorsed for coinsurance under Section 221(d) or 223(F) of the National Housing Act on or after the date of this letter, except those mortgages which are funded with the proceeds of State or local bonds sold prior to January 12, 1987. I. Basic Policy A. Mortgages funded with the proceeds of tax-exempt or taxable bonds-issued by State or local governmental bodies may include the following, so long as the conditions cited in Section II below are met: (1) a lock-out provision with a maximum term of ten years plus the construction period stated in the construction contract, if any; and (2) a penalty provision applicable to prepayments made after the lock-out period, provided the penalty: -- would not exceed five percent during the first year following the lock-out period, -- would decline on a graduated basis (to the extent practicable, the decline in the penalty percentage should be the same each year), and * Note: Mortgagee Letter 87-4 was not fully distributed. 2 -- would be no higher than one percent by the end of the fifth year following the lock-out period. B. Mortgages funded with the proceeds of GNMA mortgage- backed securities or other bond obligations (as defined below) may include the following, so long as the conditions cited in Section II below are met: (1) a lock-out provision with a maximum term of ten years plus the construction period stated in the construction contract, if any; or (2) a prepayment penalty that would be no more than one percent at the end of the tenth year following the construction period stated in the construction contract (if the initial penalty is three percent or less and the penalty meets the other limits enumerated in paragraph C(2) below, the conditions of Section II need not be met); or (3) a combination lock-out/penalty provision with a lock-out period of less than ten years and a penalty that would be no more than one percent at the end of the tenth year following the construction period stated in the construction contract. NOTE: For purposes of this Category B, "other bond obligation" refers to any agreement under which the Insured mortgagee has obtained the mortgage funds from third party investors and has agreed in writing to repay such investors at a stated interest rate and in accordance with a fixed repayment schedule. C. All other mortgages: (1) may not include any lock-out provisions other than prepayment prohibitions required by HUD regulations (e.g., 24 CFR, Section 207.32a(e)(2), 231.12(a), or 255-503(i)); but (2) except for Section 241 mortgages of $200,000 or less, may include a prepayment penalty provision, so long as the penalty: -- would not apply to any prepayments which, in any calendar year, do not exceed 15 percent of the original mortgage amount, -- would not exceed three percent during the first year of the mortgage term unless the conditions cited in Section II below are met, in which case, the initial penalty could be set as high as ten percent, 3 -- would decline on a graduated basis (to the extent practicable, the decline in the penalty percentage should be the same each year), and -- would be no higher than one percent by the end of the tenth year following the construction period stated in the construction contract. II. Conditions for Inclusion of Lock-outs and/or Penalties We will allow lock-outs (Category A or B mortgages) or prepayment penalties that initially exceed three percent (Category A, B, or C mortgages) only when the conditions noted below are met. A. For both full insurance and coinsurance cases, the following language, allowing HUD to override the lock-out and/or prepayment penalty provision in the event of a default in order to facilitate a refinancing or partial prepayment of the mortgage and avoid an insurance claim, must be included in the mortgage note: Notwithstanding any prepayment prohibition imposed and/or penalty required by this Note with respect to prepayments made prior to ____________, 19__, [enter first date on which prepayments may be made with a penalty of one percent or less] the indebtedness may be prepaid in part or La full without the consent of the mortgagee and without prepayment penalty if HUD determines that prepayment will avoid a mortgage insurance claim and is therefore in the best interest of the Federal Government. HUD would consider exercising an override of a mortgagee's prepayment lock-out and/or penalty provision only if: 4 (1) the project mortgagor has defaulted and HUD has received notice of such default, as required by 24 CFR Section 207-256 (full Insurance cases) or Section 251.810 or 255.808 (coinsurance cases); (2) HUD determines that the project has been experiencing a net income deficiency, which has not been caused solely by management inadequacy or lack of owner interest, and which is of such a magnitude that the mortgagor is currently unable to make required debt service payments, pay all project operating expenses and fund all required HUD reserves; (3) HUD finds there is a reasonable likelihood that the mortgagor can arrange to refinance the defaulted loan at a lower interest rate or otherwise reduce the debt service payments through partial prepayment; and (4) HUD determines that refinancing the defaulted loan at a lower rate or partial prepayment is necessary to restore the project to a financially viable condition and to avoid an insurance claim. B. For full insurance cases only, the mortgagee must certify at initial endorsement (final endorsement, in insurance upon completion cases) that, in the event of a default during the term of the prepayment lock-out and/or penalty (i.e., prior to the date on which prepayments may be made with a penalty of one percent or less), it will: (1) request a three-month extension of the deadline prescribed by 24 CFR Section 207.258 for filing a notice of its intention to file an insurance claim and its election to assign the mortgage; (2) if HUD grants the requested (or a shorter) extension of the notice filing deadline, assist the mortgagor in arranging a refinancing to cure the default and avert an insurance claim; 5 (3) report to HUD at least monthly on any progress in arranging a refinancing; (4) otherwise cooperate with HUD in taking reasonable steps in accordance with prudent business practices to avoid an insurance claim; and (5) require any successor's or assigns to certify in writing that they agree to be bound by these conditions for the remainder of the term of the prepayment lock-out and/or penalty. The above certification must be incorporated by reference into the Mortgagee's Certificate. In the event of a default, HUD would determine whether to grant the three-month (or shorter) extension of the election notice filing deadline based on its analysis of the project's financial condition and its assessment of the feasibility of arranging a successful refinancing. No further extension of the election notice filing deadline would be considered by HUD, unless an additional extension were specifically requested by the mortgagee. III. For Further Information Questions concerning this letter should be directed to the Insurance Division, (202)755-6223, or the Coinsurance Division, (202)426-7113, of the Office of Insured MultiFamily Housing Development. Sincerely yours, Thomas T. Demery Assistant Secretary U.S. Department of Housing and Urban Development Washington, D.C. 20410-8000 July 31, 1987 OFFICE OF THE ASSISTANT SECRETARY FOR Mortgagee Letter 87-9 Supp HOUSING-FEDERAL HOUSING COMMISSIONER TO: ALL COINSURING LENDERS SUBJECT: Addendum to Mortgagee Letter 87-9 2530 Clearance Procedures Mortgagee Letter 87-9 , cited above, included an invitation to Coinsurance lenders to forward copies of 2530 certificates to Headquarters for monitoring purposes. The address included in our mortgagee letter 87-9 dated June 25, 1987 is incomplete. In order to expedite the monitoring process, please address your copies of 2530 submissions as follows: Office of Assistant Secretary for Housing Director, Field Monitoring Staff Department of Housing & Urban Development, Rm 9224 451 - 7th Street, S.W. Washington, D.C. 20410 Sincerely yours, Thomas T. Demery Assistant Secretary