Since the incorporation of the Alternative Reference Rates Committee’s “fallback” language (“ARRC language”) into the uniform FNMA and FHLMC ARM notes and ARM riders (see https://compliance.docutech.com/2020/03/18/document-updates-adding-fallback-language-to-standard-arm-notes-and-arm-riders/ for details), questions have been raised as to whether or not this language should also be incorporated into our standard FHA and VA ARM notes and riders. After careful research, we have come to the following conclusions:
Under 38 U.S.C.A. §§ 3707(b)(1) & 3707A(c)(1), adjustments to the interest rate for an ARM must “correspond to a specified national interest rate index approved by the Secretary [of the VA]”. The VA has, under 38 C.F.R. §§ 36.4212(e)(1) & 36.4312(d)(1), so specified that the index to be used is the one-year constant maturity Treasury (“CMT”).
Unlike the GSE uniform notes, which (prior to the ARRC language) permitted the Note Holder to select a replacement index at its discretion, our standard VA ARM Note (Cx3148) and ARM Rider (Cx3149) contain the following provision concerning a replacement index:
“If the Index is no longer available, the Note Holder will choose a new index prescribed by the Department of Veterans Affairs upon comparable information.”
The ARRC language basically requires a two-step method for selecting a replacement index: (1) the Note Holder must choose an index recommended by the Federal Reserve system as a replacement; or (2) if the Federal Reserve system does not provide such a recommendation, the Note Holder may choose the replacement index.
There are no provisions for replacing an index under VA’s regulations, the VA “does not have a specific note . . . that lender must use for VA-guaranteed loans” (VA Lender’s Handbook ch. 9, a) and, absent any further guidance, Federal law mandates that the only indices which can be used are the ones approved by the VA. This conclusion is at odds with the provisions of the ARRC language (which, incidentally, are not required to be used by any laws).
Therefore, we have decided not to include the ARRC language into Cx3148 and Cx3149, until further instructions (if any) are provided by the VA.
Under 12 U.S.C.A. § 1715z-16(a), the Secretary of Housing and Urban Development is permitted to insure certain ARMs, in which “[a]djustments in the effective rate of interest shall correspond to a specified national interest rate index approved in regulations by the Secretary”. The referenced “regulations” state that “[c]hanges in the interest rate charged on an adjustable rate mortgage must correspond either to changes in the one-year London Interbank Offered Rate (LIBOR) or to changes in the weekly average yield on U.S. Treasury securities, adjusted to a constant maturity of one year.” (24 C.F.R. § 203.49[b])
This legal structure is very similar to that of the VA’s: (1) the head of a Federal Department must choose the index; and (2) based on current regulations, the types of indices permitted are limited (CMT for VA, LIBOR or CMT for FHA). In the absence of specific rules regarding how an index is replaced (which is the case for both the VA and FHA), a reasonable (albeit paradoxical) conclusion is that if the Note Holder has the discretion to choose a replacement index, such discretion is limited to only those indices permitted by such regulations.
However, a major difference between HUD and the VA is that the former, through the FHA, has promulgated a Model ARM Note, which contains the same replacement index provisions as those found in the GSE’s uniform notes prior to the incorporation of the ARRC language. Again, these provisions authorize the Note Holder, at its discretion, to choose a replacement index.
Such a provision could conflict with Federal law (specifically HUD’s regulations), but the FHA did review the GSE’s uniform notes in 2015 (which formed the basis for FHA’s model notes) and “identified several provisions . . . that are inconsistent with either FHA requirements or policy, and has modified the FHA Model ARM accordingly” (see “Instructions for Model Notes”, available at: https://www.hud.gov/program_offices/housing/sfh/model_documents). Because FHA did not identify the GSE’s replacement index provision to be one these “inconsistent” provisions, it is reasonable to assume that a Note Holder’s wide discretion in choosing the replacement index is consistent with HUD’s regulations (else such provision should have been changed to something akin to: “the Note Holder will choose a new index pursuant to, and in compliance with, HUD requirements”).
The “Instructions” stipulate that “[a]ny 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.” Thus, ARRC’s language can (but does not have to) be incorporated into the FHA Model ARM Note, so long as such incorporation: (1) does not substantially change any “FHA-Specific Modification”; and (2) conforms with Federal law.
Due to the foregoing, we will be incorporating most of the AARC language into “FHA ARM Note – Treasury” (Cx861) and “FHA ARM Rider – Treasury” (Cx901), but such language will only print when “ARRC Fallback Language Indicator” (FI 138607) equals “Yes” (else the current language on these two forms will continue to print). This will allow clients who want to continue using the current language (because they prefer it or because they believe the ARRC language is incompatible with HUD regulations) to do so.
Because any changes to the FHA Model ARM Note must be done in accordance with the “Instructions”, we will be deviating from the ARRC language in the following ways:
- Even though the second sentence in Subsection 4(B) is an FHA-Specific Modification, we will be changing the phrase “Federal Reserve Board” to “Board of Governors of the Federal Reserve System” within this sentence. This is permitted under the “Instructions”, which require the Mortgagee to “adopt the [FHA-Specific Modification] or use substantially similar language” (emphasis added). The ARRC language, in this case, is “substantially similar” to the FHA-Specific Modification’s language.
- All references of changes to the margin and the “Replacement Margin” in Subsections 4(C) and 4(G) of the ARRC language will be omitted, due to the requirements of FHA Handbook 4000.1 Pt. II.A.8.f(iii) that “the margin must be constant for the entire term of the Mortgage.”
- The phrase “the margin plus the Current Index” will be replaced by the phrase “this addition” within the second sentence of Subsection 4(C). However, “margin” in our documents will be a common noun (instead of a proper noun, as used in the ARRC language), since the common-version of this noun is used throughout FHA’s Model ARM Note.
- The last sentence in Subsection 4(D) (capping changes to the interest rate) will not be modified, not only because it is a FHA-Specific Modification, but also due to 24 C.F.R. § 203.49(f) and FHA Single Family Handbook Pt. III.A.3.a(i)(D), which limit interest rate adjustments in ways not compatible with the ARRC language.
- In addition to omitting references to the Replacement Margin (as noted above), we will be adding the following to Subsection 4(G):
- Because there is a possibility that the Note Holder is limited in its choices of a replacement index under HUD regulations (despite the “Instructions” indicating otherwise), a “fail safe” clause will be added to the first sentence in the second paragraph, which allows the Note Holder to choose the Replacement Index, but only in compliance with HUD’s regulations. This is done pursuant to the “Instructions” which state that, if new provisions in the GSE uniform notes are incorporated into the FHA Model Notes, they must be “incorporated in a manner that remains consistent with all relevant statutes and regulations.”
The first sentence will state the following:
“If a Replacement Event occurs, the Note Holder will, unless otherwise required or prohibited by Federal law and the regulations of the Department of Housing and Urban Development, select a new index (the “Replacement Index”) as follows:”
- We will be adding the phrase “with the margin” to Subsection 4(G)(2), to make the clause grammatically correct due to the omission of “Replacement Margin” (e., instead of stating “select a Replacement Index and a Replacement Margin that, when added together, the Note Holder [etc.]”, the clause will state: “select a Replacement Index that, when added together with the margin, the Note Holder [etc.]”).
In addition to the changes we are making to Cx861 and Cx901, we are retiring “FHA ARM Note – LIBOR” (Cx13045) and “FHA ARM Rider – LIBOR” (Cx13046) as generic documents, since no clients have used these documents recently and LIBOR is tentatively set to be retired at the end of 2021. These documents may still be assigned to clients upon their request (but they will not be generically supported).
These changes will take effect on June 1, 2020. Questions or concerns about these changes should be directed to Client Support at 1.800.497.3584.