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Lenders Fear FHA Rule Could Cripple Program

Lenders and servicers are warning the Department of Housing and Urban Development that a proposal to impose severe penalties for loss mitigation violations could undermine the Federal Housing Administration loan program.

Under a HUD proposal, servicers could face a $277,000 penalty for failing to help a delinquent borrower avoid foreclosure.

Servicers claim this penalty is unfair and excessive, and HUD would do better to provide monetary awards to encourage loss mitigation efforts.

Commenting on the proposal, SunTrust Mortgage Inc., Richmond, Va., and Midland Mortgage Co., Oklahoma City, urged HUD to limit the potential liability of servicers so they are not hit with large fines for past mistakes or minor violations of the agency's loss mitigation standards.

A servicer with a 95% compliance record that has a 1.5% foreclosure rate on 100,000 FHA loans could incur over $20 million in penalties, according to Midland Mortgage. "If HUD were to actually impose penalties of such magnitude for a 95% compliance record, we believe the lenders would quickly begin charging higher interest rates to new FHA borrowers or exit the FHA lending business," Midland Mortgage says in a comment letter.

Midland and SunTrust, along with the Mortgage Bankers Association, want HUD to create a "safe harbor" for servicers who have demonstrated overall compliance with HUD's loss mitigation rules.

"We are concerned that the inability to avoid tremble damages may make FHA servicing less attractive. FHA must continue to be an affordable source of financing for low- and moderate-income borrowers," MBA says.

SunTrust also warns that FHA servicing may become "less attractive" if HUD does not provide a safe harbor.

In 1998, Congress directed HUD to impose treble damages on servicers who fail to engage in loss mitigation. Damages are based on the insured amount of the FHA loan, which averaged $92,254 in fiscal year 2003. So tremble damages would be $276,762 per violation. Servicers argue that this is excessive because the average loss to the FHA insurance fund on a foreclosure is $26,014.

"This penalty is 10 times HUD's average FY 2003 loss per property of $26,014. In fact, the treble damage penalty is the largest single monetary sanction that can be imposed by HUD, yet it stems from the borrowers' failure to perform," MBA says in its comment letter. MBA also asked HUD to impose an annual $1.25 million cap on loss mitigation penalties.

HUD received 10 comment letters on the proposed rule.

Congress passed the treble damages provision when HUD was just starting to get FHA servicers to adopt loss mitigation techniques that are designed to help delinquent borrowers remain in their homes.

HUD did not ask Congress for such an enforcement whip and it has found excuses to delay implementation of treble damages.

HUD officials are quite proud of the way the loss mitigation program has developed and they are limiting the penalties to the handful of servicers whose compliance rating places them in the fourth and lowest tier of the agency's rating system.

"Without loss mitigation, foreclosures would be significantly higher," FHA commissioner John Weicher said in an interview last October. "We know from previous experience that about half of families that have loss mitigation are current within a year."

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