When reviewing adjustments made for ARM loans it services for Fannie Mae, the servicer must follow all of Fannie Mae’s procedures, in accordance with C2.201, Identifying and Disclosing Adjustment Errors, regardless of whether the review is undertaken as a result of
a full audit,
a routine spotcheck of its ARM adjustments, or
an inquiry from a third party.
The following table describes how to review adjustments for ARM loans that have been assumed, in accordance with C2.201, Identifying and Disclosing Adjustment Errors
If the previous borrower…  Then the servicer must… 

requested the review 
review only those adjustments that occurred prior to the effective date of the assumption. 
did not request the review 
review only those adjustments that occurred after the effective date of the assumption. 
The following table describes various scenarios and resulting actions the servicer must take after correcting an ARM adjustment error, in accordance with C2.201, Identifying and Disclosing Adjustment Errors
If the servicer…  Then the servicer must… 

does not reflect the adjustment error consistently in its own internal records, Fannie Mae’s records, and notices sent to the borrower 
adjust its records by reamortizing the mortgage loan to properly allocate the P&I distribution for any incorrectly applied payments and to correct the UPB.
Note: Generally, the borrower does not need to be notified of the correction since it results in amortization of the mortgage loan under the terms that were disclosed to the borrower in his or her mortgage loan documents. 
is required to file a corrected Mortgage Interest Statement (IRS Form 1098) with the IRS 
send the borrower the appropriate notification of the correction. 
notifies the borrower of an incorrect interest rate and/or monthly payment, but updates its records and Fannie Mae’s records correctly 
notify the borrower of the correction and update Fannie Mae’s records if the borrower’s UPB after the correction differs from the UPB that Fannie Mae has in its records. 
If the ARM adjustment errors require a correction to the Fannie Mae investor reporting system records, the servicer may need to change
the monthly payment,
the mortgage loan interest rate,
the mortgage loan PTR,
the pool accrual rate, and/or
other key ARM plan parameters that Fannie Mae retains in its records.
ARM adjustment errors may also have resulted from the servicer’s erroneous remittances to Fannie Mae. Fannie Mae may require the servicer to submit appropriate documentation to support its proposed corrective action. This documentation may include:
copies of the mortgage note and ARM rider;
the payment history records;
the corrected amortization schedule; and
the lender’s negotiated contract, if it permitted the ARM adjustments to be handled in a manner that differs from Fannie Mae’s standard requirements.
The following table provides instructions for verifying the correct interest rate for each ARM adjustment period in accordance with C2.201, Identifying and Disclosing Adjustment Errors.
Step  Servicer Action 

1 
Use the correct index value applicable for each adjustment date. 
2 
Apply any peradjustment interest rate caps. 
3 
Round the resulting rate as specified in the mortgage loan instrument. 
Note: If application of a peradjustment cap to the final interest rate change would perpetuate the error(s), the servicer must not apply it. The corrected interest rate must never exceed the original interest rate by more than the lifetime cap specified in the mortgage loan instruments.
This same procedure must be used to verify ARM adjustment errors that involve only incorrect interest rate changes, as well as to verify errors that involve only incorrect payment changes if the errors were not identified until after an interest rate change occurred.
The following table shows a variation of this procedure that must be used for ARM adjustment errors involving only incorrect payment changes that are identified before an interest rate change occurs.
Step  Servicer Action 

1 
Use the correct monthly payment applicable for each payment adjustment date. 
2 
Apply any payment caps for each adjustment date that occurred during the period for which the ARM loan was incorrectly adjusted.
Note: If applying a peradjustment cap to any payment change would perpetuate the previous error(s), the servicer must not apply it. 
In accordance with ReAmortizing the Mortgage Loan in C2.201, Identifying and Disclosing Adjustment Errors, the servicer must adhere to the following instructions.
To reamortize the mortgage loan, the servicer must use
the correct interest rate for each interest rate adjustment date that occurred during the period the ARM loan was incorrectly adjusted, and
the actual payment that the borrower has been making.
However, if the adjustment error for any given adjustment period involved only an incorrect monthly payment, the ARM loan should be reamortized for only that adjustment period. For this scenario, the servicer must use
the correct interest rate, and
the correct monthly payment (instead of the actual payment the borrower was making).
The servicer must also ensure the dates on which it applies any curtailments under the corrected amortization schedule are the same as those on which the curtailments were actually applied.
Note: The overcharge or undercharge to the borrower is the difference between the reamortized UPB for the ARM loan and the actual UPB that resulted from the incorrect payment application.
When the servicer identifies and corrects an adjustment error, it must then calculate the new monthly payment, in accordance with Calculating the New, Correct Monthly Payments in C2.201, Identifying and Disclosing Adjustment Errors. The following table describes the process for determining the correct monthly payment.
If the adjustment error involved…  Then the interest rate… 

both an incorrect interest rate and monthly payment 
may or may not need to be changed, depending on whether the subsequent interest rate adjustments resulted in the borrower being charged interest at the correct rate. To calculate the correct monthly payment, the servicer must use

an incorrect monthly payment only 
does not need to be changed. To calculate the correct monthly payment, the servicer must use the monthly payment that should have become effective on the last payment adjustment date.
Note: This is necessary even if the difference between the correct payment and the erroneous payment is greater than the applicable peradjustment cap. 
an incorrect interest rate only 
may or may not need to be changed, depending on whether subsequent rate adjustments resulted in the borrower being charged interest at the correct rate. 
When the servicer identifies and corrects an adjustment error, it must then determine the amount of the undercharge or overcharge, in accordance with Calculating the New, Correct Monthly Payments in C2.201, Identifying and Disclosing Adjustment Errors. The following table describes the process for making this determination.
If...  And...  Then the borrower... 

both the mortgage loan interest rate and the monthly payment were incorrect 
the UPB that results from the reamortization is lower than the actual principal balance of the mortgage loan 
was overcharged, and is due a refund of (or a credit for) the overcharge. 
both the mortgage loan interest rate and the monthly payment were incorrect 
the UPB that results from the reamortization is higher than the actual principal balance of the mortgage loan 
was undercharged, although the servicer must not require the borrower to make up the difference between the actual payment and the correct payment, nor may it charge the borrower interest on the amount of the undercharge. 
the mortgage loan interest rate was incorrect, but the monthly payment was correct 
the UPB that results from the reamortization is lower than the actual principal balance of the mortgage loan 
was charged too much interest, and is due a credit for the overcharge. Because the monthly payment was correct, the borrower is not due an actual cash refund of the interest overcharge. Instead, the servicer must reallocate the payment it received between P&I to reduce the UPB by the amount of the overcharge. 
the mortgage loan interest rate was incorrect, but the monthly payment was correct 
the UPB that results from the reamortization is higher than the actual principal balance of the mortgage loan 
was charged too little interest. The servicer must not require the borrower to make up the interest undercharge, reallocate the borrower’s payment between P&I, or charge the borrower interest on the amount of the undercharge. 
the monthly payment was incorrect, but the mortgage loan interest rate was correct 
the UPB that results from the reamortization is higher than the actual principal balance of the mortgage loan 
was overcharged, and is due a credit for the overcharge. Under certain conditions, the borrower is due a refund of the overcharge. 
the monthly payment was incorrect, but the mortgage loan interest rate was correct 
the UPB that results from the reamortization is lower than the actual principal balance of the mortgage loan 
was undercharged. The servicer must not require the borrower to make up the difference between his or her actual payment and the correct payment, nor may it charge the borrower interest on the amount of the undercharge. 
The servicer must adhere to the following procedures if a borrower questions the servicer’s failure to provide advance notification of an upcoming opportunity to exercise an option to convert to a fixedrate mortgage loan, in accordance with C2.202, Assuming Responsibility for Conversion Notice Errors.
The servicer must verify the correct interest rate for a borrower who questions the servicer’s failure to provide advance notification of an upcoming opportunity to exercise the option to convert to a fixedrate mortgage loan. To accomplish this, the servicer must calculate the rate that would have been in effect had the borrower been given timely notice of the conversion option and made his or her election within the required time frame.
The interest rate must
be calculated in accordance with the provisions of the mortgage loan instruments, and
not exceed the original interest rate by more than the lifetime interest rate cap specified in the mortgage loan instruments.
The following table provides instructions for the servicer to determine whether to refund or credit overcharges related to an incorrect monthly payment for a current ARM loan, in accordance with C2.203, Determining Whether to Provide a Refund or Credit for Overcharges.
If the ARM loan is…  Then the servicer must… 

current, and the servicer has not advanced funds to cure an escrow overdraft 
give the borrower the choice between

current, and the servicer has advanced funds to cure an escrow overdraft 
give the borrower a choice between
If the borrower chooses a credit, the servicer must increase the UPB of the mortgage loan to the amount that it would have been if the payment adjustment had been correct. However, the servicer may decrease the borrower’s payment by any amount previously added to the payment to repay the servicer for its advance. If the borrower chooses a curtailment, then the actual, lower UPB remains in effect and the borrower must continue to pay the advance as part of the monthly payment. 
delinquent, but the servicer has not advanced funds to cure an escrow overdraft 
base its action on the amount of the overcharge, and either

delinquent, and the servicer has advanced funds to cure an escrow overdraft 
repay its advance and apply any remainder toward reducing or curing the delinquency. To repay its advance, the servicer must
Note: The borrower will not be given an option on how to credit the overcharge. 
The servicer must issue a cash refund or credit if the incorrect monthly payment and incorrect interest rate results in a net overcharge of more than $1.00. The following table describes procedures the servicer must follow in determining whether to refund or credit overcharges related to an incorrect monthly payment and an incorrect interest rate, in accordance with C2.203, Determining Whether to Provide a Refund or Credit for Overcharges.
If the mortgage loan is…  Then the servicer must…  

current, and the servicer has not advanced funds to cure an escrow overdraft 
send the borrower a cash refund. 

current, but the servicer has advanced funds to cure an escrow deficit 
credit the overcharge by applying it to reduce the amount of the outstanding advance.
Note: If any of the net overcharge remains after the advance is fully paid, the servicer must send the borrower a cash refund of the remaining amount. 

delinquent, but the servicer has not advanced funds to cure an escrow deficit 
credit the borrower for the net overcharge, as follows: If the net overcharge is sufficient to bring the mortgage loan current, the servicer must
If the net overcharge is not equal to the full amount of the delinquent monthly payments and applying the overcharge to them jeopardizes current or potential foreclosure proceedings, the servicer must treat the net overcharge as unapplied funds until the borrower submits all of the delinquent monthly payments. If the servicer subsequently must initiate foreclosure proceedings because the borrower did not submit the additional amounts requested, the servicer must apply the funds being held as unapplied toward the reduction of the total indebtedness. If the net overcharge is not equal to the full amount of the delinquent monthly payments, but applying the overcharge does not jeopardize foreclosure proceedings, the servicer must apply the overcharge to the delinquent monthly payments. 

delinquent, and the servicer has advanced funds to cure an escrow overdraft 
credit the borrower for the net overcharge by completing the steps in the following table. 

Step  Servicer Action  
1 
Apply the overcharge to reduce the amount of the servicer’s outstanding advance. 

2 
Apply any remaining overcharge to reduce the delinquency. 
The servicer must notify Fannie Mae about the conversion of a portfolio ARM loan or participation pool ARM loan to a fixedrate mortgage loan when it submits its monthly accounting reports, in accordance with C2.301, Processing ARM Conversions to Fixed Rate Mortgage Loans.
The following table provides a timeline that compares the requirements for exercising and reporting conversions of ARM plans that have a monthly conversion option to those that have a periodic conversion option.
Action Date  Monthly Conversion Option  Periodic Conversion Option 

Date by which borrower must give notice of election to convert 
Lenderspecified date. Generally, the date will be in the first 5 days of a month for conversions that will become effective on the first¹ day of the second month following the election notice. 
Lenderspecified date. Generally, the date will be between 15 and 45 days before the scheduled interest rate change date. 
Date by which borrower must pay conversion fee and return executed documents 
Lenderspecified date. Generally, the date will fall between 5 and 45 days before the date on which the new converted interest rate will become effective^{1}. 
Lenderspecified date. Generally, the date will fall between 5 and 30 days before the scheduled interest rate change date. 
Date of Fannie Mae required net yield used as basis for new converted interest rate 
Applicable yield in effect as of the beginning of the first business day of the month in which the election notice is given. 
Applicable yield in effect as of the beginning of the day that is 45 days before the scheduled interest rate change date. 
Effective date for new converted interest rate 
First^{2} day of the second month following the election notice. 
Scheduled interest rate change date. 
Effective date for new payment 
First^{2}day of the month following the effective date of the new converted interest rate. 
First^{2}day of the month following the scheduled interest rate change date. 
Last date for notifying borrower of new payment 
Twentyfive days before the effective date of the new payment. 
Twentyfive days before the effective date of the new payment. 
Last date for reporting conversion to Fannie Mae 
Third business day of the month following the effective date for the new payment (which is when the Fannie Mae investor reporting system reports for the reporting period that includes that effective date are due). 
Third business day of the month following the effective date for the new payment (which is when the Fannie Mae investor reporting system reports for the reporting period that includes that effective date are due). 
The following content describes how to determine Fannie Mae’s required net yield for ARM loans, in accordance with C2.301, Processing ARM Conversions to Fixed Rate Mortgage Loans.
Convertible ARM Plans with a Periodic Conversion Option:
The required net yield is the yield in effect for
60day mandatory commitments for comparable term conventional fixedrate first lien mortgage loans,
accounted for under the actual/actual remittance type, and
at the time Fannie Mae’s Pricing and Sales Desk opened on the first business day of the month in which the borrower requested the conversion.
If the ARM loan is part of an MBS pool, the definition of required net yield depends on the postconversion disposition option designated by the seller when it delivered the MBS pool to Fannie Mae. The following table provides the required net yield information for each postconversion disposition option.
Some plans apply the limit on the amount by which the interest rate can change over the life of the mortgage loan to the new rate established for the fixedrate mortgage loan at the time of the conversion. Therefore, the servicer must compare the newly calculated interest rate to the original note rate. If the new interest rate exceeds the original note rate by more than the specified percentage, the new interest rate will be the rate determined by adding that percentage to the original note rate.
Seller selected disposition option  The required net yield is… 

Market rate postconversion option 
the posted 60day mandatory delivery actual/actual commitment yield for 30year conventional fixedrate mortgage loans (or the yield for 15year mortgage loans, if the term of the ARM was 15 years or less) that was in effect on a specific date (as specified at the time of mortgage loan origination) that falls during the month that is two months before the date on which interest will begin to accrue at the new fixed rate. 
Takeout postconversion option 
the yield that Fannie Mae has posted for the actual/actual remittance type when Fannie Mae’s Pricing and Sales Desk opens on the first business day of the second month before the date on which interest begins to accrue at the new fixed interest rate. The new interest rate becomes effective on the conversion date. 
Convertible ARM Plans with a Monthly Conversion Option
The required net yield is the yield that was in effect 45 days before the conversion date. The following table provides additional yield information depending on the date of the ARM loan commitment.
For ARM loans…  Fannie Mae’s required net yield is… 

purchased under commitments dated prior to December 9, 1987 
the posted yield for similar 30day mandatory delivery commitments for fixedrate mortgage loans. 
purchased under commitments dated on and after December 9, 1987 
the posted yield for similar mandatory delivery commitments that have a 60day term. 
To establish the new interest rate please refer to the ARM Note (with Conversion Option). The new interest rate becomes effective on the conversion date.
These plans also apply the limit on the amount by which the interest rate can change over the life of the ARM loan to the new rate established for the fixedrate mortgage loan at the time of the conversion. Therefore, the servicer must compare the new calculated interest rate to the original note rate. If the new interest rate exceeds the original note rate by more than the specified percentage, the new interest rate will be the rate determined by adding that percentage to the original note rate.
The following procedure provides instructions for determining the new monthly payment and effective date, in accordance with C2.301, Processing ARM Conversions to Fixed Rate Mortgage Loans.
To calculate the new monthly payment, the servicer must determine the amount required to repay the UPB of the ARM loan
in substantially equal payments,
over the remaining term of the mortgage loan, and
at the new fixed interest rate.
This new monthly payment becomes effective in the month following the month in which the new fixed interest rate goes into effect, either on
the first day of the month; or
on the applicable due date, if the mortgage loan has a payment due date other than the first of the month.
The following table provides additional information regarding the repurchase and redelivery of converted MBS mortgage loans in accordance with C2.303, Repurchasing Converted MBS Mortgage Loans and Redelivering Them to Fannie Mae.
PostConversion Disposition Option  Under this option, the servicer must… 

Option 1: Market Rate 
If the servicer chooses to redeliver the mortgage loan to Fannie Mae, it may either deliver the mortgage loan
The servicer is authorized to use any outstanding commitment it has with Fannie Mae (or obtain a new one) for the redelivery of the mortgage loan. 
Option 2: TakeOut Option 
Redeliver the converted mortgage loan to Fannie Mae as a portfolio mortgage loan. Fannie Mae does not require the servicer to requalify the borrower or to verify that the mortgage loan still meets Fannie Mae’s eligibility requirements. Procedures for obtaining a takeout option commitment are in the Selling Guide, C3501, Creating StatedStructure ARM MBS. 
To ensure consistent treatment of borrowers, servicers that service both portfolio mortgage loans and MBS mortgage loans should consider using the time frame required for MBS mortgage loans – which is no later than the 15th day of the month in which the election notice is given.
Timeline assumes that the monthly payments are due on the first day of each month. If not, the servicer must change these references to reflect the day of the month on which monthly payments are actually due.