REQUIRED READING: Mortgage servicers and investors envision a scenario in which a borrower is happily living in his or her house, maintaining the property and promptly paying the mortgage every month. In this ideal world, the borrower is also timely in paying taxes and maintaining the appropriate insurance coverage on the property.
However, that is not the scenario we are talking about here. This article will discuss the opposite situation – one that begins with a delinquency and evolves into an inspection that reveals a property to be damaged and either vacant or abandoned. All too often, the borrower in this scenario is nowhere to be found and cannot be contacted. A foreclosure date is set in the distant future, but only as long as no unexpected delays or moratoria push it back even further.
It is in this scenario that servicers face a common dilemma. When dealing with pre-sale damaged properties, two questions usually arise: What are the servicers' legal rights when considering property repairs, and what are the servicers' responsibilities with regard to investor and guarantor guidelines?
Over the years, servicers and investors have often questioned the lender's legal right to repair pre-sale damaged properties. The common belief has been that the borrower's rights to the property eclipse those of the lender, as the borrower holds title to the property.
In reality, this is simply not the case. Pursuant to the mortgage document, the lender's rights are not compromised by the rights of the borrower when it comes to preserving the value of the collateral. In fact, the lender is given explicit permission to take reasonable steps to protect the value of the property, including, but not limited to, performing repairs prior to a foreclosure sale.
Mortgage and deed-of-trust documents are very beneficial to servicers with regard to handling pre-sale damaged properties. In the covenants of the security instrument, the mortgagor agrees to explicit contractual obligations to maintain the property, the subject of the lender's security interest. Upon failure to maintain the property, the mortgagor agrees explicitly to grant the lender the opportunity to enter the property and execute repairs in order to maintain, preserve or restore value to the collateral.
Although most government-sponsored enterprise (GSE) and U.S. Department of Housing and Urban Development (HUD) instruments contain substantially similar language, the example language cited below has been excerpted from Form 3033, Fannie Mae/Freddie Mac Uniform Mortgage Instrument for New York State. Section 7 of the instrument, ‘Maintenance and Protection of the Property,’ defines the following borrower obligation as it pertains to the condition of the collateral:
‘I will not destroy, damage or harm the property, and I will not allow the property to deteriorate. Whether or not I am residing in the property, I will keep the property in good repair so that it will not deteriorate or decrease in value due to its conditionâ�¦I will promptly repair the property if damaged to avoid further deterioration or damageâ�¦If the insurance or condemnation proceeds are not sufficient to repair or restore the property, I promise to pay for the completion of such repair or restoration.’
Section 9 of the instrument, titled ‘Lender's Right to Protect Its Rights in The Property,’ defines the mortgagee's rights with additional specificity. If the mortgagor fails to ‘keep [his or her] promises on agreements made in this security instrument,’ or has ‘abandoned the property,’ the lender ‘may do and pay for whatever is reasonable or appropriate to protect the lender's interest in the property.’ Specific to damaged properties, the instrument provides the lender with the right to secure or repair the property; enter the property to make repairs, change locks, replace or board up doors; and eliminate building or other code violations or dangerous conditions.
While it has been understood and considered industry standard that the security instruments provide rights to property inspection and preservation, the language in the documents is equally clear as to the mortgagee's rights to intervene and pursue property repairs as a remedy for the borrower's failure to keep the obligations agreed to within the instrument. Servicers should keep their legal rights in mind when considering how they will handle damaged properties prior to foreclosure sale.
Servicers and investors both have an interest in minimizing damaged-property losses. Often, a large obstacle to achieving efficient and reasonable property-repair decisions is communication between the parties. Effective communication allows everyone involved to have the same expectations for the repair process, timeline and expected outcome.
Clearly, the increased volumes of defaulted properties only serve to exacerbate the situation. Servicers can facilitate efficient outcomes by understanding the expectations of the investors, clearly communicating and documenting the property damages and stating with clarity a resolution recommendation to those investors. Knowledge of the various investor guidelines can help put servicers on the right path and reduce frustration.
The HUD environment
HUD has historically mandated thorough property condition guidelines and servicer responsibilities for handling damaged properties. Mortgagee Letter 2010-18 (ML 2010-18): Update of Property and Preservation Requirements and Cost Reimbursement Procedures, implemented in July 2010, provided servicers with revised damaged-property guidelines and has changed how many servicers handle damaged HUD properties.Â
Prior to ML 2010-18, HUD identified six catastrophic forms of damage as surchargeable. HUD would disallow conveyance of properties that had sustained damages caused by the ‘Big Six’ – i.e., fire, flood, hurricane, tornado, earthquake or boiler explosion – unless HUD had previously given the servicer permission to ‘convey with damages.’ Properties damaged by non-Big Six perils, such as vandalism or freeze, servicers would apply any available insurance funds recovered to the 27011 claim.
With ML 2010-18, HUD extended the prior approval requirement to all types of damage. Specifically, the ML states, ‘If a property that was secured by an FHA-insured mortgage is conveyed damaged to the secretary without prior approval, the department may reconvey the property.’ At its most basic level, ML 2010-18 gives the servicer two options: repair damaged properties prior to conveyance or request HUD permission to convey the property as is.
When HUD properties are damaged prior to a foreclosure sale, the servicer has additional considerations. The mandate to repair or obtain as-is conveyance approval still applies. However, the question for the servicer is whether to repair prior to the foreclosure sale or to ‘kick the can’ down the road to the post-foreclosure stage, and make the repair determination once foreclosure sale has taken place. In making this decision, the servicer should consider several factors:
Aggravated damages. Certain types of damage – such as water, freeze or roof damage – can be progressive and may worsen over time if not addressed. In these situations, the cost to repair post-sale may be considerably higher than pre-sale repairs, causing additional book loss for the servicer. Another aspect to consider regarding aggravated damages is the HUD review of mortgagee responsibility pursuant to HUD guidelines. HUD may consider unaddressed, progressive damages, to be mortgagee neglect, even in pre-sale, and if so, the damage becomes surchargeable and the risk exposure for reconveyance increases.
Recoverable depreciation. Another variable servicers should consider when determining whether to repair a damaged property pre-sale is the value of the recoverable depreciation of any hazard-insurance claim filed. In the vast majority of hazard-claim settlements, the insurance carrier withholds a percentage of the settlement due to the reduction in the value of an asset with the passage of time, due, in particular, to wear and tear (i.e., depreciation).
Most depreciation is recoverable, but in order for a servicer to realize the recoverable depreciation, it must repair the insurable damage within a predetermined time frame. Failure to complete repairs prior to the recoverable expiration means the servicer could lose 20% to 60% of the overall value of the claim. When this occurs, HUD may still require repairs prior to conveyance, and the servicer may be forced to use corporate funds in order to complete the repairs and ensure conveyance.Â
Time frames/curtailments. Finally, when considering whether to repair properties pre-sale, the servicer should examine conveyance time frames and projected loss due to curtailment. When the servicer considers waiting until post-sale to perform repairs, the extent of damages and how long the property repairs will take should be major factors in the decision. The servicer must also consider the likelihood that HUD will grant conveyance extensions in order to complete the repairs, as well as the potential loss if the conveyance deadline be missed and curtailment occurs. Weighing the potential monetary loss of repairing post-sale is key in the servicer's making the most effective decision.
The Fannie Mae environment
Fannie Mae has historically been less inclined to have servicers repair damaged properties in pre-foreclosure status. Proper communication and documentation of damages, as well as reasonable recommendations on property disposition, are key components in enabling Fannie Mae to make informed decisions regarding damaged pre-sale properties. Fannie Mae expects prompt notification of damages from servicers.
In the servicing guidelines, Fannie Mae provides direction for two categories of damage: hazard-insurance loss (insured damage) and property maintenance and management (uninsured damage, safety risk, code issues, etc.).Â Â Â
In Part VIII, Section 106 of Fannie Mae's guidelines – a section titled ‘Property Maintenance and Management’ – the GSE directs servicers to ‘Notify Fannie Mae about any damage to the property, any injury to a person on the property, [or] any conditions that could result in injury to someone who enters the property….’ This notice should be provided by submission of the Property Preservation Request for Repair form (Form 1095) and supporting photos and documentation to firstname.lastname@example.org.
In Part II, Section 501.02 (‘Report of Hazard Insurance Loss’), Fannie Mae states the servicer ‘should submit a Report of Hazard Insurance Loss (Form 176) to Fannie Mae, with its recommendation for disposition of the insurance loss proceeds.’ For insured damage, Fannie Mae has a dedicated mailbox at email@example.com.
When servicers submit notice to Fannie Mae, thorough documentation and a reasoned disposition recommendation are crucial. Servicers should consider submitting information including, but not limited to, the following:
- status of mortgage (including recent borrower contact, if any);
- Fannie Mae's interest in the loan;
- damage type and/or insured peril;
- accounting statistics (unpaid principal balance, due date, total delinquent installments, etc.);
- inspection and preservation history, including first-time vacancy and date of discovery;
- property photos;
- property valuation (a recent broker price opinion or appraisal, if available);
- repair costs (servicers should provide a clear explanation of whether damages require costs for which they will be seeking reimbursement on their expense claim or whether the recommendation is to use insurance claim proceeds to cover repair costs);
- insurance claim explanation-of-benefits letter; and
- adjuster's estimate of damage.
Specific to the Report of Hazard Insurance Loss (Form 176), Fannie Mae provides ample room for servicers to provide information and make recommendations for disposition. As agents for Fannie Mae in managing the default process, servicers are the first point of contact for these loans and are best equipped to make sound, reasonable disposition recommendations to Fannie Mae.
The Freddie Mac environment
Freddie Mac requires servicers to document property damage and provide reasonable restoration recommendations. Freddie Mac provides direction on how to handle damaged properties under its guidelines on distressed properties. Servicers' responsibilities for damage notification are outlined in the Freddie Mac Seller/Servicer Guide Chapter on Adverse Matters, Section 67.27.
Notification of damage should be made to the Special Asset Unit by submission of Freddie Mac Form 1013 (‘1-4 Unit Property Inspection Report’) via email to firstname.lastname@example.org. Please note that although this form is a little restrictive in comparison to Fannie Mae Form 176, servicers are encouraged to use the email@example.com email box to provide additional narrative, documentation and photos to the Special Asset Unit.
Freddie Mac defines distressed properties as those requiring substantial repairs, those that are under condemnation and those that pose risk of property ownership to Freddie Mac. In addition, Freddie Mac explicitly directs servicers to ‘file a claim with the applicable property insurer’ in cases where the borrower has not done so.
Finally, with regard to repair disposition, Freddie Mac only requires ‘written pre-approval before incurring expenses that exceed the limits contained in Exhibit 57,’ meaning proactive servicers are given authority to complete insurance repairs (those repairs that can be completed without incurring corporate expense) at their discretion. Although Freddie Mac grants the servicer more discretion, diligent and thorough communication with Freddie Mac's Special Asset Unit is recommended throughout the repair project.
In summary, many factors enter into the pre-sale repair decision. Each servicer has to weigh its own core values, risk assessment, servicing strategy, vendor partnerships and level of expertise when evaluating how to most efficiently address pre-sale damaged properties.
Pre-sale repairs are feasible in many cases and certainly are within the servicer's range of possible actions relating to vacant, abandoned properties. The benefits of such repairs, when appropriate, are clear, as are the steps that need to be taken in order to reduce any potential risk. By understanding the mortgagee's legal rights as outlined in the mortgage or security instrument, and by complying with the servicing responsibilities as directed by investors, servicers will have a strong foundation for creating the most beneficial strategy regarding pre-sale damaged properties.
Patrick Nackley is director of marketing and business development for Superior Home Services, based in Scottsdale, Ariz. He can be reached at firstname.lastname@example.org or (480) 391-5512.