Background
The Federal National Mortgage Association (Fannie Mae or Enterprise) is a federally chartered corporation that was placed in conservatorship by the Federal Housing Finance Agency (FHFA or Agency) in September 2008 due largely to losses on residential mortgage loans from defaults. While in conservatorship, FHFA has the decision-making authority in addition to its responsibilities as a regulator for the Enterprise. Short sales, also known as preforeclosure sales, are a part of Fannie Mae’s foreclosure alternative strategy that can minimize the severity of losses it incurs as a result of loan defaults. In a short sale, the borrower sells the residence for less than the balance remaining on the loan and uses the proceeds to help satisfy the mortgage obligation. The proceeds received from a short sale are less than the amount of debt secured by liens against the property, which most often results in a loss to the Enterprise. In certain short sale transactions, depending on the borrower’s financial condition, the borrower may be required to make a contribution toward the short sale, which in turn reduces the Enterprise’s loss on the sale.
Through their Seller/Servicer Guides, Fannie Mae and Freddie Mac provide guidance on a large number of matters, including delinquency management and default prevention. Servicers are required to comply with the guidance through their contractual agreements with the Enterprises. The Enterprises have quality control processes that are designed to identify and address servicer noncompliance and the contracts include remedial tools, such as financial penalties. Pursuant to its delinquency management and default prevention guidance, Fannie Mae expects servicers to identify borrowers who are having difficulty making mortgage payments due to a financial hardship and offer appropriate workout options, such as a short sale. Fannie Mae also depends on its servicers to evaluate borrowers for contributions unless they are required to request approval from Fannie Mae for the contribution amount. Furthermore, Fannie Mae relies on its servicers to collect borrower contributions with the net proceeds from the short sale closing.
Before Fannie Mae clarified the requirements for borrower contributions, there was little guidance for servicers to follow with respect to requesting contributions and collecting them. On August 22, 2012, Fannie Mae issued Servicing Guide Announcement SVC-2012-19 that introduced new requirements to simplify and streamline the short sale process.1 This announcement provided specific guidance for evaluating a borrower for a contribution and reminded servicers that they must not request cash contributions and/or promissory notes where applicable law prohibited borrower contributions; however, it did not state that borrower contributions were prohibited in California.
Although Fannie Mae issued guidance to its servicers informing them of the requirements for evaluating borrower contributions, Fannie Mae and its servicers did not always have the option to collect them. On September 30, 2010, the state of California enacted a law which went into effect on January 1, 2011, that prohibited a deficiency judgment for any note where the property sold for less than the indebtedness.2 According to Fannie Mae, the language of this new law was unclear and did not expressly prohibit borrower contributions in short sale transactions.
On July 11, 2011, the state of California amended Section 580e on an emergency basis to provide clarity in connection with borrower contributions on short sale transactions. The amendment, which went into effect four days later on July 15, clarified the law to include an express prohibition against any type of borrower contribution in connection with a short sale. Specifically, Section 580e subsection (b) forbids “A holder of a note” from requiring the borrower “to pay any additional compensation, aside from the proceeds of the sale, in exchange for the written consent to the sale.”
Fannie Mae and its servicers were also prohibited from collecting contributions for short sales completed through Fannie Mae’s Home Affordable Foreclosure Alternatives (HAFA) Program that went into effect on August 1, 2010.3 Fannie Mae’s HAFA Program was discontinued with the implementation of the Standard Short Sale Program on November 1, 2012, which was created as part of FHFA’s Servicing Alignment Initiative (SAI).4
