On September 21, 2018, the Department of Housing and Urban Development (“HUD”)’s Office of Inspector General (“OIG”) completed a review of HUD’s partial claims program. In many ways, the title of the OIG audit report, “HUD Did Not Have Adequate Controls To Ensure That Partial Claim Notes for FHA Loans Were Properly Tracked for Future Collection,” speaks for itself. As OIG reports typically drive process changes within HUD program offices, FHA mortgagees may need to brace for increased partial claim reimbursement demands, which typically total tens of thousands of dollars per loan.

A partial claim is a loss mitigation tool that allows lenders to advance funds on behalf of borrowers to reinstate a delinquent FHA-insured mortgage. The partial claim defers the repayment of mortgage principal through an interest-free subordinate mortgage that is not due until the first mortgage is paid off. HUD has strict guidelines requiring lenders to provide HUD with partial claims notes and mortgages within specific timeframes; failure to comply with those guidelines results in the lender being required to reimburse HUD for the total value of the partial claim plus the incentive fee (a “bonus” paid to the lender for each eligible loan that the lender enrolls in the partial claims program).

The OIG audited HUD’s partial claims program from January 1, 2013, until August 31, 2017, a timeframe that accounted for 407,984 partial claims totaling $11.7 billion. The OIG reviewed 695 of those partial claims at random and found that 421 (60.6%) contained deficiencies in the boarding process, i.e. entering the partial claims into HUD’s SMART system, and 394 (56.7%) contained deficiencies in HUD’s tracking of partial claims documents. For many of these deficient partial claims, the mortgage documents were either missing or had not been properly recorded before being sent to HUD.

In light of the error rate of tracking partial claim collateral documents, the OIG recommended that HUD reach out to lenders to obtain the missing documents or get them re-recorded, and also recommended that HUD require reimbursement for any loans for which the missing documents could not be obtained. The OIG report also recommended that HUD develop and implement additional controls to ensure these problems do not persist, meaning compliance by lenders will likely be under a microscope going forward.

In the last eighteen months, FHA mortgagees have seen an uptick in HUD making partial claim reimbursement demands from lenders that failed to strictly comply with HUD’s guidelines to timely provide HUD with the partial claims documents. This OIG report indicates that HUD will likely continue to aggressively pursue partial claims reimbursements from lenders who failed to comply with the guidelines, and may begin to pursue such reimbursements even more aggressively. In light of the report, FHA mortgagees would be well-advised to consider their potential liability and exposure from historic partial claim filings, ensure their current partial claims procedures strictly comply with HUD’s requirements, and consider all options when responding to a partial claim reimbursement demand from HUD.