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December 4, 2013

Best Practices: Insuring and Rating Mortgage Modifications Under Florida’s SBA 504 Closing Pilot Program

by Victor A. Diaz

In March 1999, the SBA created the Florida 504 Closing Pilot Program (the “Pilot”), “[f]or the purpose of relieving 504 borrowers from unnecessary duplication of costs.” SBA Procedural Notice 5000-597. Available only in Florida, the goal of the Pilot is to reduce recording fees and related title insurance premiums associated with recording lien instruments on the 504 Project by allowing the assignment by the interim lender of their security instruments and corresponding loan title insurance policies to the CDC and ultimately the SBA. Although the Pilot has been in place for sometime, title insurance underwriters are revisiting how to rate and calculate premiums being charged for the assignments being insured.

By way of background, the borrower in a typical 504 Project incurs title insurance costs twice: first, in connection with insuring the lien instruments securing the Permanent and Interim Loans; and second, when insuring the lien instruments securing the 504 debenture. In Florida, for example, the promulgated premium for the permanent and interim mortgage title insurance policies in a typical 504 project are calculated at the original rate of $5.75 per thousand for the first $100,000, plus $5.00 per thousand for the next $100,000 to $1 million, plus $2.50 per thousand for the next $1 million and up to $5 million. Rules 69O-186.003 and 69O-186.005 (13), Fla. Admin. Code. Allowing assignment of the loan title insurance policy was seen as a way to avoid the duplication of these premiums.

Until recently, CDCs in Florida would request the title insurance company insuring the interim mortgage to issue the title insurance commitment in the amount of the debenture and would ask for the mortgagee clause to include the lender’s “successors and/or assigns as their interest may appear.” When it came time to close the 504 debenture, the CDC would simply request an endorsement to the policy naming the CDC and ultimately to the SBA, or would rely on the mortgagee clause of the mortgagee policy to be deemed insured. Routinely, title insurance companies would issue the assignment endorsement charging a minimum premium.

Loan documents mandated by the SBA Pilot include an Assignment of Note and Mortgage and Modification Agreement, a Renewal Note in the amount of the debenture and an Assignment of Assignment of Note and Mortgage. These documents place burdens on borrowers which may inadvertently impact the priority of lien instruments and result in higher than anticipated title insurance premiums. At the heart of the query is whether the required mortgage modification results in a “novation” for purposes of insuring the lien priority of the assigned mortgage, particularly in light of the existence of intervening liens or interest holders recorded after the original mortgage but prior to the modification.

“Modifications that place additional burdens on the borrower, increase the likelihood of default, and/or prejudice the rights of third parties are likely to be viewed as novations with respect to the interests recorded after the original mortgage but prior to the subject modification.” The Fund Concept, Vol. 43, Page 76, August 2011, Florida Edition. Factors considered by Florida courts in determining whether a novation has occurred are whether the modification includes a future advance, changes in interest rate, or the addition of prepayment penalties. Id. Title insurance underwriters in Florida are reviewing loan modifications on a case by case basis to determine if the modification “in its totality is prejudicial in terms of the ability of the debtor/borrower to pay other creditors.” Id.

All mortgage modifications under the Pilot include, at a minimum: (i) a future advance to increase the interim note and mortgage to the debenture amount; (ii) an extension of maturity date to coincide with the term of the debenture; (iii) potential changes in interest rate; and (iv) mandatory prepayment penalties. Consequently, taken in their totality, these changes could constitute a novation with respect to interests recorded after the original mortgage but prior to the subject modification. If deemed a novation, the premium for insuring the modification would be calculated under the substitution loan rate equal to 30 percent of the original rate. Rules 69O-186.003 and 69O-186.005 (13), Fla. Admin. Code.

In large construction projects or in projects where there is junior financing and where there are likely to be intervening liens or interest holders recorded after the original mortgage but prior to the modification, the best practice is to obtain the commitment to endorse the loan policy increasing the amount insured to the debenture amount following completion of construction and just prior to debenture funding. By so doing, the CDC and SBA will have the benefit of the endorsed policy with payment of the appropriate premium without the risk of the title underwriter deeming the mortgage modification a novation and declining coverage at a future date. For any further questions, please contact Victor, at 407-667-8811 or by email at vdiaz@starfieldsmith.com.