A federal appeals court has overturned a lower court decision that the Department of Housing and Urban Development was in contempt of a judge's order to reprocess the applications of more than 35,000 homeowners denied help when they faced foreclosure on their homes.

The appeals court ruled that HUD did not violate an "unequivocal command" in a 1979 decree requiring the agency to aid certain low-income homeowners who defaulted on mortgages, as a Chicago district court judge ruled in March 1985. The department may have violated other sections of the decree, however, by changing policy for deciding how the foreclosure aid should be applied after the 1979 settlement was reached, the appeals court said last week.

The case was sent back to the Chicago court for a new hearing before a different judge.

The lawsuit was filed in 1973 by a group of homeowners denied aid under a federal program that permits owners who default on HUD-insured loans to ask for help in keeping their homes. Under the program, HUD will take over mortgages and work out new payment plans if owners are unable to make payments because of circumstances beyond their control, such as loss of a job. A settlement in the case was reached in 1976, but the borrowers went back to court in 1979, and again in 1983 and 1984, claiming that HUD had not complied with the terms of the settlement.

District Court Judge Hubert L. Will agreed with them in a March 1985 contempt citation against HUD, ruling that the agency improperly applied new eligibility criteria in denying help to homeowners between Jan. 1, 1980, and July 11, 1983.

Will followed up last June with orders to HUD to begin notifying homeowners within 60 days that they might be eligible for assistance. He prescribed ways in which the agency was to notify the former owners, and to return their homes or pay other compensation. The appeals court also threw out these orders.