The U.S. Court of Appeals for the Third Circuit recently held that the calculation of the private mortgage insurance (PMI) automatic termination date under the federal Homeowners Protection Act, 12 U.S.C. § 4901 et seq., for modified loans is tied to the initial purchase price of the home, not the updated property value used for a borrower’s modification.

In so ruling, the Third Circuit rejected several arguments set forth by trade group amici, including reliance on Fannie Mae Servicing Guidelines that allow mortgage servicers to use the estimated value of the property used for a loan modification to calculate the new PMI auto-termination date.

A copy of the opinion Fried v. JPMorgan Chase & Co. is available at: Link to Opinion.

As you may recall, private mortgage insurance protects the owner or guarantor of mortgage debt from a borrower’s risk of default. Normally, lenders require borrowers to pay at least 20 percent of a home’s purchase price in cash and finance 80 percent of the home’s purchase price. If borrowers cannot pay at least 20 percent, then they must purchase mortgage insurance. Once the balance due on the loan falls below 80 percent of the home’s purchase price, mortgage insurance is no longer necessary.

In the HPA, Congress set national standards for mortgage insurance termination. The HPA requires mortgage servicers to among other things: (1) provide periodic notices to a borrower/mortgagor regarding mortgage insurance obligations; (2) automatically terminate mortgage insurance on a statutorily defined schedule; and (3) grant a borrower’s request to cancel his mortgage insurance once certain conditions are met. See 12 U.S.C. §§ 4901-03.

Under the HPA, mortgage servicers must automatically terminate mortgage insurance for a fixed-rate loan on “the date on which the principal balance of the mortgage . . . is first scheduled to reach 78 percent of the original value of the property securing the loan.” 12 U.S.C. § 4901(18)(A). The “original value” of a home is defined as “the lesser of the sales price of the property securing the mortgage, as reflected in the contract, or the appraised value at the time at which the subject residential mortgage transaction was consummated.” 12 U.S.C. § 4901(12).

The HPA also addresses the auto-termination date for loans that have been modified: “If a mortgagor and mortgagee (or holder of the mortgage) agree to a modification of the terms or conditions of a loan pursuant to a residential mortgage transaction, the cancellation date, termination date, or final termination shall be recalculated to reflect the modified terms and conditions of such loan.” See 12 U.S.C. § 4902(d).

In this case, the borrower purchased her home for $553,330, but only needed to borrow $497,950 at a fixed interest rate. Because the loan-to-purchase price ratio was more than 80 percent, the mortgage lender required borrower to obtain PMI. Under the HPA, borrower’s loan-to-value ratio would reach 78 percent of the original value in March 2016.

After the housing market crashed, the borrower had trouble making her mortgage payments. As a result, the borrower received a loan modification pursuant to the Home Affordable Mortgage Program (HAMP) that reduced her principal balance to $463,737.

Under the HPA, when the borrower modified her loan, the mortgage servicer was required to update the PMI auto-termination to reflect the “modified terms and conditions” to which the parties “agree[d.]” Pursuant to the loan’s modified amortization schedule, the loan-to-value would reach 78 percent in July 2014. The servicer, however, informed the borrower that her PMI would automatically terminate in November 2026. As a result of extending the borrower’s PMI auto-termination date, the borrower would have paid an additional $30,339.60 in PMI premiums.

When pressed by the borrower, the servicer explained that it extended the PMI auto-termination date because it substituted the estimated value of the property used for the loan modification (the Broker’s Price Opinion (BPO)) for that of the original value. The substantially lower value of the property used for the loan modification ($420,000) caused the date where the loan-to-value reached 78 percent to be extended 10 years.

The borrower brought a putative class action against the servicer, alleging that by using the BPO to calculate the PMI auto-termination date, rather than the original appraised value, the servicer violated the HPA. The servicer moved to dismiss the complaint, asserting that it did not violate the HPA because the BPO was supposed to be used to calculate the PMI auto-termination date. The trial court denied the servicer’s motion, but certified for appeal the question of whether the original value or the BPO used for the modification should be used to calculate the new PMI auto-termination date.

On appeal, the Third Circuit held that the HPA required calculation of the PMI auto-termination date on the basis of the original appraised value, which under the HPA here was the purchase price, not the BPO used for the modification. In doing so, the Court addressed several arguments that the servicer (and several mortgage lending and banking trade groups) made in support of using the BPO to calculate the new PMI auto-termination date.

The Third Circuit first addressed the plain language of the HPA. In particular, the HPA establishes that the termination date is “the date on which the principal balance of the mortgage, based solely on the initial amortization schedule for that mortgage, and irrespective of the outstanding balance for that mortgage on that date, is first scheduled to reach 78 percent of the original value of the property securing the loan[.]” See 12 U.S.C. § 4901(18)(A).

The Court stated, “Simply put, a homeowner’s termination date is when she will have paid down her loan’s principal balance to the point that it equals 78% of her home’s original value.”

In addressing the application of the HPA provision applicable to loan modifications, the Court stated “we ask which terms or conditions of [the borrower’s] loan she and [the servicer] agreed to modify; then we recalculate her termination date to reflect the modified terms and conditions.” The Court concluded that the borrower and servicer expressly agreed to modify the principal balance, which produced a new amortization schedule. According to the Third Circuit, however, the borrower and servicer never agreed to replace the original value with the BPO.

The servicer argued that the substitution of the BPO was permissible because it was a “term” or “condition” of the modification that the HAMP rules required. In addressing the HAMP rules, the Court concluded that although the HAMP handbook requires the servicers to obtain an assessment of the current value of the property for the modification, the HAMP handbook says nothing about using the BPO to calculate the PMI auto-termination date. The Court further concluded that use of the BPO was not a “condition” of the modification, and rejected the servicer’s argument that the borrower impliedly agreed to substitute the BPO for the original value.

In addressing the legislative history of the HPA, the Court rejected the servicer’s argument that the HPA’s statutory structure and legislative history supported its interpretation that the BPO should be used to calculate the new PMI auto-termination date.

The Third Circuit specifically analyzed the amendments to the HPA in 2000 where Congress intended for the amendments to eliminate “uncertainty relating to the cancellation and termination of [mortgage insurance] for . . . loans whose terms or rates are modified over the life of the loan.” 146 Cong. Rec. H. 3578-02, H3579 (May 23, 2000). The Court observed that Congress amended the HPA to address loan refinances, where the “original value” would be re-established because the refinance was a new “residential mortgage transaction.” See 12 U.S.C. § 4901(15). Whereas, for loan modifications, the only change Congress made to the HPA was to address the language instructing the lender/servicer to recalculate the cancellation date, termination date, and final termination to reflect the modified terms and conditions. See 12 U.S.C. § 4902(d). The Court concluded that because Congress did not address the “original value” for loan modifications, it purposely intended for a different result between a loan modification and a refinance.

The servicer’s third argument relied exclusively on the Fannie Mae Servicing Guidelines, which expressly required the servicer to use the BPO and modified terms to re-calculate the PMI auto-termination date after a loan modification. The Third Circuit rejected this argument for several reasons.

First, the Court noted that the HPA contains a specific provision that anticipated the possibility of a conflict between the HPA and other pooling-and-servicing agreements that rely on the servicing guidelines, and explicitly provided that the HPA would take precedence: “The provisions of this chapter shall supersede any conflicting provision contained in any agreement relating to the servicing of a residential mortgage loan entered into by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, or any private investor or note holder (or any successors thereto).” See 12 U.S.C. § 4908(b). The Third Circuit specifically held that “if the Servicing Guidelines would produce a result that departs from the [HPA’s] text, there is a conflict, and per § 4908(b) the statute prevails.”

Next, the Third Circuit concluded that the Fannie Mae guidelines were not entitled to deference because (i) they were not consistent with the language contained in the HPA, and (ii) Fannie Mae was not an administrative agency and it did not administer or otherwise oversee the administration of the HPA.

The Court then observed that the application of the Fannie Mae guidelines would conflict with guidance offered by the Consumer Financial Protection Bureau in an August 2015 Compliance Bulletin. In particular, the compliance bulletin at issue stated, in relevant part, “Servicers should nonetheless remember that investor guidelines cannot restrict the [mortgage insurance] cancellation and termination rights that the [HPA] provides to borrowers.” See CFPB Bulletin 2015-03, Compliance Bulletin: Private Mortgage Insurance Cancellation and Termination, at 5, (Aug. 4, 2015).

The Third Circuit also rejected the servicer’s reliance on the Fannie Mae guidelines because Fannie Mae actually benefitted from mortgage insurance. As a result, according to the Court, Fannie Mae “is not acting as an administrative agency neutrally interpreting laws for the marketplace; it is a market participant interpreting laws for the benefit of its shareholders and is not entitled to deference.” Thus, the Third Circuit held, the guidelines were not persuasive.

The servicer’s final argument in support of using the BPO to calculate the new PMI auto-termination date was that the purpose of the HPA was to protect consumers from continuing to pay PMI after they had acquired 20 percent equity in the property. Although the value of the borrower’s property in this case had decreased, the servicer argued that using the “original value” for calculating the PMI auto-termination date for properties that had increased in value would actually cause those borrowers to pay PMI after they had acquired 20 percent equity in the property.

The servicer contended that because most home values increase over time, most borrowers would benefit from using the BPO instead of the original value to calculate the PMI auto-termination date. The Court rejected this rationale, and concluded that Congress, in enacting the HPA, “chose to prioritize predictability of consumers’ mortgage insurance obligations over economic precision.”

The Third Circuit indicated there was inadequate support for the servicer’s argument that most property values increase over time, and that, as a result of the volatility of property values, the HPA attempted to “approximate the economic need for mortgage insurance in any particular case. This sacrifice of precision for predictability allows the [HPA] to provide both consumers and lenders with certainty as to their respective mortgage insurance obligations from the moment the original value is known and the amortization schedule is set.”

In sum, the Court analyzed the issue of whether the original value or the BPO used for the modification is to be used for calculating the new PMI auto-termination date, and upheld the trial court’s conclusion that the original value must be used in the calculation.

In doing so, the Third Circuit expressly rejected reliance on the Fannie Mae Servicing Guidelines. According to the Third Circuit, for servicers who were using the BPO value to calculate the new PMI auto-termination date based on the guidelines, they will have to change their methods for calculating the new date.