Applying HUD Regulations with the Force and Effect of Law
Notably, some Illinois courts treat HUD’s regulations as having “the force and effect of law” independent of the parties’ mortgage contract, despite the Illinois Supreme Court’s unambiguous ruling that “where the mortgage contract does not specifically incorporate the FHA regulations or expressly indicate agreement thereto, such regulations are not determinative of the content of the contract created between the parties.” Nevertheless, the result should remain the same. Illinois courts “construe administrative rules and regulations under the same principles that govern the construction of statutes,” and their “primary objective is to ascertain and give effect to the drafters’ intent.” Importantly, they “may not depart from the plain language of a regulation by reading into it exceptions, limitations, or conditions that the agency did not express.” Yet this is exactly what the Second District did in Olivera.
Nothing in the plain language of the relevant HUD regulations suggests that the drafters intended to forever bar lenders from foreclosing if they failed to strictly comply with the regulations, or that they intended to require lenders to forgive substantial sums of principal and interest as punishment for any failure to comply with a regulation. To the contrary, Section 203.500 specifies HUD’s intent “that no mortgagee shall commence foreclosure . . . until the requirements of [Sections 203.500 to 203.681] have been followed.” Similarly, Section 203.606 requires that “[b]efore initiating forecloure, the mortgagee must ensure that all servicing requirements of [Sections 203.500 to 203.681] have been met.” By precluding foreclosure “until” the lender follows the regulatory requirements and requiring compliance “[b]efore initiating foreclosure,” the plain language of these sections expressly anticipates allowing the lender to take future action to bring itself into compliance.
Importantly, if HUD had intended to prohibit lenders from foreclosing or to force lenders to forgive substantial amounts of debt for servicing errors, it could have done so. HUD could have drafted Section 203.500 to read: “The mortgagee shall not commence foreclosure unless the requirements of [Sections 203.500 to 203.681] have been met.” It could have drafted Section 203.606(a) to read: “The mortgagee cannot initiate foreclosure if all servicing requirements of [Sections 203.500 to 203.681] have not been met.” It did not. Instead, HUD used different language that specifically contemplated the possibility of future action to correct alleged noncompliance. HUD presumably chose this language for a reason; the agency’s chosen words should matter.
Moreover, HUD itself confirmed in its Notice of Policy published in the Federal Register that only “some regulations [ ] exist which limit a lender’s rights to foreclose,” noting that the language required in its form mortgage “does not incorporate all of HUD’s servicing requirements into the mortgage.” Rather, HUD explained, the language “simply prevents acceleration and foreclosure on the basis of the mortgage language when foreclosure would not be permitted by HUD regulations.” HUD continued: “If a mortgagee has violated parts of the servicing regulations which do not specifically state prerequisites to acceleration or foreclosure, [ ] the reference to regulations in the mortgage would not be applicable.” In other words, unless the regulation at issue specifically states it is a prerequisite to acceleration or foreclosure, then a lender’s failure to comply does not bar foreclosure.
The regulations creating HUD’s face-to-face meeting requirements do not specifically state prerequisites to acceleration or foreclosure, as required for a lender’s failure to comply to bar foreclosure. To illustrate what constitutes a specific prerequisite to acceleration or foreclosure, HUD highlighted the language from Section 203.606 that “specifically prohibits a mortgagee from foreclosing unless three full monthly payments due on the mortgage are unpaid.” This language reads: “The mortgagee may not commence foreclosure for a monetary default unless at least three full monthly installments due under the mortgage are unpaid.” Section 203.604 — which creates HUD’s face-to-face meeting requirements — has no corresponding prohibition against foreclosure or acceleration.
By its express terms, Section 203.604 creates a requirement that lenders conduct a face-to-face interview or make reasonable efforts to arrange such an interview, unless specified circumstances exist to excuse the requirement. The section outlines the time that the lender should conduct or make a reasonable effort to arrange the interview, but it nowhere prohibits the lender from foreclosing if the lender fails to meet the timeline. In fact, under its express terms, the section does not even prohibit the lender from foreclosing if the lender fails to conduct or attempt to arrange the interview at all. According to HUD’s own explanation, a lender’s failure to comply with Section 203.604’s face-to-face meeting requirement therefore does not limit foreclosure or acceleration under the terms of the mortgage.
As with Sections 203.500 and 203.606, HUD could have used language that made compliance with Section 203.604 a prerequisite to acceleration and foreclosure. For example, it could have written the regulation to read: “The mortgagee shall not commence foreclosure for a monetary default unless it has a face-to-face interview with the mortgagor, or makes a reasonable effort to arrange such a meeting, before three full monthly installments due on the mortgage are unpaid.” It did not. Again, HUD’s chosen words should matter.
Importantly, applying HUD’s Notice of Policy to preclude foreclosure for noncompliance with a regulation only where the regulation specifically states that it is a prerequisite to foreclosure would conform to the rules governing other types of mortgage foreclosures. As already discussed, it would preclude foreclosure until at least three full monthly installments become unpaid, which tracks with CFPB regulations governing other types of mortgage foreclosures. It would also preclude foreclosure where the lender failed to “notify the mortgagor . . . that the mortgagor is in default and that the mortgagee intends to foreclose unless the mortgagor cures the default,” which would track with the standard notice of default requirements in non-FHA-insured mortgages.
In other words, interpreting the HUD-mandated language in FHA-insured mortgages in accordance with HUD’s own Notice of Policy provides borrowers with the same protections they would receive under non-FHA mortgages. Illinois courts should not question HUD’s policy decision to treat the mortgage language in this way, and they should not read additional requirements or conditions into the regulations that HUD did not express.
The Housing Act's Purpose
The Second District in Olivera did not address the regulations’ plain language, or HUD’s specific explanation about which regulations it intended to bar foreclosure under the mortgage. Instead, the court focused on its own misunderstanding of the Housing Act’s purpose.
Extensively quoting the Third District’s opinion in Denton, the Second District’s Olivera ruling recites the Housing Act’s purpose “to assist in providing a decent home and a suitable living environment for every American family.” According to Olivera and Denton, HUD’s decision to limit the penalty for a lender’s noncompliance to levying a fine against the lender or withdrawing its status as a HUD-approved lender does not sufficiently protect “the individual faced with the immediate problem of the foreclosure action.” To correct HUD’s perceived oversight, the court in Olivera improperly departed from the plain language of HUD’s regulations to impose a strict compliance standard on the face-to-face meeting requirement.
Yet both Olivera and Denton misunderstand the Housing Act’s legislative purposes. As discussed above, the Housing Act created the FHA during the Great Depression to achieve “the realization as soon as feasible of the goal of a decent home and a suitable living environment for every American family.”Congress’s purpose in pursuing policies to realize this goal was to “contribut[e] to the development and redevelopment of communities and to the advancement of the growth, wealth, and security of the Nation.” The Olivera and Denton courts mistakenly refocus Congress’s purpose away from community development and national growth to individual homeowners, and they seek to equip individual homeowners with extra tools to ensure a lender’s compliance with HUD regulations beyond those HUD itself chose to create.
Put differently, Congress designed the Housing Act to create programs that would help communities grow so “every American family” could have “a decent home and a suitable living environment.” This included programs that would encourage lenders to make financially risky mortgage loans to borrowers who may not otherwise qualify for the financing needed to purchase a home. Interpreting HUD regulations to effectively require lenders to choose between forgiving substantial amounts of principal and interest or losing the ability to promptly foreclose will discourage — not encourage — lenders from making the intended loans. In any event, even if the Olivera and Denton courts disagree with HUD about the appropriate penalties for noncompliance with its regulations, it is not their place to supplant their opinions for HUD’s. Congress gave the responsibility for administering the Housing Act to HUD, not to the Illinois Appellate Court.
Impractical and Absurd Results
Similarly, Illinois courts interpret administrative regulations under the same rules applied to statutes, and the Illinois Supreme Court “has long held that statutes should be construed in such a way as to avoid impractical or absurd results.” Applying Olivera to real-world scenarios leads to just such impractical and absurd results.
Consider the not-uncommon scenario where a lender acquires its interest in the loan after three full monthly installments have already become unpaid under the regulation. Examining an entire hypothetical foreclosure step-by-step, starting from the beginning, helps illustrate the problem. Let’s say that Borrower takes out a $250,000 mortgage loan from Bank with a 30-year term on July 1, 2012. The loan has an annual interest rate of 2.5%. Borrower’s first payment is due August 1, 2012, and the loan matures on July 1, 2042. An amortization schedule showing the monthly amounts due on the loan is included as Appendix No. 1.
Borrower timely pays on the loan for the first five years, but she defaults on her payment due July 1, 2017. After the first missed payment, Bank’s loan servicer sends Borrower a letter inviting her to apply for loss mitigation and providing her contact information to call to schedule a face-to-face meeting. Bank’s servicer sends one copy by regular mail and another copy by certified mail. It also conducts a field visit to the property, where an agent hand-delivers a copy of the letter to Borrower and offers to go over her loss mitigation options with her in person.
Borrower applies for a loan modification following the instructions in the letter, and the parties spend four months exploring Borrower’s loss mitigation options, with a substantial portion of that time devoted to Borrower gathering and sending in the necessary documents. In late October 2017, Bank approves Borrower for a trial loan modification requiring three timely payments before it will consider Borrower for a permanent modification. The offer sets trial payments to begin November 1, 2017. Borrower makes the November and December 2017 trial payments, but she misses the January 2018 payment, and she makes no more payments on the loan.
During the trial period, Bank sells the loan to Trust, who transfers servicing of the loan to a new servicer. At the end of January 2018, Borrower submits a second loss mitigation application to the new servicer, and she sends all the necessary documents by mid-February 2018. Trust’s servicer determines that Borrower does not qualify for a loan modification and invites her to consider other loss mitigation options such as a deed-in-lieu of foreclosure or short sale. Borrower appeals the loan modification denial, which Trust’s servicer timely reviews and denies.
On May 1, 2018, after nine months of cumulative loss mitigation efforts, Trust’s servicer refers Borrower’s account to foreclosure. It sends Borrower a notice of default advising her of the amount of her delinquency and notifying her that unless she pays the delinquency within thirty days, Trust may accelerate the balance of her mortgage loan and foreclose. After the notice of default’s thirty-day period expires, Trust’s servicer directs its foreclosure attorneys to begin taking the necessary steps to file a foreclosure complaint under Illinois law. The attorneys file the complaint on August 1, 2018, and they serve Borrower on August 15, 2018. Borrower does not answer the complaint, and after sixty days pass from the date of service, Trust moves for a default judgment on October 15, 2018, which the court schedules for hearing on November 15, 2018. At the hearing, an attorney appears for Borrower and requests thirty days to respond to the complaint, which the court allows.
On December 15, 2018, Borrower moves to dismiss the complaint, alleging that Trust lacks standing despite having attached a copy of the blank-indorsed note to its complaint. She obtains a hearing for her motion to dismiss on January 15, 2019. The trial court denies the borrower’s motion to dismiss without briefing, and it gives her another thirty days to answer the complaint. On February 15, 2019, Borrower files her answer and affirmative defenses, alleging for the first time that Trust failed to comply with HUD’s face-to-face meeting requirements. On March 1, 2019, Trust files its reply to the affirmative defenses.
On March 15, 2019, Borrower serves written discovery on Trust. After Trust responds to the written discovery, Borrower sends a notice to depose Trust’s corporate representative. She schedules the deposition for June 1, 2019. Shortly after the deposition, on June 8, 2019, Trust moves for summary judgment. Trust provides copies of the face-to-face letter Bank’s servicer initially sent to Borrower along with the account notes from Bank’s servicer indicating that it sent letters by certified and regular mail. It also provides the account notes from Bank’s servicer describing the field visit. The court sets the motion for presentment on July 1, 2019.
At the hearing, the court enters a briefing schedule giving Borrower twenty-eight days to respond and giving Trust fourteen days to reply. It sets a hearing on the motion for September 1, 2019. Borrower responds by alleging that she only received a copy of the face-to-face letter by regular mail and not certified mail, and she attaches a copy of the letter she received by regular mail to her response. On September 1, 2019, the court enters summary judgment in Trust’s favor and grants Trust’s judgment of foreclosure giving Borrower three months to redeem.
Borrower fails to redeem, and Trust schedules a foreclosure sale for December 15, 2019. After the sale, Trust moves to approve the sale, and it receives a hearing date for its motion on January 7, 2020. The court enters a briefing schedule on the motion giving Borrower twenty-eight days to respond and giving Trust fourteen days to reply. It sets a hearing date for March 1, 2020. Borrower does not file a response to the motion, and on March 1, 2020, the court enters the order approving sale.
On March 30, 2020, Borrower files a notice of appeal challenging the trial court’s ruling. After briefing and oral arguments, the appellate court finds that the question of whether Bank’s servicer sent the letter by certified mail constitutes a material issue of fact. On January 15, 2021, over three and a half years after Borrower’s initial payment default, the appellate court reverses the trial court’s judgment and remands for further proceedings.
Applying Olivera to this hardly unrealistic timeline, Trust would face a decision after the appellate court’s ruling. It could continue to litigate whether Bank’s servicer sent the face-to-face letter by certified mail, or it could cut its losses and forgive three and a half years of missed payments — amounting to $42,475.50 of combined principal and interest — to bring the loan current. Importantly, Trust must base this decision not on a definitive ruling that Bank’s servicer failed to comply, but instead on the chance that Trust may not be able to prove Bank’s servicer complied — a prospect that only first arose as a realistic possibility over three years after Borrower’s first payment default.
The Olivera court agreed “to an extent” that this result, i.e. “requir[ing] a lender to forgive potentially years of missed payments,” was “unjust.” Nevertheless, the court pushed forward, deeming the openly recognized injustice of its holding mitigated because it “simply incentivizes lenders to follow the rules or quickly cure any violation thereof.” So when should either Bank or Trust in this hypothetical have “quickly cured” the alleged possible violation of HUD’s face-to-face meeting rules by bringing the loan current under Olivera?
Should Bank have brought the loan current after its servicer fully complied with the regulation, while the servicer was negotiating a loan modification with Borrower in response to its HUD face-to-face letter? Should Bank have brought the loan current after it approved Borrower for a trial loan modification? Should Trust have brought the loan current when Borrower defaulted on the trial loan modification, or after it determined Borrower could not qualify for a new modification? Should Trust have brought the loan current after it filed its foreclosure, or after Borrower moved to dismiss the foreclosure complaint on grounds the trial court rejected without briefing? Or should Trust have brought the loan current after Borrower filed her affirmative defenses, or when the trial court ruled in Trust’s favor on the face-to-face issue, or after the trial court confirmed the foreclosure sale, or after the parties finished briefing the appeal, or after the appellate court conducted oral arguments?
Of course, it would not have made sense for either Bank or Trust to “quickly cure” its alleged violation and bring the loan current at any of those points. Bank never had any indication that its servicer failed to comply with HUD’s face-to-face requirement. Indeed, its servicer did comply. The only question is whether Trust — who later purchased the loan — can prove Bank’s servicer complied. Moreover, the first indication Trust had that a court may not accept the prior servicer’s notes alone as proof of certified mailing occurred when the appellate court reversed the trial court’s summary judgment order, and even then Trust still had no definitive reason to believe Bank’s servicer failed to comply with HUD regulations, or even that Trust necessarily could not ultimately prove full compliance. The problem facing Trust is that it now risks having to forgive more principal and interest for every month that goes by while it waits to see what evidence the trial court, and then the appellate court, will accept as proof of compliance.
Yet over three and a half years passed between Borrower’s first payment default and the appellate court’s ruling. Bringing the loan current in accordance with Olivera’s new strict compliance standard would involve forgiving over $40,000 in principal and interest. Trust must therefore decide whether to risk having to forgive even more principal and interest for the possible benefit of not having to forgive any principal and interest at all if it can prove the prior servicer’s compliance — all despite Bank and Trust’s extensive efforts to negotiate a loan modification in good faith, and despite Trust moving as quickly as reasonably possible to finish the foreclosure once it became clear that continued loss mitigation efforts would not bear fruit. Illinois courts should not interpret HUD regulations to compel such an impractical and absurd result.
Adverse and Unintended Consequences for Borrowers
Importantly, applying the Olivera opinion to real-world fact patterns may also cause adverse and unintended consequences for borrowers. Initially, forgiving over $40,000 in principal and interest in accordance with Olivera could create tax consequences for borrowers that the Olivera court may not have considered. As other courts have recognized, Congress created the FHA-insured mortgage loan program to help low to moderate income borrowers obtain financing from reputable lenders. Potentially imputing a significant amount of additional taxable income on low to moderate income borrowers could significantly affect their tax liability, possibly cutting into — or altogether wiping out — tax refunds that many families rely on as part of their yearly income.
The lender could avoid this negative result for borrowers by instead moving up the next payment’s due date, rather than forgiving missed payments outright. Consider Appendix No. 2’s modified amortization schedule for the hypothetical above. In the hypothetical, Borrower first defaulted on her July 1, 2017, payment. Instead of forgiving over $40,000 in principal and interest, Trust could alternatively move the due date for that payment up to January 1, 2021, which would return Borrower to the position of not having missed three full monthly installments without resulting in a huge potential increase in Borrower’s taxable income. However, that would then create either a balloon payment of $39,684.87 when the loan matured after Borrower’s July 1, 2042, payment, or Trust would have to reamortize and increase the remaining payments to allow Borrower to pay the full balance by the maturity date. The lender likely could not take either of these actions without the borrower’s agreement.
Notably, the parties’ mortgage contract does not expressly contemplate any of these scenarios, including Olivera’s requirement that lenders forgive monthly payments, which only highlights the problems with applying Olivera to real-world fact patterns. The ruling effectively forces the parties to rewrite their contractual obligations to adjust for the court’s desire to mandate strict compliance with HUD regulations that are not expressly included in the contracts themselves. And this is all despite HUD having specified that it never intended for courts to treat regulations that do not specifically state they are a prerequisite to acceleration or foreclosure, such as the face-to-face meeting requirement, as a bar to foreclosure.
Alternatively, the lender could also choose not to forgive significant portions of principal and interest and simply leave the entire loan balance as a mortgage lien against the property without foreclosing. At most, reading the mortgage contract together with HUD’s regulations only prevents the lender from accelerating the loan balance and foreclosing for payment defaults. The lender’s failure to strictly comply with HUD’s face-to-face meeting requirements would not invalidate the mortgage against the property, or prevent foreclosure for non-payment defaults. Rather, the mortgage would remain, continuing to accrue interest and late charges (among other fees), and preventing the borrower from selling the property. In other words, to purportedly protect borrowers “faced with the immediate problem of” foreclosure, Olivera creates a scenario where borrowers could instead face the long-term problem of being stuck in a house they cannot sell, encumbered by ever-increasing debt they cannot repay or refinance.
Relatedly, Olivera’s impact on the borrower’s ability to sell the property also runs counter to Illinois courts’ longstanding recognition that “law and public policy favor the free alienability and transferability of property.” The Second District in other contexts has described analytical approaches that leave the lender “without any remedy unless and until the property was sold or transferred” as an “unreasonable and unjust result” that would “reward” the borrower for “defaulting every month” for an extended period of time. Thus, when applied to real-world fact patterns, Olivera creates an unreasonable and unjust result for lenders that rewards borrowers in the short term for continuing to ignore their payment obligations while harming borrowers in the long term by locking them into property ownership without any ability to sell the property, build equity in the property, or otherwise enjoy the attendant financial benefits.
Further, Illinois courts treat mortgage loans as installment contracts. “The general rule is that where a money obligation is payable in installments, a separate cause of action arises on each installment and the statute of limitations begins to run against each installment as it becomes due.” Also: “the party entitled to payments may bring separate actions on each installment as it becomes due or wait until several installments are due and then sue for all such installments in one cause of action.” Thus, even if HUD’s regulations prevent acceleration and foreclosure under Olivera’s strict compliance standard, the lender could obtain separate judgments against the borrower for each missed installment payment or sue for multiple missed installments at once.
In fact, the lender in the hypothetical above could presumably dismiss its foreclosure after the appellate court’s adverse ruling, accept Olivera’s premise that its alleged failure to comply with the regulation prevented it from properly accelerating the loan, sue on three and a half years of missed unaccelerated installment payments, and then record and foreclose a judgment lien for its judgment on those missed payments. At that point, the lender’s mortgage would take priority over its separate judgment lien, and the lender could recover the full amount due under its senior mortgage from the proceeds of its judgment lien foreclosure sale.
Simply put, Olivera does not protect borrowers “faced with the immediate problem of the foreclosure action,” as the court seems to have wanted to do.Instead, the opinion subjects borrowers to a host of unforeseen adverse and unintended consequences with unpredictable outcomes, from increased tax burdens to defending alternate legal actions. Other appellate districts in Illinois should not follow Olivera down this path.
Olivera creates a new strict compliance standard for interpreting HUD’s face-to-face meeting requirement by reading non-existent terms into the mortgage loan documents. Yet HUD itself specified that it did not intend for regulations not expressly stated as prerequisites for acceleration to bar foreclosure, and the Second District’s contrary ruling creates impractical and absurd results that could ultimately harm borrowers. Illinois practitioners should challenge Olivera as needed to prevent it from becoming commonly accepted practice, and other Illinois courts should decline to follow the opinion’s ill-considered analysis.
Appendix No. 1
Amortization schedule showing monthly amounts due on hypothetical loan described in the text.
Appendix No. 2
Modified amortization schedule showing monthly amounts due on hypothetical loan described in the text.