U.S. Department of Housing and Urban Development Washington, D.C. 20410-8000 June 5, 1995 OFFICE OF THE ASSISTANT SECRETARY FOR HOUSING-FEDERAL HOUSING COMMISSIONER TI-431 TO: ALL TITLE I LENDING INSTITUTIONS SUBJECT: CHANGES TO ENCOURAGE GREATER LENDER PARTICIPATION IN THE TITLE I LOAN INSURANCE PROGRAMS The Department is making several major changes to foster greater lender participation in the Title I loan insurance programs. These changes are aimed particularly at commercial banks and other depository institutions that are seeking loan products such as Title I to help them reach unserved market niches and assist in meeting their obligations under the Community Reinvestment Act. The changes being made by this letter are consistent with those previously announced in two Title I Letters issued last year: TI-428 issued July 22, 1994, and TI-429 issued October 6, 1994. They reflect a redirection of the Title I property improvement loan program to serve community development needs, with a focus on assisting more low and moderate income borrowers in making needed home repairs, supporting revitalization and rebuilding efforts in central cities, and upgrading housing in rural areas and other underserved credit areas. The Department has determined that the strict application of certain requirements of the program regulations in 24 CFR Part 201 would adversely affect achievement of the purposes of Title I, section 2 of the National Housing Act. Therefore, these requirements are being waived, in whole or in part, to effectuate the changes described in this letter. Elimination of Annual Adjustment in Insurance Reserves Section 201.32(b) of the regulations requires that a ten percent annual reduction be applied to each lender's insurance coverage reserve account, after the lender has had a Title I contract of insurance for more than five years. The Department has decided that this annual reduction in reserves no longer serves the purpose of protecting the FHA insurance fund against excessive claim losses caused by lenders that exhaust their insurance reserves. Rather, it penalizes lenders who build their loan volume methodically over a period of years and those who maintain low claim rates. The annual adjustment of insurance reserves was instituted in the early 1950's, when the Title I program was being extended for a time period that exceeded the maximum allowable term of the loans being made. 2 The concern was that lenders might accumulate reserves that were excessive in relation to the loans remaining in the lender's portfolio. In today's lending climate, the annual adjustment is an anachronism, left over from the days when all lenders held loans in their own portfolios. Currently, many lenders who originate Title I loans sell the to servicing lenders; the servicing lenders then sell them to investing lenders who issue securities backed by the loans for sale to investors. With the movement of loans from lender to lender, the annual adjustment is no longer meaningful or effective in protecting the program against excessive claim losses. Instead, it is restricting the growth of the Title I program, creating uncertainty about the lender's future insurance coverage, and preventing the active participation of larger, better capitalized lenders in the program. Therefore, as of October 1, 1995, the Department will no longer be applying an annual adjustment to any lender's insurance reserves. While this change will be of primary benefit to lenders in the property improvement loan program, it will also apply to lenders in the manufactured home loan program. Increased Origination Fee for Property Improvement Loans Section 201.25(a) of the regulations limits the maximum origination fee that may be paid by the borrower to one percent of the loan amount on any new Title I loan, and to one percent of the additional advance on any existing Title I loan being refinanced by the lender. Section 201.25(c)(1) specifies that this origination fee may not be financed in the loan. On October 6, 1994, the Department issued Title I Letter TI-429 , which waived these two limitations to permit the financing of origination fees up to three percent of the loan amount. However, this waiver was only for single family property improvement loans made to low and moderate income borrowers in connection with a housing assistance program administered by a State or local government agency or a nonprofit organization. The Department recognizes that a one percent origination fee is simply not enough to cover the lender's costs in originating property improvement loans, where the maximum loan on a single family property is $25,000 and the average loan is $10,700. Therefore, the following changes are being made: o The one percent limitation in §201.25(a) is being modified to permit lenders to charge a maximum origination fee of five percent of the loan amount on property improvement loans. o The list of fees and charges that may be financed in connection with a property improvement loan in § 201.25(b)(1) is being revised to permit the origination fee to be financed, as long as the maximum loan amounts in 201.10(a) are not exceeded. 3 o In a conforming change, §201.25(c)(1), which prohibits the financing of the origination fee, is being deleted in the case of property improvement loans. These changes will allow property improvement lenders to charge a more reasonable origination fee, while at the same time reducing the out-of-pocket expenses of borrowers obtaining Title I loans. Limitation on Discount Points Paid by Borrowers As used in the Title I regulations, the term discount point is intended to have the same meaning it has throughout the banking, finance and investment communities; that is, an up-front fee charged by the lender, separate from interest but part of the total finance charge, that is to increase the lender's yield on the loan to a competitive position with other types of investments. One point equals one percent of the principal amount of the loan. When interest rates increase, discount points can be expected to go down in a fairly consistent relationship. In recent years, property improvement lenders in certain areas of the country have been charging high up-front fees to borrowers and calling them "discount points," although they seem to have no relationship to the lender's overall yield on the loan. Rather, they are being used to cover the lender's costs in originating the loan and marketing the Title I program. HUD's Monitoring Division has found evidence that these discount points are often financed from the loan proceeds, in contravention of the program regulations. The result is that many low and moderate income borrowers, who are otherwise creditworthy and need Title I loans, cannot obtain them because of the high discount points. The Department has decided that the continued practice of borrowers' being charged high levels of "discount points," when there is no benefit to the borrower in a lower interest rate, is no longer acceptable. Therefore, the collection of discount points from the borrower will no longer be permitted, unless the lender can demonstrate a clear relationship between the charging of discount points and some tangible benefit to the borrower such as a compensating decrease in the interest rate being charged. Effective Dates of These Changes Elimination of the annual adjustment in insurance reserves applies to all lenders holding active Title I contracts of insurance and will take effect on October 1, 1995. The other changes outlined in this letter apply to any new loan for which the credit application is received on or after 4 July 5, 1995, and to any loan refinancing approved by the lender on or after that date. These changes shall remain in effect until rulemaking procedures to change the regulations have been carried out. For Further Information If you have any questions about this letter, please write to Robert J. Coyle, Director, Title I Insurance Division, 490 L'Enfant Plaza East, Suite 3214, Washington, D.C. 20024, or call the Division at 202-755-7400. Sincerely yours, Nicolas P. Retsinas Assistant Secretary for Housing-Federal Housing Commissioner