Servicing Quality Control: System and Procedures

QUESTION 

We are a mortgage lender in the Midwest. We were doing portfolio retention through a servicer, but now we are bringing servicing in-house and doing our own servicing. 

The plan is to launch the new servicing department in the next ninety days. We need a full complement of servicing policies and procedures. 

In addition, we need to know about the system requirements for servicing quality control and the basic servicing quality control procedures. 

Your firm provides a servicing policies and procedures library, so we hoped you could provide the information we need. Please note we contacted your office recently for assistance. 

What are the system requirements for quality control servicing? 

What are some quality control procedures involved in servicing? 

ANSWER 

We provide a policies and procedures compliance library for servicing (as well as one for mortgage loan originations). The compliance library is customized to your servicing platform. And we’ll maintain it for you. 

As a servicer, you must have fully documented, written policies and procedures that address all aspects of mortgage servicing. If you want to contact me directly, I would be glad to discuss your needs in detail. Contact me here. 

With respect to system requirements, I advise thinking ahead about the quality control system needs because how your system operates will determine its effectiveness and flexibility. 

There are numerous investor and legal requirements in each jurisdiction where you operate as a servicer. These must be well-documented and provide for a review of the following:

 

·       aspects of the delinquent mortgage loan servicing system;

 

·       the system to control and monitor bankruptcy proceedings; and

 

·       the foreclosure monitoring system.

The servicer must develop a quality control program addressing delinquency management and default prevention. Proper staffing and training are mandatory. And you must implement a strong business continuity and disaster recovery program. 

The servicer must audit quality control regularly at the loan level. (If you are subservicing, you must audit the servicer’s process at the loan level.) For loan level servicing quality control audits, contact us here. 

The servicer must implement certain primary system requirements for servicing quality control, as follows:

 

1.   Conduct regular testing of compliance with applicable laws in all jurisdictions in which it operates;

 

2.   Regularly review and assess the adequacy of internal controls;

 

3.   Keep a record of any activity under the applicable internal systems;

 

4.   Report comprehensive results of all testing to the senior management;

 

5.   Promptly take appropriate corrective action if these systems identify a problem area; and

 

6.   Make comprehensive testing results and any evidence of corrections available for review upon the investor’s request. 

With respect to servicing quality control procedures, there are a few themes that run throughout the written policies and procedures. As a servicer, you must monitor your compliance with the investor’s requirements and federal and state mandates through regular quality control procedures that are ratified, established, conducted, and monitored. 

The servicer must maintain adequate quality control procedures and systems. Implementing a self-assessment for various operational functions should be considered. At a high level, the servicer must be able to:

 

·      ensure that the mortgage loans are serviced under sound mortgage banking and accounting principles and in compliance with investor guidelines;

 

·      guard against misrepresentation and dishonest, fraudulent, or negligent acts by any parties involved in the mortgage loan servicing process;

 

·      protect against errors and omissions by officers, employees, or other authorized persons;

 

·      verify and audit the accuracy of the loan adjustment (i.e., ARM adjustments) and facilitation of timely responses to errors identified by the borrower, the servicer’s regulatory agency, or the investor; and

 

·      protect the investor’s investment in the security properties. 

Failure to maintain adequate servicing quality control standards may result in a servicer being in breach of its contact with investors. 

Furthermore, I urge you to perform annual quality control tests to ensure that all outsourcing firms and third-party vendors fully comply with investor guidelines and federal and state requirements. 

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

Servicing Quality Control: Recurring Adverse Findings

QUESTION 

We have used your servicing quality control group for many years. We like how we can have direct contact with the auditors. Recently, we asked one of your auditors for feedback about the adverse findings they see happening among the many servicers you audit. 

The response was very helpful because your servicing compliance group provides servicing quality control to servicers in many states. We have virtually eliminated “confirmation bias” by getting your wide-ranging information across the servicing spectrum. 

We’re hoping you would share with others a few of these findings. 

What are some recurring violations in your servicing quality control findings concerning servicing transfers, payment posting, loss mitigation, and UDAAP? 

ANSWER 

Thank you for the opportunity to provide our servicing compliance solutions. Most of our servicing clients retain us for servicing quality control and monthly or hourly servicing compliance support. 

Because we work with servicers of differing sizes, complexity, and risk profiles, we constantly update our review criteria to reflect the range of audit findings. One of the aims of servicing quality control is to anticipate examiners’ regulatory compliance expectations. 

Contact us for information regarding our servicing quality control.

Active subscribers receive a 10% discount per loan file. 

Contact us HERE. 

I will provide an outline of recurring adverse findings along with remedial recommendations. Of course, the potential list of adverse results is formidable. Since 2006, when we first began servicing quality control, we have identified numerous recurring regulatory violations. 

Interestingly, as noted in its reports, the Consumer Financial Protection Bureau has picked up on similar violations.[i] Clearly, anticipating adverse findings is critical to quality control auditing. 

Servicing Transfers 

Policies and Procedures 

Regulation X[ii], implementing the Real Estate Settlement Procedures Act (RESPA), requires servicers to maintain policies and procedures reasonably designed to achieve specific objectives.[iii] By “procedures,” Regulation X refers to the actual practices the servicer follows.[iv] 

Under Regulation X[v], transferee servicers must maintain policies and procedures to identify necessary documents and information not included in a servicing transfer and obtain such information from the transferor servicer. 

But we have found that some servicers violated Regulation X when they failed to maintain policies and procedures reasonably designed to achieve the objective of facilitating the transfer of information during servicing transfers. 

For instance, servicers’ policies and procedures were not reasonably designed because they failed to obtain copies of the security instruments or, in fact, any documents reestablishing the security instrument, to establish the lien securing the mortgage loans after servicing transfers. 

Recommendation: Update policies and procedures; implement new training. 

Payment Posting 

After a transfer of servicing, Regulation X requires that, during the 60-day period beginning on the effective date of transfer, servicers not treat payments sent to the transferor servicer as late if the transferor servicer receives them on or before the due date.[vi] We’ve found that servicers treated payments received by the transferor servicer during the 60-day period as late when not transmitted by the transferor to the transferee until after the 60-day period. 

This violates Regulation X because the transferor had received the payment within the 60-day period beginning on the effective date of the transfer. 

Recommendation: Remediate consumers; update policies and procedures; implement training; and revise internal controls. 

Contact us for information regarding our servicing quality control.

Active subscribers receive a 10% discount per loan file. 

Contact us HERE. 

Loss Mitigation 

Disclosure Violations 

We have issued adverse findings when servicers violated Regulation X and Regulation Z by failing to provide the specific required information in several circumstances: 

• Specific reasons for denial when they sent notices that included vague denial reasons, such as informing consumers that they did not meet the eligibility requirements for the program; that is, If a servicer denies a borrower’s complete loss mitigation application for any loan modification option available to the borrower, then its evaluation notice[vii] must include the specific reason or reasons for the denial.[viii] 

• Correct payment and duration information for forbearance: When a servicer offers a short-term loss mitigation option, such as a forbearance plan, it must promptly provide a written notice that includes the specific payment terms and duration of the program.[ix] and

• Information in periodic statements about loss mitigation programs, such as forbearance, to which consumers had agreed. Regulation Z requires servicers to include delinquency information on the periodic statement or in a separate letter if a consumer is more than 45 days delinquent.[x] This includes a requirement to provide a notice of any loss mitigation program to which the consumer has agreed.[xi] 

Recommendation: Update letter templates; implement enhanced monitoring. 

Timing and UDAAP Violations 

Suppose a servicer receives a complete application more than 37 days before a scheduled foreclosure sale. In that case, Regulation X[xii] requires servicers to evaluate the complete loss mitigation application within 30 days of receipt and provide written notices to borrowers stating which loss mitigation options, if any, are available. We have found that some servicers violated Regulation X when they failed to evaluate complete applications within 30 days of receipt.[xiii] 

Indeed, examiners often find that some servicers evaluate the application within 30 days but fail to provide the required notice to borrowers within 30 days as required.[xiv] 

Recommendation: Improve policies; implement additional training. 

Also, there is a UDAAP issue involved in this determination since examiners have found that servicers engage in an unfair act or practice when they delay processing borrower requests to enroll in loss mitigation options (including COVID-19 pandemic-related forbearance extensions) based on incomplete applications.

Imperative of Pre-Funding Quality Control

QUESTION

My problem is that I have a CEO who does not want to do pre-funding quality control. When I insist on it, then we do it for a while. But he cuts it off again and again. He says our investors only care about post-closing quality control. 

Last month, one of our investors wanted to see our pre-funding quality control reports and checklists. Well, we had the checklists, but we only had a few pre-funding QC reports. Somehow, the word got out, and other investors are now asking for these things. 

Yesterday, we got a letter from Fannie Mae that singled out that we did not do pre-funding QC. The CEO called us into his office, showed us the letter, and admitted he was wrong. In the meantime, he's telling us to put pre-funding QC into action immediately. 

I am so frustrated I could scream! This was all avoidable. I want you to write something that I can show the CEO so that he understands what has happened and I don't have to deal with him again on this issue. 

Why is pre-funding quality control important, useful, and required? 

ANSWER

You deserve a badge of honor for warning your management all along. Sometimes, management thinks it is smarter and wiser than those handling the departments and functions. Good managers listen, learn, and are open to staff suggestions; bad managers pontificate and dictate. So, I am going to respond as if I were talking to your CEO. 

Mr. CEO, listen up! 

I have no skin in the game, but you do – and you have put your enterprise at risk. When you start to cut corners with investors, they will cut you out. Trust me, I've seen it happen many times. First, it's a letter. Then it's a per-file audit. Then it's a warning to restrict loan originations, putting you on a tight leash. The repurchase threats will accumulate. Keep it up and you're out. If Fannie gets burned, expect other investors to drop you. Game over! 

So let me give you some guidance. I suggest you give it your undivided attention. 

Think of pre-funding QC as a process, a tool to obtain real-time loan quality information about the loan you want to sell to investors. Without pre-funding reviews, you cannot proactively gauge the risk in advance while the loan is being originated. Post-closing and investor audits are "look-backs;" pre-funding QC reviews are "look-forwards." 

Read your Reps and Warrants – are you really sure you meet them without a pre-funding check? The fact is, an ineligible loan can lead to repurchase risk and impact your bottom line due to the time and effort needed to remediate defects. Get it right in the pre-funding stage, given that eligible loans are ostensibly eligible because they pass positively through pre-funding, notwithstanding that you have some confidence that the borrowers are in a sustainable home loan. 

And there are derivative benefits to your company. For instance, From point of sale to closing, insights are gained into the loan flow process – the very process in which specific risk elements, such as income calculation opportunities, appraisal quality, and fraud – can be identified early. Furthermore, pre-funding reviews allow management to implement initiatives to prevent recurring systemic or incidental errors. 

You need to keep pre-funding quality control separate from operations. Obviously, the purpose of pre-funding can be thwarted if the underwriters are evaluating their own decision process. How will a good understanding of loan quality be obtained if the pre-funding review does not provide independently derived information? 

Perhaps your organization's reporting structure doesn't have the capacity to separate these duties. That means you are exposed to increased risk, leading to potential conflict of interest, which can cause a failure to maintain an impartial view of your loan origination performance. If you can't provide internally independent personnel, you should use externally independent resources. Many audit firms, including mine, provide this service. Our LCG Quality Control pre-funding reviews are reasonably priced and cost-effective. You can contact us HERE. And visit our pre-funding QC audit overview HERE. We are very hands-on, as that is the only effective way of conducting pre-funding QC reviews. 

Whatever the case, you should deploy guardrails. For example, adverse pre-funding QC findings should not be overridden without conclusive and appropriate documentation. The Quality Control Plan needs to reflect an audit process that includes the pre-funding reviews, whether conducted internally or externally, to ensure that quality control procedures are performed correctly and independent from undue influence. 

As a CEO, you must ask the right questions if you are going to get useful answers. Here are four questions that I want you to discuss with your QC staff.

 

1. Does the pre-funding QC process lead to decisions that drive organizational change?

 

2. Does our Quality Control Plan detail the pre-funding process, setting expectations for all relevant stakeholders, departments, functions, and investors?

 

3. How confident are you that your pre-funding department operates independently from outside influence?

 

4. Is your QC plan compliant with Fannie Mae guidelines, such as:

·       Timing of the review,

·       Loan selection process,

·       Verification of data and documents, and

·       Reporting. 

These are the actions you should take in concert with your staff:

 

·     Review your Quality Control Plan to ensure all required pre-funding elements are included.

 

·     Determine if an audit process is in place to confirm that pre-funding QC is fully independent.

 

·     Review your pre-funding reporting to confirm it complies with investor guidelines regarding timing, process flow, and content.

 

·     Review your pre-funding QC reporting to improve the information provided to management.

A good suggestion is for you to use our QC Tune-up, which will let you know if your QC department and plan are properly interfaced internally and externally. For more information, contact us HERE. 

Finally, I will share with you some of the recurring findings that occur in our pre-funding QC reports. If you haven't been doing pre-funding reviews continually, you may have only a sparse understanding of these risks (and other risks) to which you have needlessly exposed your company. 

Untimely Selection of the Loan. This is a weak link because the timing of the pre-funding QC significantly affects the amount of information in the file. You should choose loans early enough in the origination process to complete all review steps but also at a point when sufficient information validates a correct credit decision. Your threshold metric must be a process that meets both the criteria for timing and validation. Ensuring the proper evaluation (i.e., timing and validation) is the basis for implementing a detailed remediation process. And, without exception, if the loan is acquired from a Third Party Originator (TPO), the pre-funding review should be performed pre-purchase. 

Defective Loan Selection Process and Quality Control Plan. You must document the pre-funding loan selection process and set forth the selection criteria in the Quality Control Plan, meaning you should:

·       Establish a process for loan selection,

·       Determine how often the selection criteria are revisited, and

·       Determine who is responsible for changing the selection criteria. 

Loans with a greater chance of errors, misrepresentation, or fraud should be selected in the pre-funding sample. Essentially, experience has shown that by tracking errors, the lender can select high risk loans and loans with a greater chance of having a defect. This is the reason behind discretionary sampling. A word about discretionary sampling is in order. The pre-funding sample method based on certain selection criteria includes emerging risks, testing of action plans, validation of employee, TPO performance, or targeting a specific component, such as complex income calculations. The discretionary pre-funding QC, therefore, leads to improved loan quality. 

"Catch-All" Provision in RESPA

QUESTION

We are a servicer licensed in all states. As the company’s Associate General Counsel, I am tasked with monitoring the legal implementation of federal and state laws pertaining to mortgage servicing. 

One of my concerns is the “catch-all” provision in Regulation X because it appears to offer borrowers a means to allege that we may implement proper error resolution procedures but still be held liable for violations of RESPA. 

Recently, a borrower has retained counsel, and the “catch-all” provision was cited in the counsel’s letter to us. I don’t want to get into litigation with the borrower. 

Is there some guidance you can provide about the “catch-all” provision that will help me decide how to resolve this matter quickly? 

ANSWER

Your question did not contain specific information about the loan or the particular procedures you follow for error resolution. So, I will provide generalized guidance and use actual litigation to demonstrate the legal effect of the “catch-all” provision in RESPA. 

The Real Estate Settlement Procedures Act (RESPA) includes error resolution procedures for mortgage loans. RESPA establishes “qualified written requests” or QWRs as part of its error resolution standards. Regulation X, RESPA’s implementing regulation, breaks QWRs into two categories: Notices of Error (NOEs) and Requests for Information (RFIs).[i] 

Let’s list what an error is and what it is not. 

Regulation X defines the term “error” by including a list of qualifying instances: 

•          Failure to accept a payment that conforms to the servicer’s written requirements for the borrower to follow in making payments. 

•          Failure to apply an accepted payment to principal, interest, escrow, or other charges under the terms of the mortgage loan and applicable law. 

•          Failure to credit a payment to a borrower’s mortgage loan account as of the date of receipt. 

•          Failure to pay taxes, insurance premiums, or other charges, including charges the borrower and servicer have voluntarily agreed that the servicer should collect and pay in a timely manner, or to timely refund an escrow account balance. 

•          Imposition of a fee or charge that the servicer lacks a reasonable basis to impose, such as a late fee for a payment that is not late, a default property management fee for borrowers not in a delinquency status, or a charge for force-placed insurance in a circumstance not permitted by Regulation X. 

•          Failure to provide an accurate payoff balance amount upon a borrower’s request. 

•          Failure to provide accurate information to a borrower regarding loss mitigation options and foreclosure. 

•          Failure to transfer accurate and timely information relating to the servicing of a borrower’s mortgage loan account to a transferee servicer. 

•          Making the first notice or filing required by applicable law for any judicial or non-judicial foreclosure process in violation of Regulation X. 

•          Moving for foreclosure judgment or order of sale, or conducting a foreclosure sale in violation of Regulation X. 

•          Any other error relating to the servicing of a borrower’s mortgage loan (sometimes referred to as the “catch-all” provision). (Note my emphases in bold and italics.) 

Regulation X offers several examples that are not “errors” subject to the NOE procedures: 

•          An error relating to the origination of a mortgage loan. 

•          An error relating to the underwriting of a mortgage loan. 

•          An error relating to a subsequent sale or securitization of a mortgage loan. 

•          An error relating to a determination to sell, assign, or transfer the servicing of a mortgage loan, not including an error relating to the failure to transfer accurately and timely information relating to the servicing of a borrower’s mortgage loan account to a transferee servicer. 

To illustrate how the catch-all qualifying instance of an error is applied in litigation, consider the case of Naimoli v. Ocwen Loan Servicing, LLC.[ii] It is a recent decision by the U.S. Court of Appeals for the 2nd Circuit. 

Here’s what happened. 

1.       Naimoli obtained a mortgage loan from IndyMac Bank to finance the purchase of her home. She then defaulted on her mortgage payments. To avoid foreclosure, she requested a Home Affordable Modification Program (HAMP) loan modification from her servicer, Ocwen Loan Servicing. 

2.       Ocwen approved her for a trial period mortgage loan modification plan, stating 

“if you successfully complete the TPP [trial period plan] by making the required payments, you will receive a modification with an interest rate of 3.50000%, which will be fixed for 40 years from the date the modification is effective.” 

The plan indicated that if Naimoli timely submitted her three payments, Ocwen would issue a permanent modification agreement for her to sign. 

3.       During the trial period, Ocwen told Naimoli that it could not implement the permanent modification agreement until she re-executed the mortgage and note that IndyMac (her lender) had failed to record and apparently lost.

Responding fully to an RFI

QUESTION 

We are a mortgage servicer, providing servicing throughout the country. I am the company’s Assistant General Counsel. 

As a result of a multistate banking examination, it is alleged that we failed to respond fully to RFI requirements. Specifically, the claim is that we did not provide sufficient information in response. 

Our staff has done considerable research on this matter; however, we have yet to determine how much information is sufficient to satisfy the RFI requirements. I am writing to you to get your view. 

How much information must a servicer provide in response to an RFI? 

ANSWER 

The Real Estate Settlement Procedures Act (RESPA) and its implementing Regulation X require servicers to respond to borrower requests for information (RFIs). This procedure results from the Dodd-Frank Wall Street Reform and Consumer Protection Act’s expansion of the scope of RESPA’s complaint handling requirements beyond the previously existing qualified written request (QWR) requirements. 

The RFI requirements apply to any written request from a borrower (or an agent for a borrower) to a servicer for information if the request includes three elements: 

(1) the name of the borrower; 

(2) information that enables the servicer to identify the borrower’s mortgage loan account; and 

(3) a statement of the information the borrower is requesting. 

Let’s take a look at the procedural components. 

Regulation X sets up a 2-step process for responding to RFIs, as follows: 

First, within five days (excluding legal public holidays, Saturdays, and Sundays) after receiving an RFI, a servicer must provide a written acknowledgment of receipt; and 

Second, a servicer generally must respond to the RFI not later than 10 days after receiving an RFI for the identity of, and address or other relevant contact information for, the owner or assignee of a mortgage loan, and not later than 30 days after receiving any other RFI. 

The servicer may extend the 30-day period by 15 days if, before the end of the 30-day period, the servicer notifies the borrower of the extension and its reasons. (The 10-day period cannot be extended.) A servicer need not comply with this 2-step process if it provides the information requested in writing within 5 days after receiving the RFI, along with contact information, including a telephone number, for further assistance. 

In general, the servicer must respond to an RFI by taking one of two actions: 

(1) providing the borrower with the requested information and contact information in writing, including a telephone number; or 

(2) conducting a reasonable search for the requested information and providing the borrower with a written notification stating that the servicer has determined that the information is not available to the servicer, with the basis for that determination and contact information, including a telephone number. 

Now, to your question about how much information must the servicer provide. 

Regulation X offers guidance regarding the types of information a servicer need not provide and what information is considered not available to the servicer. For example, information is not available if a borrower requests information stored on electronic back-up media that is not accessible by servicer personnel in the ordinary course of business without undertaking extraordinary efforts to identify and restore the information. Also, a servicer is not required to respond to RFIs that are overbroad or unduly burdensome, such as RFIs that seek documents relating to substantially all aspects of mortgage origination, mortgage servicing, foreclosure, and mortgage sale or securitization. 

I think a recent court decision may provide some clarification. 

The U.S. Court of Appeals for the 6th Circuit addressed a borrower’s claim that her mortgage loan servicer failed to provide all the information she requested in an RFI.[i] 

In 2005, Ms. Miller bought a home and financed the purchase with a mortgage loan. She fell behind on her payments and by January 2019 was 29 payments past due. She unsuccessfully sought a loan modification. In March 2019, a sheriff’s sale took place. 

In August 2019, Miller sued the lender’s assignee and the loan servicer, including RESPA claims for violating Regulation X’s RFI requirements and “dual-tracking” prohibition. (I’ll get to “dual tracking” shortly.) She claimed that the defendants “did not provide all of the information sought in her letters” and that she “was inconvenienced and incurred expenses in seeking the information that [d]efendants refused to provide.” 

Miller asked for “actual damages, including, but not limited to: 

(1) out-of-pocket expenses incurred dealing with the RESPA violation including expenses for preparing, photocopying and obtaining certified copies of correspondence, 

(2) lost time and inconvenience to the extent it resulted in actual pecuniary loss, 

(3) late fees, and 

(4) denial of credit or denial of access to full amount of credit line, additional [statutory] damages in the amount of $2,000.00, plus attorney’s fees, the costs of this lawsuit, and litigation expenses.” 

The district court dismissed all her claims for lack of standing, finding that she had failed to plead sufficient damages to establish an injury-in-fact.

Servicing Borrowers’ COVID-19 Emergencies

QUESTION
We are currently servicing $8 billion. As you know, COVID has really put a lot of pressure on servicers.

We are studying new directives and proposed rules from the CFPB. One of them deals with a proposed rule involving COVID-19 emergencies and hardships. We would like your feedback. 

What are the highlights of the proposed servicing rule that deals with COVID issues?

ANSWER
To begin, you should understand that the proposal, if finalized, would generally add to existing Regulation X provisions to help address COVID-19-related hardships. Given the nature and scope of the proposed rule, I will provide a cursory summary.

For servicing compliance support, you should contact us. 

Our Servicers Compliance Group will get you ready to implement the Proposed Rule.

The Consumer Financial Protection Bureau (CFPB) issued a notice of proposed rulemaking (viz., 2021 Mortgage Servicing COVID-19 Proposed Rule) to propose amendments to its Mortgage Servicing Rule that would provide additional assistance for borrowers impacted by the COVID-19 emergency ("Proposed Rule").

The Proposed Rule includes:

-Adding information that servicers would provide to certain borrowers during live contacts;

-Adding loan modification options that servicers may offer based on an incomplete loss mitigation application in certain circumstances; and,

-Establishing a temporary COVID-19 emergency-related preforeclosure review period, added to existing foreclosure protections.

Let’s dig a little deeper.

The Proposed Rule would add a definition for COVID-19-related hardship to generally mean

a financial hardship related to the COVID-19 emergency, as defined in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). 

I will set forth a summary of the Proposed Rule’s amendments.

There are four paramount changes.

1) Early Intervention: Live Contact

During live contacts established under the existing Mortgage Servicing Rule requirements, the Proposed Rule would require servicers to take additional actions with certain borrowers. 

For borrowers not yet in a forbearance plan at the time of live contact, if forbearance options are available to the borrower through the servicer, the servicer would be required to ask the borrower if they are experiencing a COVID-19-related hardship. If the borrower indicates they are, the servicer would be required to list and describe forbearance programs made available to that borrower. The servicer would also be required to provide the actions that the borrower must take to be evaluated for such forbearance programs.

For borrowers in a forbearance plan at the time of live contact, the servicer would be required to identify the date the borrower’s forbearance program ends and list and describe loss mitigation options made available to the borrower to resolve any delinquency the borrower will have at the end of the forbearance program. The servicer would also be required to provide the actions that the borrower must take to be evaluated for such loss mitigation options, information the servicer has under existing continuity of contact requirements. The servicer would only need to provide this information in the last live contact required under the existing rule that occurs prior to the end of the forbearance period.

This proposed provision is temporary. If finalized, it would only apply until August 31, 2022, one year after the proposed effective date.

2) Loss Mitigation Procedures: Reasonable Diligence

Under the existing rule’s reasonable diligence obligations for servicers in obtaining a complete loss mitigation application, the Proposed Rule would clarify when the servicer must perform reasonable diligence requirements for borrowers in a short-term payment forbearance program made available to borrowers experiencing a COVID-19-related hardship. 

For those borrowers, if the short-term payment forbearance program was offered based on the evaluation of an incomplete application, then, no later than 30 days before the end of the short-term payment forbearance program, the servicer would be required to contact the borrower and determine if the borrower wants to complete their loss mitigation application and proceed with a full loss mitigation evaluation. 

If the borrower requests further assistance, the servicer would be required to exercise reasonable diligence to complete the application before the end of the forbearance program.

3) Loss Mitigation Procedures: Evaluation of a Loss Mitigation Application

The Proposed Rule would add another exception to the existing rule’s prohibition on offering a loss mitigation option based on an evaluation of an incomplete loss mitigation application. A servicer would be allowed to offer certain loan modifications based on the evaluation of an incomplete application if certain criteria are met.

Those criteria include:

-The loan modification would extend the term of the loan by no more than 480 months and would not result in an increase to the borrower’s periodic principal and interest payment.

-If the loan modification allows a deferral of amounts until certain points, such as when the loan is refinanced or the property is sold, the amounts would not accrue interest; the servicer would not charge a fee connected to the loan modification; and certain existing charges owed by the borrower, such as late fees and stop payment fees, would be waived by the servicer upon acceptance of the loan modification.

-The loan modification must be made available to borrowers experiencing a COVID-19-related hardship, as that term is defined in the proposal.

-The borrower’s preexisting delinquency would be resolved by acceptance of the loan modification (and potential completion of a trial loan modification first, if required by the servicer).

If the borrower accepts a loan modification as described in the Proposed Rule, the acceptance would terminate the servicer’s obligation to exercise reasonable diligence to complete any loss mitigation application the borrower submitted prior to the borrower’s acceptance of an offer made under the proposed exception. It would also terminate the servicer’s obligation to review such an application under the existing rule requirements. 

he obligation to exercise reasonable diligence to complete any loss mitigation application the borrower submitted prior to the borrower’s acceptance of an offer made under the proposed exception would restart if the borrower fails to perform under any required trial loan modification or if the borrower requests further assistance.

4) Loss Mitigation Procedures: Prohibition on Foreclosure Referral

The Proposed Rule would add a temporary COVID-19 “preforeclosure review period” where a servicer is not permitted to make the first notice or filing for foreclosure. 

In addition to the existing rule that generally prohibits a servicer from making the first notice or filing unless the borrower is more than 120 days delinquent, the Proposed Rule would add a temporary blanket prohibition on making the first notice or filing for foreclosure because of delinquency until after December 31, 2021.

Jonathan Foxx Ph.D., MBA

Chairman & Managing Director

Lenders Compliance Group

The "Superpriority" Lien

QUESTION
I hope you will take my question. I am counsel to several banks that provide loan resources to HOAs. I have always held the position that HOA liens have superpriority, and they do not violate takings or due process.

My concern involves proper notice from an HOA that involves superpriority issues with respect to the Takings Clause and Due Process. I know this can be kind of tricky. I would like your view.

So, in the context of an HOA, how do the Takings and Due Process Clause impact the superpriority lien?

ANSWER
Let’s begin by providing a brief discussion about the meaning of “superpriority.” With respect to Homeowners Associations (HOAs), many states offer “super – priority” of HOA liens set up in connection with townhouse, condominium, and other housing developments. In other words, applicable statutes grant an HOA a lien on its members’ residences for unpaid assessments and charges, rendering that portion superior to all other liens, including the first deed of trust held by the mortgage lender.

Lenders that extend mortgage loans secured by homes located within these HOA developments must be aware of the risk that a borrower might not pay HOA assessments when due, leading to the HOA’s foreclosure in the exercise of its superpriority lien. Accordingly, they need to pay attention to any foreclosure notices they receive regarding HOA proceedings.

Now to expand on your question. I will provide a response by citing recent litigation. The U.S. Court of Appeals for the 9th Circuit considered a bank's desperate attempt to rescue its security interest in a home lost to HOA foreclosure.[*]

Carrasco and Kongnalinh bought a house within the Copper Creek Homeowners Association, financing the purchase with a loan from Wells Fargo Bank secured by the home. The homeowners fell behind on their HOA dues, and the HOA recorded a lien for the delinquent assessments. The HOA foreclosed on the property to satisfy the lien, and Mahogany Meadows Avenue Trust bought the property for $5,332 at a public auction, extinguishing Wells Fargo’s deed of trust.

Wells Fargo conceded that it had received actual notices of the foreclosure sale but argued that the contents of the notices were constitutionally deficient because they did not state that the HOA was foreclosing to satisfy the superpriority portion of the lien, how large the superpriority portion was, or that Wells Fargo’s own lien was in jeopardy. Wells Fargo received precisely the notice prescribed by the statute.

Wells Fargo brought a quiet title action against Mahogany Meadows, the HOA, and the HOA’s agent, seeking a declaration that the foreclosure sale was invalid and Wells Fargo’s deed of trust “continues as a valid encumbrance against the Property,” which had been worth about $200,000. Wells Fargo asserted that the Nebraska state law giving the HOA lien superpriority violated the Takings Clause and the Due Process Clause of the U.S. Constitution.

The Takings Clause and Due Process Clause refers to the Fifth Amendment of the Constitution, where provisions concerning the due process of law and just compensation are explicated.

Check out the commodiously, unexpurgated legalese of the text itself; then I’ll make it easy on the eye with a brief translation:

No person shall be held to answer for a capital, or otherwise infamous crime, unless on a presentment or indictment of a Grand Jury, except in cases arising in the land or naval forces, or in the Militia, when in actual service in time of War or public danger; nor shall any person be subject for the same offence to be twice put in jeopardy of life or limb; nor shall be compelled in any criminal case to be a witness against himself, nor be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation.

Brief translation: private property cannot be taken for public use without just compensation.

“Just compensation” typically means, in this context, that the property owner has to receive at a minimum the fair market value of the property in its best alternative use – independent of the government taking.

Now, let’s return to the case. 

The district court dismissed the complaint and the 9th Circuit affirmed.

First, the “superpriority” statute did not facilitate an uncompensated taking of property or violate the Due Process Clause. The Takings Clause, which states “Nor shall private property [including liens such as Wells Fargo’s deed of trust lien] be taken for public use, without compensation,” governs the conduct of the government, not private actors. The HOA, which conducted the foreclosure, was not an arm of the State of Nebraska.

The U.S. Supreme Court has held that “[p]rivate use of state-sanctioned private remedies or procedures does not rise to the level of state action.” Although Nevada law authorized the HOA’s action, that authorization did not make the HOA’s action government action sufficient to invoke the Fifth Amendment.

Second, because the enactment of the state statute had predated the creation of Wells Fargo’s lien, Wells Fargo could not establish that it suffered an uncompensated taking. The statute was enacted in 1991, the HOA covenants and restrictions were recorded in 2003, and both of these things happened before Wells Fargo acquired its lien. Thus, the interest Wells Fargo asserted – that is, the right to maintain its lien unimpaired by a later HOA lien – was not part of its title to begin with. To be sure, when background principles of state law already serve to deprive the property owner of the interest it claims to have been taken, it cannot assert a claim under Takings Clause.

Wells Fargo had options. It easily could have avoided the harsh result by deeming a lien subject to the statutory scheme inadequate security for its loan and refusing to lend. Or, Wells Fargo could have paid off the HOA lien to avert loss of its security, or established an escrow for HOA assessments to avoid having to use its own funds to pay delinquent dues.

Third and finally, regarding due process, because Wells Fargo did not dispute that it received actual notice, its due process rights were not violated.

Wells Fargo did not argue that it was particularly unsophisticated so that a level of notice that might be adequate for an average person would be inadequate for it. Instead, it argued that the notice contemplated by the statute was insufficient. If that were correct, then the notice would be equally insufficient for any holder of an interest in the property, which would mean that essentially all applications of the statute would be invalid. Yet the court had already held the opposite in an earlier decision.

So, here’s my observation.

As I see it, the 9th Circuit rejected Wells Fargo’s assertion that it could not have known about the potential impairment of its lien because even though the statute had been enacted before it acquired its lien, only in a Nevada Supreme Court decision rendered after Wells Fargo obtained its lien “did the [court] radically reinvent [the statute] and hold that it not only granted a homeowner’s association first-payment priority during foreclosure, but that foreclosure of such a lien also destroyed every other lien on the property.”

The Nevada Supreme Court had explained that its decision did not change the law, but “did no more than interpret the will of the enacting legislature.” If the Nevada courts wished to treat that interpretation as reflecting the statute's meaning from the day it was enacted, no principle of federal constitutional law prevented them from doing so.

Furthermore, the 9th Circuit noted that no contrary interpretation had been established before the Nevada Supreme Court decision. The Takings Clause only protects property rights as they are established under state law, not as they might have been established or ought to have been established.

Several points, therefore, deserve reiteration.

The creditor easily could have avoided the harsh result of the decision. It could have refused to lend because of the statutory superpriority scheme. Alternatively, as part of the loan setup, it could have made the loan and implemented a procedure, including training, to assure receipt, and employee understanding of, notices from the HOA. Upon receiving notice, the creditor could have paid off the HOA lien to prevent loss of its security. From the beginning of the loan, the creditor could have required an escrow account for HOA assessments and coordinated payments with the HOA.

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

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[*] Wells Fargo Bank v. Mahogany Meadows Ave. Trust, 979 F.3d 1209 (9th Circuit 2020)