Reviewing ARM Adjustment Correction Errors

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 C-2.2-01, Identifying and Disclosing Adjustment Errors, regardless of whether the review is undertaken as a result of

  • a full audit,

  • a routine spot-check of its ARM adjustments, or

  • an inquiry from a third party.

Reviewing ARM Adjustment Correction Errors for Assumed Mortgage Loans

The following table describes how to review adjustments for ARM loans that have been assumed, in accordance with C-2.2-01, 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.

Correcting ARM Adjustment Errors

The following table describes various scenarios and resulting actions the servicer must take after correcting an ARM adjustment error, in accordance with C-2.2-01, 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 re-amortizing 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.

Verifying the Correct Interest Rate and Payment Amount for Each Adjustment Period

The following table provides instructions for verifying the correct interest rate for each ARM adjustment period in accordance with C-2.2-01, Identifying and Disclosing Adjustment Errors.

Step Servicer Action
1

Use the correct index value applicable for each adjustment date.

2

Apply any per-adjustment interest rate caps.

3

Round the resulting rate as specified in the mortgage loan instrument.

Note: If application of a per-adjustment 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 per-adjustment cap to any payment change would perpetuate the previous error(s), the servicer must not apply it.

Re-Amortizing the Mortgage Loan

In accordance with Re-Amortizing the Mortgage Loan in C-2.2-01, Identifying and Disclosing Adjustment Errors, the servicer must adhere to the following instructions.

To re-amortize 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 re-amortized 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 re-amortized UPB for the ARM loan and the actual UPB that resulted from the incorrect payment application.

Calculating the New Monthly Payment After an Adjustment Error

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 C-2.2-01, 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

  • the correct interest rate;

  • the actual UPB and remaining mortgage loan term as of the LPI date; and

  • any applicable payment cap, unless its application would perpetuate the previous error(s).

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 per-adjustment 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.

Determining the Amount of an Under- or Overcharge Related to an Adjustment Error

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 C-2.2-01, 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 re-amortization 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 re-amortization 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 re-amortization 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 re-allocate 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 re-amortization 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, re-allocate 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 re-amortization 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 re-amortization 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.

Correcting Conversion Notice Errors

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 fixed-rate mortgage loan, in accordance with C-2.2-02, 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 fixed-rate 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.

Refunding or Crediting Overcharges Resulting from an Incorrect Monthly Payment

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 C-2.2-03, 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

  • receiving a cash refund and having the UPB of the mortgage loan increased to the correct amount; or

  • having the previous overpayment of principal treated as the application of a curtailment and leaving the actual, lower UPB in effect.

current, and the servicer has advanced funds to cure an escrow overdraft

give the borrower a choice between

  • having the overcharge credited against the servicer’s outstanding advance, or

  • having the overcharge treated as the previous application of a curtailment.

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

  • leave the actual, lower UPB in effect if the overcharge is less than a monthly payment of P&I; or

  • credit the borrower if the overcharge is equal to one or more monthly payments of P&I by

    • changing the UPB of the ARM loan to the balance that would have been in effect if the adjustment error had not occurred; and

    • re-applying the overcharge as P&I installments to advance the LPI date, with any remaining overages credited as a curtailment.

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

  • increase the UPB of the ARM loan by the amount of the overcharge; and

  • reduce the monthly payment accordingly, if the monthly payment had been increased to repay the advance.

Note: The borrower will not be given an option on how to credit the overcharge.

Refunding or Crediting Overcharges Resulting from an Incorrect Monthly Payment and an Incorrect Interest Rate

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 C-2.2-03, 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

  • apply the overcharge to the past due installments, and

  • provide the borrower a cash refund of any remaining amount.

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.

Exercising/Reporting ARM Conversions for Portfolio Mortgage Loans

The servicer must notify Fannie Mae about the conversion of a portfolio ARM loan or participation pool ARM loan to a fixed-rate mortgage loan when it submits its monthly accounting reports, in accordance with C-2.3-01, 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

Lender-specified 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.

Lender-specified 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

Lender-specified date. Generally, the date will fall between 5 and 45 days before the date on which the new converted interest rate will become effective1.

Lender-specified 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

First2 day of the second month following the election notice.

Scheduled interest rate change date.

Effective date for new payment

First2day of the month following the effective date of the new converted interest rate.

First2day of the month following the scheduled interest rate change date.

Last date for notifying borrower of new payment

Twenty-five days before the effective date of the new payment.

Twenty-five 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).

Determining Fannie Mae’s Required Net Yield for an ARM Loan Conversion

The following content describes how to determine Fannie Mae’s required net yield for ARM loans, in accordance with C-2.3-01, 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

  • 60-day mandatory commitments for comparable term conventional fixed-rate 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 post-conversion 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 post-conversion 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 fixed-rate 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 post-conversion option

the posted 60-day mandatory delivery actual/actual commitment yield for 30-year conventional fixed-rate mortgage loans (or the yield for 15-year 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.

Take-out post-conversion 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 30-day mandatory delivery commitments for fixed-rate mortgage loans.

purchased under commitments dated on and after December 9, 1987

the posted yield for similar mandatory delivery commitments that have a 60-day 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 fixed-rate 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.

Determining the Monthly Payment and Effective Date for an ARM Loan Conversion

The following procedure provides instructions for determining the new monthly payment and effective date, in accordance with C-2.3-01, 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.

Repurchasing Converted MBS Mortgage Loans and Redelivering Them to Fannie Mae

The following table provides additional information regarding the repurchase and redelivery of converted MBS mortgage loans in accordance with C-2.3-03, Repurchasing Converted MBS Mortgage Loans and Redelivering Them to Fannie Mae.

Post-Conversion Disposition Option Under this option, the servicer must…

Option 1: Market Rate

  • decide whether or not to redeliver the converted mortgage loan to Fannie Mae;

  • retain the interest rate risk associated with the period of time between the date the mortgage loan is converted and the date of any future sale of the mortgage loan; and

  • verify the mortgage loan meets the specific eligibility requirements for converted ARM loans that are specified in the Selling Guide, C3-5-01, Creating Stated-Structure ARM MBS.

If the servicer chooses to redeliver the mortgage loan to Fannie Mae, it may either deliver the mortgage loan

  • as part of a new MBS pool of fixed-rate mortgage loans, or

  • as a portfolio mortgage loan that must be either an actual/actual or a scheduled/actual remittance type.

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: Take-Out Option

Redeliver the converted mortgage loan to Fannie Mae as a portfolio mortgage loan.

Fannie Mae does not require the servicer to re-qualify the borrower or to verify that the mortgage loan still meets Fannie Mae’s eligibility requirements.

Procedures for obtaining a take-out option commitment are in the Selling Guide, C3-5-01, Creating Stated-Structure ARM MBS.

1

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.

2

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.