FHA Servicers Now Face Threat of Treble Damages from HUD

Federal Housing Administration servicers are facing the threat of severe penalties if they don't do everything possible to help delinquent borrowers avoid foreclosure.

Under a final rule that goes into effect May 26, the Department of Housing and Urban Development can impose treble damages on FHA servicers who fail to comply with the agency's loss mitigation rules.

The long-dreaded rule means that HUD could impose a $300,000 fine if a $100,000 loan goes into foreclosure.

Lenders and servicers have warned HUD that treble damages, mandated by Congress in 1998, are unfair and excessive. And the threat of such penalties will make FHA servicing less attractive.

HUD never asked for such penalties. In fact, the department is quite proud of the loss mitigation program, which helped 78,000 delinquent FHA borrowers in fiscal year 2004 remain in their homes.

To HUD's credit, it stalled implementation of the rule for seven years while it developed a tiered system for ranking servicers by loss mitigation performance.

"HUD helped us out by creating a tiered system," said Vicky Vidal, senior director for the Mortgage Bankers Association. She stressed, however, that HUD got stuck with the "bad law" that it had to implement.

Under the final rule, HUD says it will focus enforcement actions on servicers in the lowest tier - Tier 4. The latest review shows that 19 out of the 220 ranked servicers are in Tier 4 and they service only 2% of all FHA loans.

Nevertheless, servicers in the top tiers are concerned that they could face treble damages for isolated violations. And they are disappointed that HUD did not provide a "safe harbor" to shield them from liability.

"The civil money statute does not allow HUD to exempt Tier 1-3 lenders from potential treble damages," the final rule says.

All servicers have a duty to engage in loss mitigation, according to HUD. "While there is a case-by-case liability stemming from failure to evaluate a loan for loss mitigation and/or a failure to then take appropriate action, treble damage penalties are more likely where there is a pattern of noncompliance as opposed to an isolated servicing mistake."

The final rule does contain some good news in terms of its impact on existing loans. The rule is prospective and treble damages will not be assessed on any loan that goes into default before May 26 - the effective date of the rule.

Separately, HUD has raised financial incentives for successful loan workouts involving loan modifications or partial claims (where HUD lends the borrower money to cure a default) by $250.

Effective June 1, servicers will receive $750 for loan modifications and $500 for partial claims.

"We encourage lenders to make use of the increased incentives to ensure that borrowers in default are given every reasonable opportunity to recover from their financial hardship and keep their homes," the FHA said.

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