In an effort to help struggling borrowers stay in their homes, the US Department of Housing and Urban Development’s (“HUD” or “Department”) Federal Housing Administration (“FHA”) recently introduced its newest loss mitigation home retention option—the Payment Supplement.¹ This innovative new option will include a combination of loss mitigation steps that will bring a borrower’s mortgage current and temporarily reduce the principal portion of the borrower’s monthly mortgage payment for three years without modifying the mortgage. The Payment Supplement has been designed to assist borrowers who are not able to achieve a sustainable monthly mortgage payment reduction using existing FHA loss mitigation options. In this Legal Update, we provide details on the mechanics of the Payment Supplement and discuss some of its potential benefits and drawbacks.

BACKGROUND

In the face and aftermath of the COVID-19 pandemic, FHA has developed several new home retention loss mitigation options for FHA borrowers. FHA’s efforts have been largely successful. As FHA reports, its COVID-19 options have provided relief for nearly 1.9 million borrowers. Despite these successes, high interest rates continue to limit borrowers’ loss mitigation options, as we describe in more detail below. In the current interest rate climate, loan modification is often not a feasible choice to provide borrowers with a lower monthly payment. FHA has developed the Payment Supplement to fill this gap for borrowers as a permanent addition to FHA’s loss mitigation waterfall.

DETAILS OF THE PAYMENT SUPPLEMENT

OVERVIEW

The Payment Supplement combines FHA’s existing Partial Claim loss mitigation option² with a temporary reduction in monthly mortgage payments for borrowers who are at least three months delinquent and cannot currently afford their monthly mortgage payment. Borrowers receiving a Payment Supplement will have Partial Claim funds applied to their arrearage in the same manner as the existing Partial Claim option to bring the borrower current. Unlike the existing Partial Claim option, however, under the Payment Supplement, additional Partial Claim funds are used as a Monthly Principal Reduction (“MoPR”) payment. This MoPR payment will cover a portion of the borrower’s outstanding principal each month for three years (the “Payment Supplement Period”), temporarily reducing the borrower’s monthly mortgage payment. After the Payment Supplement Period ends, the borrower will resume paying the full monthly principal and interest payment.

Importantly, the Payment Supplement is not a loan modification because the loan terms, including the monthly principal and interest payment, remain the same. The Payment Supplement allows FHA to provide the funds to temporarily pay a portion of the borrower’s monthly mortgage payment so that the payment is made in full according to the terms of the first lien loan (assuming the borrower pays the difference between the MoPR and the monthly payment amount). Because the Payment Supplement does not involve a loan modification, servicers will not be required to buy loans out of a Ginnie Mae-securitized pool to complete the Payment Supplement.

To receive the Payment Supplement, the borrower must agree to enter into a zero-interest promissory note and subordinate mortgage with the Department. In addition, the borrower must execute a Payment Supplement Agreement. Similar to a Partial Claim, the servicer will work with the borrower to execute the Payment Supplement documentation and apply the funds to the mortgage. As with a standard Partial Claim, the second lien is executed between the borrower and HUD—the servicer is not a party to the contract. Also similar to a Partial Claim, the note and subordinate mortgage are repaid when the first lien mortgage is extinguished, whether at maturity, sale, refinance, payoff, or otherwise. The second lien is serviced by HUD’s servicer, not the FHA-approved servicer of the first lien mortgage.

FHA published the details of the Payment Supplement in Mortgagee Letter 2024-02 and, simultaneously with the Mortgagee Letter, published the documents necessary to complete the Payment Supplement: an Annual Payment Supplement Disclosure, a Final Payment Supplement Disclosure, a Payment Supplement Promissory Note and Payment Supplement Security Instrument, and a Payment Supplement Calculation Worksheet (the “Payment Supplement Documents”). Mortgagee Letter 2024-02 announced that, upon successful completion of the Payment Supplement, HUD will pay a $1,750 incentive fee to the servicer.

Servicers may begin to implement the Payment Supplement on May 1, 2024, and must implement the new loss mitigation option by January 1, 2025. Mortgagee Letter 2024-02 also extends the COVID-19 Recovery Options through April 30, 2025.

BORROWER QUALIFICATIONS

A borrow may qualify for the Payment Supplement if:

• The borrower is at least three or more full monthly payments due and unpaid (i.e., 61 days delinquent);
• The borrower has a fixed rate mortgage;
• Sufficient Partial Claim funds are available to bring the mortgage current and fund the MoPR as determined by the Payment Supplement calculation;
• The borrower meets the requirements for loss mitigation during bankruptcy proceedings;
• The MoPR is equal to or greater than 5% of the principal and interest portion of the borrower’s monthly mortgage payment as of the date the Payment Supplement period begins;
• The MoPR is at least $20 per month;
• The MoPR does not exceed the lesser of a 25% principal and interest reduction for three years or the principal portion of the monthly mortgage payment as of the date the Payment Supplement period begins; and
• The borrower indicates they have the ability to make their portion of the monthly mortgage payment (the borrower does not need to provide documentation in support).

The Payment Supplement is subject to the statutory maximum for Partial Claims. Accordingly, as part of the Payment Supplement calculation, a servicer must determine whether the Payment Supplement, in addition to any other Partial Claim on the loan, would exceed the statutory maximum. A servicer must also determine whether the borrower can achieve a lower monthly payment with the COVID-19 Recovery Modification and, if so, offer the COVID-19 Recovery Modification instead.

EXECUTION OF THE PAYMENT SUPPLEMENT

After a borrower signs and returns the Payment Supplement Documents, the servicer must advance the funds needed to bring the mortgage current and apply the first MoPR. A servicer must submit the claim for a Payment Supplement within 60 days of the execution of the Payment Supplement Documents. Once a servicer receives funds from FHA for the Payment Supplement, the servicer will be required to place those funds in a separate, non-interest bearing insured custodial account (the “Payment Supplement Account”). Servicers will be required to keep these funds separate from other funds associated with the mortgage, including escrow funds, and will only be permitted to use the funds in the Payment Supplement Account to pay the MoPR. Additional payments by the borrower during the three-year Payment Supplement Period will not impact the application of the MoPR.

DISCLOSURES

After the Payment Supplement is finalized, the servicer must send the borrower written disclosures annually and between 60 and 90 days before the expiration of the Payment Supplement Period. A servicer may use the model disclosures published by FHA or develop its own, provided that certain information is contained in the disclosures. The annual disclosure must include, for example, details regarding the amount of the Payment Supplement, an accounting of the funds, the expiration date of the Payment Supplement Period, and a statement regarding the borrower’s option to voluntarily terminate the Payment Supplement. The final disclosure prior to the end of the Payment Supplement Period must include information about the expiration of the Payment Supplement and an accounting of funds.

POST-EXECUTION

After the Payment Supplement is completed or terminates, the FHA-approved servicer of the FHA-insured mortgage must first remit any remaining funds from the Payment Supplement Account to HUD and then, within 45 days of completion or termination of the Payment Supplement Period, provide a final accounting to HUD. Until the Payment Supplement Period ends and the FHA-approved servicer has made its final accounting to HUD, the Mortgagee Letter requires the servicer of the FHA-insured mortgage to issue Payment Supplement payoff statements regarding the Payment Supplement as requested. The Mortgagee Letter states that the payoff statement will be required to include the total amount due for the Payment Supplement, a statement that the Payment Supplement is a subordinate lien between the borrower and HUD, instructions that payoff funds for the Payment Supplement must be remitted to HUD, a statement that the payoff amount will change if additional account activity occurs, and any other information required by law.

As noted above, however, the FHA-approved servicer is not a party to the note and mortgage secured by the Payment Supplement amounts. That subordinate lien loan will be serviced by HUD’s servicer. While the FHA-approved first lien servicer likely would be able to provide an accounting of the Payment Supplement amounts, it remains unclear how the FHA-approved servicer of the first lien FHA mortgage will be able issue a payoff statement for the subordinate lien loan being serviced by HUD’s servicer when the FHA-approved servicer is not a party to the note and security interest executed between the borrower and HUD.

The Mortgagee Letter also details the FHA-approved servicer’s obligations if the borrower defaults during the Payment Supplement Period. In that case, the servicer must review the borrower in accordance with the COVID-19 Recovery Loss Mitigation waterfall. If the mortgage is reinstated without a permanent loss mitigation option or with a COVID-19 Recovery Standalone Partial Claim, the MoPR continues once the missed payments are made. If the mortgage is reinstated with another permanent loss mitigation option or cannot be reinstated, the MoPR will terminate, and the FHA-approved servicer must remit any funds remaining in the Payment Supplement Account to HUD.

Notably, a borrower can choose to voluntarily terminate the Payment Supplement and resume their full monthly mortgage payment. In that circumstance, the FHA-approved servicer will be required to return any amounts remaining in the Payment Supplement Account to HUD to reduce the total outstanding Payment Supplement balance. However, currently, the full amount of the Payment Supplement as reflected in the promissory note will still count towards the statutory maximum for Partial Claims if the borrower seeks a Partial Claim in the future.

ADDITIONAL CONSIDERATIONS REGARDING THE PAYMENT SUPPLEMENT

THE PAYMENT SUPPLEMENT SHOULD CREATE A USEFUL TOOL IN THE CURRENT HIGH INTEREST-RATE ENVIRONMENT

Because the Payment Supplement allows borrowers to lower their monthly payment, at least temporarily, without modifying their loan, the option is important for delinquent borrowers in the current high interest rate environment. When the prevailing rate is below the note rate, a modification can achieve a lower monthly payment by, among other things, reducing the note rate to the lower prevailing rate. Today, because the market rate is often higher than the borrower’s existing note rate, a modification could actually increase a borrower’s monthly payment. Significantly, the Payment Supplement allows the borrower to keep the note interest rate. Further, it is possible that after the three-year Payment Supplement Period expires, the interest rate environment will have changed such that, if the borrower still needs payment assistance, a modification could be a viable option.

As explained above, the FHA announced that the Payment Supplement will become a permanent part of its loss mitigation waterfall. This addition should create an important tool to help borrowers who need loss mitigation assistance in a high interest-rate environment going forward.

PAYMENT SUPPLEMENT RELIEF IS TEMPORARY, AND BORROWERS MAY NEED FURTHER ASSISTANCE AFTER PROGRAM ENDS

As explained above, the Payment Supplement is designed to lower the borrower’s monthly payment for a three-year period. After the three years expire, the borrower will be responsible for resuming their regular monthly payment. The Mortgagee Letter explains that HUD understands that the program may create “payment shock” for borrowers at the end Payment Supplement Period and that HUD will assess the issue on an ongoing basis.

Because of this novel structure of this loss mitigation option, borrowers may not easily understand that they will be required to resume their regular monthly payment after three years. This means that servicers will need to ensure they are clearly communicating the contours of the program to consumers, as the Consumer Financial Protection Bureau has closely scrutinized servicers’ assistance of borrowers nearing the end of temporary loss mitigation options.

INCENTIVE PAYMENT MAY BE INSUFFICIENT TO COVER INCREASED SERVICING COSTS ASSOCIATED WITH THE PAYMENT SUPPLEMENT

Finally, as noted above, FHA-approved servicers may submit a claim to HUD for a $1,750 incentive in connection with a Payment Supplement. For context, servicers may submit a claim for a $750 incentive for a COVID-19 Recovery Modification and a $500 incentive for a COVID-19 Recovery Standalone Partial Claim. Although the incentive for the Payment Supplement is higher than the amounts offered for these other loss mitigation options, the Payment Supplement could be significantly more administratively burdensome than other options. For example, it requires servicers to administer an escrow account and apply on a monthly basis for up to three years the MoPR to the principal portion of the borrower’s monthly payment after the borrower has paid their portion of the monthly payment. As noted above, the servicer will also be required to provide additional disclosures to borrowers in a Payment Supplement. Because of the additional servicing functions required to administer the Payment Supplement, it is unclear if the incentive amount will be sufficient to account for servicers’ increased costs.

As noted above, FHA-approved servicers may begin to implement the Payment Supplement on May 1, 2024, and must implement it by January 1, 2025. Given the unique characteristics of the Payment Supplement, it will be important for servicers to monitor any additional guidance from HUD regarding this new option in the coming months as they work to implement the Payment Supplement into their existing waterfall of loss mitigation options for FHA borrowers.

¹ FHA, Mortgagee Letter 2024-02 (Feb. 21, 2024).

² A Partial Claim is FHA’s reimbursement of an FHA-approved mortgagee’s advancement of funds on behalf of the borrower in an amount necessary to assist in reinstating a delinquent FHA-insured mortgage.

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