Though federal housing officials didn't ask Congress for the power to levy treble damages against servicers of FHA loans that fail to engage in loss mitigation activities prior to foreclosure, the Department of Housing and Urban Development intends to publish a proposed rule on the penalty.

"We were looking for a hammer," Joseph McCloskey, director of the FHA's single-family asset management division, said of HUD's efforts to find a way to force servicers to try to keep delinquent borrowers in their homes. "We didn't expect to get a cannon."

Nevertheless, to not follow up would be tantamount to flaunting the intent of Congress, the HUD official added. And he vowed to "enlist the thoughts" of servicers and lenders in "an open discussion" before moving forward. "We're about working together with our business partners," he explained. "We know servicers have the best interests of borrowers at heart."

Apparently, lawmakers didn't agree with that assessment when it appropriated operating funds the department late last year. Treble damages "are usually reserved for only the most serious violations, and certainly emphasize the great significance of loss mitigation issues to Congress," according to Phillip Schulman, a partner in the Washington office of Kirkpatrick & Lockhart.

But McCloskey said his agency won't intrude on (servicers') decision-making processes." Rather, the HUD official explained, it wants only to be certain services make a real effort.

"We no longer dictate how servicers should service," he said. "That's best left in (their) hands. We don't want regulations to restrict (their) judgement. (They) have to be allowed to make responsible and reasonable decisions."

Admitting the FHA "got into the loss mitigation game a little late," McCloskey said his agency is merely trying to keep borrowers in their homes or provide them with "a peaceful exit" if various forbearance plans fail to achieve that goal.

"Betting on home owners is a good bet," he said. "It means money in the bank for HUD and servicers, and a more comfortable life for our home owners."

In reality, the loss mitigation tools may or may not help borrowers keep their homes. But they will avoid foreclosure -- a difficult, lengthy and expensive process for lenders and an traumatic ordeal for most home owners -- and reduce claims by lenders against the FHA insurance fund.

Servicers of FHA loans must offer financial strapped borrowers these alternatives to foreclosure:

• Forbearance -- This allows the mortgage to be restructured so the borrower can have up to 18 months to catch up on his payments and bring the loan up-to-date.
• Refinancing -- This permits the borrower to pay off a loan that's in default and create a new mortgage at more favorable terms on the same property.
• Partial Claims -- Under the option, the servicer would submit a claim for the amount of any deficiency. The proceeds from that claim would, in turn, be used to bring the loan current.
• Modifications -- For borrowers who are behind because of a reduction in income but are still able to make monthly payments, servicers are permitted to alter the loan -- lower the rate, for example, or extend the term.

If any of these alternatives don't work, HUD also has authorized servicers to engage in preforeclosure sales or accept deeds in lieu of foreclosure. Both options are designed to avoid the cost and stigma of foreclosure.

Under a preforeclosure sale, the servicer sells the property at fair market value and accepts the proceeds as satisfaction of the loan. That way, if there is a claim against the insurance fund, it's only for the amount of the loan that's not covered in the sale. With a deed in lieu of foreclosure, the lender accepts title to the property in order to extinguish the outstanding mortgage debt.

Published: September 27, 1999

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