As previously announced (see here and here), FNMA and FHLMC have adopted the “fallback” language proposed by the Alternative Reference Rates Committee (“ARRC”; see https://www.newyorkfed.org/arrc/fallbacks-contract-language) and have incorporated it into their uniform ARM promissory notes and ARM riders. They are requiring this language to be in use starting June 1, 2020 but (in FNMA’s case) have encouraged mortgage lenders to adopt this language as soon as possible.
Standard, Conventional ARM Notes and ARM Riders
We have completed incorporating the “fallback” language into our standard, conventional ARM notes and ARM riders. These documents include the following:
Because loan origination systems may still be in the process of updating their systems to support the new “fallback” language (e.g., sending the right values for the ULDD), we are configuring this language to print when new indicator “ARRC Fallback Language Indicator” (FI 138607) is set to “Yes”. This Field will be so set under the following conditions:
- “Loan Purpose” (FI 1063) does not equal either:
- ConstructionOnly
- HELOC
- “Base Type” (FI 2274) does not equal either:
- FHA
- VA
- “Amortization Type” equals AdjustableRate (ARM)
- Either of the following:
- “Closing Date” (FI 678) is greater than or equal to 4/1/2020
- If “Closing Date” is empty, then “Today’s Date” (FI 15408) is greater than or equal to 4/1/2020
Clients who wish to not have the new “fallback” language print at this time may map this new field to “No”. When set to “No”, the language of the ARM notes and ARM riders will revert back to the FNMA/FHLMC versions last revised prior to February, 2020.
Lifetime Floor
Part of the new “fallback” language is the replacement of the provision in Subsection 4(D) which stipulates that the interest rate will never be “less than the Margin”, with a similar provision capping the lowest rate charged to a percentage (with the percentage being determined by the lender).
We will be using “Minimum Interest Rate for the Term of The Loan” (FI 18) to disclose such percentage. If this Field is lacking a value, then “Margin Percent” (FI 19) will be used instead, since FHLMC requires that “the Lifetime Floor must equal the Margin stated in the Note.” (FHLMC Selling Bulletin 2020-3; see also FHLMC Seller/Servicing Guide ch. 4101.2[c][i]). However, using FI 18 first instead of FI 19 will give clients the flexibility to enter a different value if they intend to sell the loan to an investor who does not require the “floor” to match the margin.
HELOCs and Construction Only Notes
We have reviewed the possibility of including ARRC’s “fallback” language into our generic HELOC documents, but will not do so due to the fact that it is extremely unlikely that the index referenced in such documents (the Prime Rate) will ever be discontinued. Also, the ARRC language is geared towards closed-end loans and there are no requirements stipulating that it must be included in contracts involving open-end credit.
We have also reviewed the possibility of including this language into our promissory notes for adjustable-rate construction-only loans, but will also not do so due to the extremely short life of such loans (typically between six to twelve months). Currently, these forms do not contain any provisions regarding a replacement index, since mortgage lenders are highly unlikely to reference an index which they reasonably anticipate (or know) will be discontinued during the construction phase. This has not changed, so we will not include the “fallback” language in these documents.
Update on FHA and VA ARM Notes and ARM Riders
We had originally planned to include the ARRC “fallback” language into our standard FHA and VA ARM notes and ARM riders, but have discovered some legal issues in doing so and will be postponing such changes, as explained below.
The “fallback” language includes “waterfall” provisions in Subsection 4(G) which require, when an index becomes unavailable, that the replacement index be one recommended by the Federal Reserve System. Absent such a recommendation, the Note Holder may then choose the replacement index.
However, regarding VA ARMs, 38 U.S.C.A. §§ 3707(b)(1) & 3707A(c)(1) require that the interest rate must “correspond to a specified national interest rate index approved by the Secretary”, thus limiting the replacement index to one approved by the Secretary of Veterans Affairs (not to one chosen by the Federal Reserve System or by the Note Holder). It is for this reason that the second-to-last sentence of Subsection 4(B) of our standard VA ARM notes (Cx3148 & Cx3149) currently states that “[i]f the Index is no longer available, the Note Holder will choose a new index prescribed by the Department of Veterans Affairs upon comparable information.”
For FHA ARMs, mortgage lenders are required to use the “FHA Model ARM Note” (see FHA Single Family Handbook 4000.1 Pt. II.A.6[b][ii]), that such “Note” should conform “generally to the Freddie Mac and Fannie Mae forms in both form and content”, and should also conform with FHA’s “Instructions for Model Notes” (available at: https://www.hud.gov/program_offices/housing/sfh/model_documents).
According to the “Instructions” (which were last revised in 2015), the ARM notes must conform with the GSE’s uniform ARM notes, except that specific changes identified as an “FHA-Specific Modification” must be made to the forms (“the Mortgagee should adopt the change or use substantially similar language to ensure compliance with FHA rules and requirements”). Also, the “Instructions” state the following:
“Any future changes to the provisions of the GSE notes that are not currently identified as FHA-Specific Modifications may be incorporated in a manner that remains consistent with all relevant statutes and regulations.”
An issue with the new “fallback” language is that it does deviate from two “FHA-Specific Modifications”, as follows:
- The second sentence of Subsection 4(B) on the “FHA Model ARM Note” states the following:
“The ‘Index’ is either i) the weekly average yield on United States Treasury securities adjusted to a constant maturity of one year, as made available by the Federal Reserve Board or ii) the one-year London Interbank Offered Rate.”
However, the second sentence in the ARRC “fallback” language states the following (note that the bracketed text can be replaced if the language is used in a note which references a different index):
“The ‘Index’ is a benchmark, known as [the one-year U.S. dollar (USD) LIBOR] index.”
- The third sentence of Subsection 4(D) on the Model ARM Note states the following:
“My interest rate will never be greater than five percentage points (5.0%) higher or lower than the initial interest rate stated in Paragraph 2 of this Note.”
However, the third sentence in the ARRC “fallback” language states the following:
“My interest rate will never be greater than ______% or less than __________%.”
Due to these issues, we will postpone making any changes to our standard VA and FHA ARM notes and ARM riders for the “fallback” language. We are hoping that both FHA and VA will provide further guidance on the ARCC’s language; therefore:
- For VA loans, no such changes will be made until the VA has issued further guidance; and
- For FHA loans, we will postpone making such changes until either FHA issues further guidance or until the “fallback” language is considered “mandatory” by the GSEs (currently scheduled for June 1, 2020), whichever occurs first. In the latter case, we hope to have our changes ready for testing two weeks in advance of the mandatory date (circa May 18, 2020).
Effective Date
We have made these changes available for immediate testing on our ConformX Stage and Stage 2 environments for all standard, conventional ARM notes and ARM riders, which are listed in the chart above. The new versions will print by default for loans with a Closing Date on or after April 1, 2020, since the “ARRC Fallback Language Indicator” will be set to “Yes” for those loans.
The updated documents with the fallback language functionality will be placed on ConformX Production March 24, 2020. As stated above, the new February 2020 versions will only trigger by default for loans with a Closing Date on or after April 1, 2020. If you have any questions or concerns about these changes, please contact Client Support at 1.800.497.3584.
DRs 310973 & 311661