What Principal Curtailments Mean for Your Loan
A principal curtailment is simply an extra payment that reduces your mortgage balance. Think of it as paying down your loan early, but it happens during the loan process rather than after you start making regular payments.
Say you close on a $300,000 mortgage but then make a $5,000 principal payment before your lender sells the loan to Fannie Mae. Your loan balance drops to $295,000, and your monthly payment gets recalculated based on the lower balance. This curtailment becomes part of your loan's permanent record.
The timing matters here. These curtailments must happen before your lender delivers your loan to Fannie Mae. Once Fannie Mae owns your loan, different rules apply through the servicing process.
When Lenders Apply Curtailments
Your lender might apply a curtailment for several reasons, and you don't always initiate it. The most common scenario involves fixing errors or compliance issues.
If your lender overcharged you for fees at closing, they can apply a curtailment to refund the difference. There's no dollar limit on these refunds - if they overcharged you $3,000, they can curtail the full amount to make it right.
For cash-out refinances, curtailments solve a specific problem. Limited cash-out refinances restrict how much cash you can receive at closing. If your lender accidentally gives you too much cash back, they can apply a curtailment to bring the loan into compliance.
Here's how that works: You refinance a $200,000 loan and receive $3,500 cash at closing, but the limit is $2,000. Your lender can apply a $1,500 curtailment to reduce your loan balance, effectively reducing your net cash back to the allowed $2,000. The maximum curtailment for this purpose is $2,500 or 2% of your original loan amount, whichever is less.
Voluntary Principal Payments
You can also request a curtailment by making additional principal payments. This might happen if you receive unexpected funds after closing but before loan delivery - perhaps from a bonus, gift, or asset sale.
These voluntary payments reduce both your loan balance and monthly payment. If you make a $10,000 curtailment on a $400,000 loan, your payment gets recalculated based on the new $390,000 balance. Your lender will provide a modification agreement showing the new payment amount.
The key restriction is timing. You cannot make these payments after your lender delivers the loan to Fannie Mae. The delivery typically happens within 30-60 days after closing, depending on your lender's schedule.
Required Documentation
Your lender must document every curtailment with specific paperwork. The requirements depend on when the curtailment occurs.
If the curtailment happens at closing, it must appear clearly on your settlement statement (HUD-1 or Closing Disclosure). The document should show the curtailment amount and explain its purpose.
For curtailments applied after closing but before delivery, your loan file needs more detailed documentation. This includes the curtailment amount, the reason for the payment, and the source of funds. If the curtailment changes your monthly payment, you'll receive a modification agreement reflecting the new terms.
Post-delivery curtailments for fee refunds require similar documentation, but only if the refund is $500 or less. Larger refunds must happen before delivery.
Why These Rules Exist
Fannie Mae's curtailment rules serve two main purposes: loan integrity and investor protection. When Fannie Mae purchases your loan, investors need accurate information about the loan balance and payment terms.
The pre-delivery requirement ensures that curtailments become part of the loan's permanent characteristics. If curtailments happened after delivery without proper controls, it could create confusion about the actual loan terms and balances.
The documentation requirements protect everyone involved. Clear records prevent disputes about payment amounts and ensure that any changes to loan terms are properly authorized and recorded.
Common Issues and Complications
The biggest challenge with curtailments is timing. Many borrowers don't realize they want to make extra principal payments until after their loan has been delivered to Fannie Mae. At that point, the curtailment rules no longer apply - you're making regular additional payments under standard servicing procedures.
Documentation problems can also create issues. If your lender fails to properly document a curtailment, it might cause problems during the loan delivery process or future servicing transfers.
For cash-out refinance corrections, lenders sometimes discover the excess cash-back issue late in the process. If they've already delivered the loan to Fannie Mae, they cannot use a curtailment to fix the problem and may need to repurchase the loan.
Some borrowers confuse curtailments with regular additional payments. Once you start making monthly payments on a delivered loan, extra principal payments follow different rules and don't require the same documentation or modification agreements.
What This Means for Your Loan Process
If you're considering making extra principal payments, discuss timing with your lender early in the process. They can tell you when your loan will be delivered to Fannie Mae and help you coordinate any curtailments beforehand.
For fee refunds or cash-back corrections, your lender handles the process. You'll receive documentation showing the curtailment and any changes to your loan terms. Keep these documents with your loan records.
Remember that curtailments are permanent changes to your loan. Unlike regular additional payments that you can stop at any time, a curtailment reduces your balance and payment for the life of the loan.
References
For the official guidelines, see B2-1.5-05: Principal Curtailments in the Fannie Mae Selling Guide.
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Original Fannie Mae Guideline Text
B2-1.5-05, Principal Curtailments (11/06/2024)
Overview
A principal curtailment is the application of funds used to reduce the unpaid principal balance of the mortgage loan. Fannie Mae permits certain curtailments prior to loan delivery provided the delivery data reflects the curtailment as described below.
Acceptable Curtailments
Fannie Mae permits curtailments prior to loan delivery for the following reasons:
The lender may apply a principal curtailment to refund the overpayment of fees or charges paid by the borrower, in any amount, in accordance with applicable regulatory requirements.
If the borrower receives more cash back than is permitted for limited cash-out refinances, the lender can apply a curtailment to reduce the amount of cash back to the borrower to bring the loan into compliance with the maximum cash-back requirement. The maximum amount of the curtailment cannot exceed the lesser of $2,500 or 2% of the original loan amount for the subject loan. For example, if the borrower received $3,500 cash back at closing on a loan amount of $200,000, the lender could apply a $1,500 curtailment prior to delivery to Fannie Mae. This would result in “net cash back” to the borrower of $2,000, thus meeting Fannie Mae’s limited cash-out refinance requirement.
Fannie Mae also allows additional principal payments remitted by a borrower to prepay the mortgage loan as permitted by the loan documents. This includes curtailments applied to the principal balance to reduce the monthly mortgage payment. See
Lenders must apply these curtailments prior to delivery of the loan to Fannie Mae. Such curtailments may not be held until after whole loan delivery or for application in the month subsequent to issuance of an MBS.
Fannie Mae permits a lender to apply a curtailment after loan delivery to refund the overpayment of fees or charges paid by the borrower in accordance with applicable regulatory requirements, provided the amount of the curtailment does not exceed $500. All other curtailments received after loan delivery must be applied in accordance with the Servicing Guide.
Documentation
If the curtailment is made at the time of closing, the amount must be clearly documented on the settlement statement. If the curtailment is applied after closing, but before delivery, the loan file must be documented with the amount of the curtailment and the reason or source of the curtailment (for example, lender refund or borrower-initiated), and include any modification agreement used to reduce the monthly payment following the application of the curtailment.
If the lender elects to apply a principal curtailment after delivery to refund the overpayment of fees and charges as permitted above, the loan file must be documented with the amount, reason, and source of the curtailment.
Delivery Instructions
Refer to the Loan Modifications Job Aid for the delivery of loans impacted by a curtailment applied prior to the delivery of the loan to Fannie Mae.
