oversight

HUD Did Not Collect an Estimated 1,361 Partial Claims Upon Termination of Their Related FHA-Insured Mortgages

Published by the Department of Housing and Urban Development, Office of Inspector General on 2016-08-17.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

     U.S. Department of Housing and
   Urban Development, Office of Single
            Family Housing
               Partial Claims Loss Mitigation Option




Office of Audit, Region 7          Audit Report Number: 2016-KC-0001
Kansas City, MO                                        August 17, 2016
To:            Robert Mulderig, Acting Deputy Assistant Secretary for
                    Single Family Housing, HU
               //signed//
From:          Ronald J. Hosking, Regional Inspector General for Audit, 7AGA
Subject:       HUD Did Not Collect an Estimated 1,361 Partial Claims Upon Termination of
               Their Related FHA-Insured Mortgages




Attached is the U.S. Department of Housing and Urban Development (HUD), Office of Inspector
General’s (OIG) final results of our review of HUD’s collection of partial claims upon
termination of Federal Housing Administration (FHA)-insured mortgages.
HUD Handbook 2000.06, REV-4, sets specific timeframes for management decisions on
recommended corrective actions. For each recommendation without a management decision,
please respond and provide status reports in accordance with the HUD Handbook. Please furnish
us copies of any correspondence or directives issued because of the audit.
The Inspector General Act, Title 5 United States Code, section 8M, requires that OIG post its
publicly available reports on the OIG Web site. Accordingly, this report will be posted at
http://www.hudoig.gov.
If you have any questions or comments about this report, please do not hesitate to call me at
913-551-5870.
                    Audit Report Number: 2016-KC-0001
                    Date: August 17, 2016

                    HUD Did Not Collect an Estimated 1,361 Partial Claims Upon Termination
                    of Their Related FHA-Insured Mortgages




Highlights

What We Audited and Why
We audited the U.S. Department of Housing and Urban Development (HUD) to determine
whether it collected partial claims upon termination of their related Federal Housing
Administration (FHA)-insured mortgages. We initiated this audit because of our concern that
FHA partial claims could go uncollected.

What We Found
HUD did not collect an estimated 1,361 partial claims that became due in fiscal year 2015. As a
result, partial claims totaling approximately $21.5 million were not returned to the FHA
insurance fund.

What We Recommend
We recommend that HUD’s Acting Deputy Assistant Secretary for Single Family Housing (1)
require HUD’s loan servicing contractor to complete the necessary debt collection efforts for an
estimated $21.5 million in uncollected partial claims that became due during fiscal year 2015, (2)
add a performance requirement measuring partial claims collection to HUD’s contractor’s
performance work statement to put more than $21.5 million to better use, and (3) strengthen
procedures to better identify and resolve all due and payable partial claims.
Table of Contents
Background and Objective......................................................................................3

Results of Audit ........................................................................................................5
         Finding 1: HUD Did Not Always Collect Partial Claims ............................................. 5

Scope and Methodology ...........................................................................................8

Internal Controls ....................................................................................................11

Appendixes ..............................................................................................................12
         A. Schedule of Questioned Costs and Funds To Be Put to Better Use ...................... 12
         B. Auditee Comments and OIG’s Evaluation ............................................................. 13
         C. Sample Results .......................................................................................................... 16
         D. Criteria ....................................................................................................................... 17




                                                                     2
Background and Objective
The Federal Housing Administration (FHA) provides mortgage insurance for loans made by FHA-
approved lenders throughout the United States and its territories. FHA mortgage insurance protects
lenders against losses from homeowners defaulting on their mortgage loans. The lenders bear less
risk because FHA will pay a claim to the lender if a homeowner defaults on his or her loan. Loss
mitigation is critical to FHA because it helps borrowers in default keep their homes while reducing
the economic impact on the insurance fund.
The FHA partial claim is a loss mitigation tool that helps borrowers keep their homes by advancing
funds on behalf of the borrowers to reinstate delinquent FHA-insured mortgages. The borrowers
execute promissory notes and mortgages payable to the U.S. Department of Housing and Urban
Development (HUD) when they accept the advances. A partial claim note does not accrue interest
and is not due and payable until the related first mortgage has been paid off, has matured, or has
been refinanced with a non-FHA-insured mortgage or the borrower sells the property. HUD paid
more than 500,000 partial claims since the program began in 1997. During the last 5 years, the
number of terminated FHA-insured mortgages with associated partial claims had increased.


                                 FHA mortgage terminations with
                                    associated partial claims
                350                                                                                       16,000

                300                                                                                       14,000
                                                                                                          12,000
   $ millions




                250
                                                                                                          10,000
                200


                                                                                                                   Count
                                                                                                          8,000
                150
                                                                                                          6,000
                100
                                                                                                          4,000
                50                                                                                        2,000
                 -                                                                                        -
                         FY12*            FY13                FY14        FY15        Projected FY16
                      FY= fiscal year                                                 (based on first 8
                                                                                          months)

                            Dollar amount of partial claims
                            Number of partial claims associated with FHA mortgages terminated each year


Source: Single Family Data Warehouse




                                                                3
HUD’s National Servicing Center helps FHA homeowners by working with lenders to administer
the Loss Mitigation program. The National Servicing Center contracts the servicing, collecting, and
managing of partial claims to its national loan servicing contractor. Partial claim notes become due
and payable when their related FHA-insured mortgages are terminated. In some cases, a lender
or title company remits a portion of the proceeds from the sale or refinance of the property to the
loan servicing contractor to pay off the partial claim. In other cases, the contractor transfers the
unpaid partial claim debt to HUD’s Financial Operations Center to take collection action against the
borrower. This action includes referring the delinquent debts to the U.S. Department of the
Treasury. HUD’s Financial Operations Center is responsible for servicing and collecting a variety
of debts and receivables that are transferred from other organizations with HUD. Federal agencies
are required to aggressively collect all debts arising from activities of that agency. This requirement
mandates that debt collection actions be taken promptly once it is determined that a debt is owed.
Our objective was to determine whether HUD collected FHA partial claims upon termination of
their related FHA-insured mortgages.




                                                   4
Results of Audit

Finding 1: HUD Did Not Always Collect Partial Claims
HUD did not collect an estimated 1,361 partial claims that became due in fiscal year 2015. This
condition occurred because HUD did not include strong performance requirements in its loan
servicing contract and did not always identify and resolve all partial claims that the contractor
needed to collect. As a result, uncollected partial claims totaling $21.5 million were not returned
to the FHA insurance fund.
Partial Claims Not Collected
HUD did not collect an estimated 1,361 partial claims that became due in fiscal year 2015. We
reviewed a statistical sample of 135 of 10,561 partial claims associated with FHA-insured
mortgages that terminated in fiscal year 2015. HUD had not collected 36 of the claims that
should have been collected. We used this result to project that a total of 1,361 partial claims were
not collected.
A partial claim becomes due and payable when the borrower either pays off the related FHA-
insured first mortgage or no longer owns the property, except for a streamlined refinance when
the partial claim note is subordinated to a new FHA first mortgage. When a partial claim note is
paid off soon after becoming due, such as through the proceeds from a property sale closing,
HUD’s loan servicing contractor receives the partial claim payoff, deposits the funds in the bank,
and notes in HUD’s loan servicing system that the claim has been collected. When the note is
not paid off soon after becoming due, the contractor notes that it is due and payable in HUD’s
loan servicing system and transfers the unpaid note to HUD’s Financial Operations Center. The
Financial Operations Center then issues demand letters to the borrowers and collects the partial
claims, along with interest on the unpaid balance assessed from the date of the demand letter
until the time of payment. Various HUD criteria provide the requirements for collecting partial
claims (appendix D).
Of the 36 uncollected partial claims in our sample, the contractor had entered only 4 into HUD’s
loan servicing system as due and payable. The contractor had not referred any of the claims to
the Financial Operations Center for collection. HUD, therefore, had not issued demand letters to
start collection in any of the 36 cases.
Contract and Monitoring Weaknesses
HUD did not include strong partial claims collection performance requirements in the loan
servicing contractor’s contract and did not always identify and resolve all partial claims that the
contractor needed to collect.
HUD’s contract for its national loan servicing contractor states that the contractor is responsible
for collecting the partial claim note when the first mortgage is terminated. However, the contract
does not set standards for expected timeframes and performance levels for partial claims




                                                  5
collection. These standards are necessary for HUD to effectively hold the contractor to an
acceptable level of performance.
HUD did not always identify and resolve all due and payable partial claims. HUD’s National
Servicing Center conducted monitoring reviews based on its quality assurance surveillance plan.
The plan required the government technical monitor to check for errors in the partial claims that
were proposed to be transferred from the contractor to the Financial Operations Center each
month. It did not, however, require the government technical monitor to determine whether any
eligible partial claims were missing. In addition, HUD did not adequately follow up on the
problems it found. HUD noted partial claims collection issues in two of its four quarterly
monitoring reviews during fiscal year 2015. HUD’s first quarter monitoring review noted 308
cases in which FHA mortgages were terminated but the partial claims were not reviewed for
collection. We reviewed 5 of these 308 cases as part of our audit sample and found that 3 of
them had not been transferred to the Financial Operations Center for collection more than a year
later. The fourth quarter monitoring review noted that necessary debt collection efforts were not
completed but did not state the number of problem cases. Of the 36 uncollected partial claims
identified in our sample, 11 became due during that fourth quarter. The contractor did not make
the necessary debt collection efforts until March 2016, after we requested documentation for
those cases.
FHA Fund Reduced
The FHA insurance fund was reduced because an estimated $21.5 million in uncollected partial
claims was not returned to the fund. When partial claims are returned, the fund’s economic
value increases. In addition, because HUD did not start collections in a timely manner, it
forfeited interest that would have accrued on the debt beginning on the date of the demand letter.
The forfeited interest would have also helped improve the fund’s value.
HUD failed to collect $625,399 for 36 of the partial claims in our sample. Using statistical
sampling procedures to project the uncollected claims to the universe of 10,561 partial claims,
we estimated that HUD failed to collect at least $21.5 million in partial claims that became due
during fiscal year 2015. During the most recent 5-year period, the volume of FHA mortgage
terminations with outstanding partial claims had increased significantly. As a result, HUD’s
failure to collect partial claims could result in an even greater loss of revenue.
Conclusion
HUD failed to collect an estimated $21.5 million in FHA partial claims that became due last
fiscal year. HUD’s contract with its national loan servicing contractor lacked a performance
requirement measuring partial claims collection. In addition, HUD’s monitoring reviews of the
contractor did not improve the contractor’s performance in collecting partial claims. HUD
should require the contractor to identify all partial claims that were due and payable, prepare the
paperwork needed for debt collection, and transfer the claims to the Financial Operations Center.
The Financial Operations Center should collect the $21.5 million in uncollected partial claims
from fiscal year 2015 from the borrowers, or if it is not possible to collect from the borrowers
due to lender error, it should collect those funds from the lender. HUD also needs to strengthen
the contract and monitoring review procedures to ensure that partial claims are properly
collected.



                                                 6
Recommendations
We recommend that the Deputy Assistant Secretary for Single Family Housing

       1A.    Require the contractor to complete the necessary debt collection efforts for
              $21,526,130 in uncollected partial claims associated with FHA mortgages
              terminated during fiscal year 2015.
       1B.    Add a performance requirement measuring partial claims collection to the
              contractor’s performance work statement to effectively hold the contractor to an
              acceptable level of performance to put more than $21,526,130 to better use.
       1C.    Strengthen procedures to better identify and resolve all due and payable partial
              claims.




                                                7
Scope and Methodology
Our audit covered the period October 2014 through September 2015. We performed our audit
work between October 2015 and June 2016. We conducted onsite work at HUD’s national loan
servicing contractor’s office at 2401 Northwest 23rd Street, Suite 1A1, Oklahoma City, OK.
To accomplish our objective, we

      Reviewed relevant laws, regulations, and HUD guidance;
      Reviewed HUD monitoring reviews of the loan servicing contractor;
      Reviewed HUD and loan servicing contractor policies and procedures;
      Interviewed HUD and loan servicing contractor personnel; and
      Selected and reviewed a statistical sample of partial claims.

We relied in part on data maintained by HUD in its Single Family Data Warehouse, HUD’s key
source for Single Family data. We also relied on HUD’s Single-Family Mortgage Asset
Recovery Technology System, HUD’s comprehensive loan servicing system used for analyzing,
processing, and tracking of FHA-insured mortgage loan servicing functions. Finally, we relied
on HUD’s Debt Collection and Asset Management System, which collects and maintains data
needed to support activities related to the collection and servicing of various HUD and FHA
debts.
Specifically, we relied on the systems to identify the universe of partial claims for which HUD
should have made collection efforts. Although we did not perform a detailed assessment of the
reliability of the data, we determined that the data were sufficiently reliable for the purposes of
our review because the data in the sampled items were corroborated by supporting
documentation supplied by HUD’s national loan servicing contractor.
Our audit universe consisted of 10,625 partial claims, valued at more than $211.5 million. The
10,625 partial claims were associated with FHA mortgages that terminated during fiscal year
2015 due to refinance, nonconveyance claim, voluntary termination of mortgage insurance, or
full repayment of the loan. This universe included mortgages terminated with nonconveyance
foreclosures for which the partial claim balances were written off. It also included streamline
refinances with partial claim balances subordinated to the new FHA mortgage, which did not
need to be paid off. It did not include partial claims associated with FHA mortgages that were
terminated in conveyance claims or assignments. To ensure a more accurate projection, the
universe excluded as outliers 64 partial claims, each exceeding $120,000, leaving 10,561 partial
claims valued at more than $202.3 million.
HUD provided a list of collected partial claims, which indicated it had collected 5,952 of the
10,561 partial claims in our universe. To control for variance, we stratified the universe based
on whether a partial claim was on HUD’s list of collected partial claims. To control for the
range of amounts in partial claims, the claims were sorted and ranked by dollar value and then
stratified into eight groups according to percentile points along this continuum. This process



                                                  8
yielded 16 strata (2 × 8). Within each stratum, we sorted by the type of termination and age of
the loan and then sampled systematically across that continuum to control for influence from
those elements.
We validated the sample design using replicated sampling (computer simulations) across several
audit scenarios, based on a variety of scenarios, both similar to and different from conditions
found during the audit. We found a sample size of 135 to be sufficient. We found that an
additional 35 samples would be required if the exception rate was very low, but they were not
needed in this case.
Based on the design, we selected a statistical sample and reviewed documentation from HUD to
determine whether HUD properly collected the sampled partial claims. Percentages, counts, and
average dollar amounts were estimated and projected to the universe as a whole. Because all
randomly selected samples are subject to “the luck of the draw,” we calculated a margin of error
for each type of measure and made a final projection on that basis. Variances were calculated
using a Taylor series. We used the traditional formulas (Cochran 1977, Wayne W. Daniel 1983)
for estimating the lower bounds (LCL) of counts and dollar amounts.
We reviewed the statistical sample to determine whether HUD properly collected the partial
claims. For each sampled partial claim we reviewed, as applicable, the

      Partial claim subordinate note,
      Partial claim subordinate mortgage,
      Partial claim payoff instructions,
      Partial claim subordination agreement,
      Neighborhood Watch case details,
      Evidence supporting partial claim collection,
      Single-Family Mortgage Asset Recovery Technology System notes, and
      Debt Collection and Asset Management System notes.

Our audit testing found that HUD failed to collect 36 of the 135 partial claims totaling $625,399.
We projected the sample results to the universe of 10,561 partial claims with a one-sided
confidence interval of 95 percent. We projected that HUD failed to collect at least $21.5 million
in partial claims that became due during our audit period. We also projected that even after
deducting a margin of error, these problems affected at least 1,361 partial claims and the actual
number could be substantially more.
Calculations below:
(16.38% - 1.6577 X 2.11%) x N = 12.9% x N ≈ 1,361 uncollected partial claims
(2878.8 - 1.6577 X 507.03) x N = 2038.3 x N ≈ $21,526,130 uncollected partial claim amounts
Because our audit period covered an entire year, these findings represent $21.5 million per year
that will be uncollected if HUD does not improve controls over partial claims collections.




                                                 9
We conducted the audit in accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain sufficient, appropriate
evidence to provide a reasonable basis for our findings and conclusions based on our audit
objective(s). We believe that the evidence obtained provides a reasonable basis for our findings
and conclusions based on our audit objective.




                                                10
Internal Controls
Internal control is a process adopted by those charged with governance and management,
designed to provide reasonable assurance about the achievement of the organization’s mission,
goals, and objectives with regard to

   Effectiveness and efficiency of operations,
   Reliability of financial reporting, and
   Compliance with applicable laws and regulations.
Internal controls comprise the plans, policies, methods, and procedures used to meet the
organization’s mission, goals, and objectives. Internal controls include the processes and
procedures for planning, organizing, directing, and controlling program operations as well as the
systems for measuring, reporting, and monitoring program performance.
Relevant Internal Controls
We determined that the following internal controls were relevant to our audit objective:

   Policies and procedures that have been implemented to reasonably ensure that the partial
    claims were properly collected.
We assessed the relevant controls identified above.
A deficiency in internal control exists when the design or operation of a control does not allow
management or employees, in the normal course of performing their assigned functions, the
reasonable opportunity to prevent, detect, or correct (1) impairments to effectiveness or
efficiency of operations, (2) misstatements in financial or performance information, or (3)
violations of laws and regulations on a timely basis.
Significant Deficiency
Based on our review, we believe that the following item is a significant deficiency:

   HUD did not include strong performance requirements in its national loan servicing contract
    (see finding).
   HUD did not have procedures to always identify and resolve all due and payable partial
    claims (see finding).




                                                  11
Appendixes

Appendix A


           Schedule of Questioned Costs and Funds To Be Put to Better Use
                                                      Funds to be
               Recommendation
                                     Ineligible 1/    put to better
                    number
                                                         use 2/
                       1A           $21,526,130
                         1B                                $21,526,130
                       Totals           21,526,130         21,526,130


1/   Ineligible costs are costs charged to a HUD-financed or HUD-insured program or activity
     that the auditor believes are not allowable by law; contract; or Federal, State, or local
     policies or regulations.
2/   Recommendations that funds be put to better use are estimates of amounts that could be
     used more efficiently if an Office of Inspector General (OIG) recommendation is
     implemented. These amounts include reductions in outlays, deobligation of funds,
     withdrawal of interest, costs not incurred by implementing recommended improvements,
     avoidance of unnecessary expenditures noted in preaward reviews, and any other savings
     that are specifically identified. In this case, if HUD implements our recommendations, it
     will ensure that partial claims are properly collected upon termination of the FHA
     mortgage. Our estimate reflects only the initial year of this benefit. These amounts do
     not include potential offsetting costs incurred by HUD to implement our
     recommendations to strengthen controls.




                                             12
Appendix B
             Auditee Comments and OIG’s Evaluation



Ref to OIG    Auditee Comments
Evaluation




Comment 1




                               13
Ref to OIG   Auditee Comments
Evaluation




Comment 2




                            14
                         OIG Evaluation of Auditee Comments


Comment 1   The scope of work provided to OIG during the audit stated “servicing tasks are
            generally limited to collection of the note when the first mortgage is terminated
            through payoff of sale of the property” but did not include any specific
            timeframes or performance levels for partial claims collection. Incorporating
            language into the loan servicing contract for specific, measurable timeframes and
            performance levels for partial claims collections and specific consequences for
            failure to adequately pursue partial claims collection will adequately address
            recommendation 1B in this report. The incorporated language will need to be
            reviewed during the audit resolution process to determine if it satisfies the
            recommendation.
Comment 2   Our concern was not with NSC’s delivery of the termination report to the loan
            servicing contractor, but rather was with NSC’s ability to identify and resolve its
            contractor’s performance problems. The contractor did not always note the partial
            claims as due and payable in the SMART system and then make the appropriate
            referral to the Financial Operations Center. Some of NSC’s quarterly monitoring
            reports on the contractor did not identify this problem with partial claims
            collection activities. Those reports that did identify uncollected partial claims did
            not always result in the specific uncollected cases being resolved. As stated in
            recommendation 1C, HUD needs to strengthen procedures to better identify and
            resolve all due and payable partial claims.




                                              15
     Appendix C
                                                  Sample Results
                                                                  Days between     Date noted as eligible
           Termination                       Date noted as        processed date      for transfer to
Control     processed         Termination      due and             and due and     Financial Operations     Partial note
number         date                type        payable*              payable             Center*              amount
  65        10/25/2014           Matured       1/7/2015                 74               3/5/2016           $   2,382.90
  170       10/28/2014         Refinanced      1/8/2015                 72                                      4,350.00
  11        11/7/2014          Paid in full    6/1/2015                206                                     13,010.76
  150       12/23/2014         Paid in full   9/11/2015                262                                      4,025.96
  81        2/17/2015          Paid in full   11/17/2015               273                                      5,274.69
  93        3/27/2015          Paid in full    1/6/2016                285                 1/6/2016             2,801.19
  13        3/17/2015          Paid in full    1/9/2016                298                1/14/2016            92,561.82
  149       3/17/2015          Paid in full   1/12/2016                301                 3/7/2016            23,910.98
   4        4/13/2015          Refinanced     1/20/2016                282                                     34,193.70
  128       3/13/2015          Paid in full   1/20/2016                313                 3/7/2016            66,500.00
  52        4/23/2015          Refinanced     1/21/2016                273                3/22/2016             2,940.88
  109        2/5/2015          Paid in full   1/22/2016                351                 3/7/2016             4,370.42
   8         2/4/2015          Paid in full   1/22/2016                352                 3/4/2016            29,142.42
  122       4/10/2015          Paid in full    2/2/2016                298                2/18/2016            27,548.06
  107       4/29/2015          Paid in full    2/6/2016                283                                      2,562.90
  129        6/1/2015            Matured      2/10/2016                254                                      4,524.20
  30        5/11/2015          Paid in full   2/22/2016                287                 3/1/2016             8,515.91
  51         9/3/2015          Paid in full    3/3/2016                182                 3/5/2016             3,058.61
  100       10/6/2014          Paid in full    3/3/2016                514                 3/7/2016             2,514.10
   1         8/6/2015          Refinanced      3/3/2016                210                                      4,688.44
   2         8/4/2015          Paid in full    3/3/2016                212                 3/5/2016             4,149.91
  125        8/4/2015          Paid in full    3/3/2016                212                                      3,770.07
  126       7/13/2015          Paid in full    3/3/2016                234                                      4,779.00
  161       6/30/2015          Paid in full    3/3/2016                247                 3/7/2016             3,438.68
  114       9/29/2015          Refinanced      3/3/2016                156                                      6,032.19
  119       6/29/2015          Paid in full    3/3/2016                248                 3/7/2016             6,439.51
  147       12/19/2014         Paid in full    3/3/2016                440                3/10/2016             5,915.20
  22        9/21/2015          Paid in full    3/3/2016                164                 3/7/2016            13,007.78
  23         7/6/2015          Paid in full    3/3/2016                241                 3/4/2016            13,962.16
  34        8/10/2015          Paid in full    3/3/2016                206                 3/5/2016            10,654.36
  82        5/14/2015          Paid in full    3/3/2016                294                 3/5/2016            11,523.56
  40        7/16/2015          Refinanced      3/3/2016                231                                     16,561.56
  141        6/9/2015          Paid in full    3/3/2016                268                 3/7/2016            19,859.92
  154       6/24/2015          Refinanced      3/3/2016                253                                     33,470.66
  104        6/5/2015          Paid in full    3/3/2016                272                 3/7/2016            42,376.78
  84         9/1/2015          Refinanced      3/3/2016                184                                     90,580.35
 Total                                                                                                      $ 625,399.63
      * Date the contractor noted each event in HUD’s Single-Family Mortgage Asset Recovery Technology System
                                                             16
Appendix D
                                            Criteria


24 CFR (Code of Federal Regulations) 203.371, Partial claim

(c) Repayment of the subordinate lien.
The mortgagor [borrower] must execute a mortgage in favor of HUD with terms and conditions
acceptable to HUD for the amount of the partial claim under §203.414(a). HUD may require the
mortgagee [lender] to be responsible for servicing the subordinate mortgage on behalf of HUD.

Mortgagee Letter 2003-19 (November 20, 2003)
Subject: Partial Claims: Program Changes and Updates

Under the partial claim option, a mortgagee will advance funds on behalf of a mortgagor in an
amount necessary to reinstate a delinquent loan (not to exceed the equivalent of 12 months’
worth of principal, interest, taxes, and insurance). The mortgagor, upon acceptance of the
advance, will execute a promissory note and subordinate mortgage payable to HUD. Currently,
these promissory or “partial claim” notes carry no interest and are not due and payable until the
mortgagor either pays off the first mortgage or no longer owns the property.

G. Repayment Terms

The partial claim advance will be secured by a note and subordinate mortgage with the following
repayment terms:

      The note is interest free. (The [HUD] Secretary reserves the right to assess interest on
       partial claim notes originated in the future.);
      No monthly or periodic payments are required, however, mortgagors may voluntarily
       submit partial payments;
      The note is due at the earlier of 1) the payoff of the first mortgage, or 2) when the
       mortgagor no longer owns the property;
      There is no prepayment penalty;
      A mortgagor is only eligible to apply for a mortgage insurance premium (MIP) refund
       when the partial claim note has been paid in full;
      The Partial Claim Note and security documents must be payable to HUD;
      Voluntary payments or prepayments should be delivered via a cashier’s check or other
       certified funds to the Department’s servicing contractor.

H. Required Documentation

A promissory note must be executed in the name of the Secretary and a subordinate mortgage
must be obtained and recorded. The mortgagee must include the provisions of HUD’s model


                                                 17
form of note and subordinate mortgage (as provided in ML [Mortgagee Letter] 97-17) and make
any amendments required by state laws. While HUD does not endorse the products or services
of vendors, the Department is aware that state specific documents are commercially available.
Mortgagees who take advantage of the convenience of purchasing these documents should
review them prior to use.

K. Loan Payoff or Refinance - Mortgagee Responsibilities

Mortgagees will be responsible for notifying HUD when the first mortgage is being paid in full
or refinanced in order for HUD to provide a payoff figure on the Partial Claim. HUD’s
Servicing Contractor, identified in Section G of this mortgagee letter, should be contacted to
request a payoff quote on the outstanding Partial Claim. The purpose of this requirement is to
ensure that no partial claim is overlooked when preparations are made to pay the first mortgage
in full.

Mortgagee Letter 2013-16 (May 14, 2013)

Subject: Subordination of Partial Claim Liens Associated with Federal Housing
Administration (FHA) Streamlined Refinances

FHA will accept subordination of Partial Claim promissory notes, provided that the current lien
position for those notes remains the same. Partial Claims do not have to be paid off at the time
of a FHA Streamlined Refinance transaction.

Subordination documents are to be sent to HUD’s Secretary-Held Portfolio Servicing Contractor.

Mortgagee Letter 2013-19 (May 31, 2013)

Subject: Partial Claim Documentation and Delivery Requirements

Required Documentation for Partial Claims
A promissory note must be executed in the name of the Secretary, and a partial claim mortgage
must be obtained and recorded. The partial claim note and mortgage must include:
    The provisions of HUD’s model partial claim note (Attachment 1) and partial claim
       mortgage (Attachment 2), and
    Any amendments as required by state laws.

While HUD provides a model partial claim mortgage and note, mortgagees are encouraged to
review these documents, make modifications as needed to comply with applicable state and local
requirements, and have their counsel review these documents for legal sufficiency.

Attachment 1
Model Subordinate Note Form

FHA Case No. _____________



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                                    PROMISSORY NOTE
[Date]

[Property Address]

1. PARTIES
        “Borrower” means each person signing at the end of this Note, and the person’s successors
and assigns. “Secretary” or “Lender” means the Secretary of Housing and Urban Development and
its successors and assigns.

2. BORROWER’S PROMISE TO PAY
      In return for a loan received from Lender, Borrower promises to pay the principal sum of
________________ Dollars (U.S. $________), to the order of the Lender.

3. PROMISE TO PAY SECURED
       Borrower’s promise to pay is secured by a mortgage, deed of trust or similar security
instrument that is dated the same date as this Note and called the “Security Instrument.” The Security
Instrument protects the Lender from losses, which might result if Borrower defaults under this Note.

4. MANNER OF PAYMENT
      (A) Time
               On, [insert maturity date of insured primary mortgage] or, if earlier, when the first of
      the following events occurs:
               (i) Borrower has paid in full all amounts due under the primary Note and related
      mortgage, deed of trust or similar Security Instruments insured by the Secretary, or
               (ii) The maturity date of the primary Note has been accelerated, or
               (iii) The primary Note and related mortgage, deed of trust or similar Security
      Instrument are no longer insured by the Secretary, or
               (iv) The property is not occupied by the purchaser as his or her principal residence.
      (B) Place
               Payment shall be made at the Office of Housing FHA-Comptroller, Director of
      Mortgage Insurance Accounting and Servicing, 451 Seventh Street, SW, Washington, DC
      20410 or any such other place as Lender may designate in writing by notice to Borrower.

5. BORROWER’S RIGHT TO REPAY

         Borrower has the right to pay the debt evidenced by this Note, in whole or in part, without
charge or penalty. If Borrower makes a partial prepayment, there will be no changes in the due date
or in the amount of the monthly payment unless Lender agrees in writing to those changes.

6. WAIVERS

        Borrower and any other person who has obligations under this Note waive the rights or
presentment and notice of dishonor. “Presentment” means the right to require Lender to demand
payment of amounts due. “Notice of dishonor” means the right to require Lender to give notice to
other persons that amounts due have not been paid.



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7. OBLIGATIONS OF PERSONS UNDER THIS NOTE
         If more than one person signs this Note, each person is fully and personally obligated to keep
all of the promises made in this Note, including the promise to pay the full amount owed. Any
person who is a guarantor, surety or endorser of this Note is also obligated to do these things. Any
person who takes over these obligations, including the obligations of a guarantor, surety or endorser
of this Note, is also obligated to keep all of the promises made in this Note. Lender may enforce its
rights under this Note against each person individually or against all signatories together. Any one
person signing this Note may be required to pay all the amounts owed under this Note.

         BY SIGNING BELOW, Borrower accepts and agrees to the terms and covenants contained
in this Note.
                                ___________________________(SEAL)
                                                                Borrower
                                ___________________________(SEAL)
                                                                Borrower

HUD Handbook 4740.2, REV-3 – Title I and Other Debt Collection Guidance

Single Family Partial Claims. These consumer debts originate as part of Housing’s loss
mitigation program. Under the loss mitigation “partial claim” option, a mortgagee will advance
funds on behalf of a mortgagor in an amount necessary to reinstate a delinquent loan (not to
exceed the equivalent of 12 monthly payments). The mortgagee then files a claim with HUD for
the funds advanced. In exchange for HUD’s payment, the mortgagor is required to execute a
promissory note and subordinate mortgage payable to HUD. No payment is due until a callable
event occurs (usually a sale or refinance of the mortgaged property.) Once the note becomes due
and payable, Housing’s Oklahoma City National Servicing Center’s contractor issues a demand
letter. Interest begins to accrue on the debt from the date of this letter. If the borrower fails to
pay, the debt can be referred to the FOC [Financial Operations Center] for appropriate collection
action. The referral package must include supporting documentation including a copy of the
note and lien.

Partial Claim Frequently Asked Questions

Question 8: What is the collection process on a Partial Claim that is not collected from
the Borrower at the time the Borrower pays off their FHA first mortgage?

Answer: For a Partial Claim that is left unpaid at the time the Borrower pays off their FHA first
mortgage, the Department bills the Borrower directly. The Partial Claim debt is not forgiven and
the Borrower is required to make a lump sum payoff.

Question 9: At what point does the Lender’s responsibility for a Partial Claim end?

Answer: The Lender’s responsibility for a Partial Claim ends when the following two events
occur: (a.) HUD receives the executed Subordinate Mortgage and (b.) When any requests for



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payoff of the first lien occur, the Lender is obligated to notify HUD to obtain full payoff amount
of the Partial Claim and supply that information to the Borrower.

Is a partial claim paid off at the time of an FHA Streamline Refinance transaction?

An FHA-insured loan with a Partial Claim (as evidenced by a second lien) may be eligible for an
FHA streamline refinance transaction because FHA will accept subordination of Partial Claim
promissory notes, provided that the current lien position for those notes remains the same.

Partial Claims do not have to be paid off at the time of an FHA Streamline Refinance transaction.
(See Mortgagee Letter 2013-16)




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