Millions of mortgages in the U.S. remain in forbearance and, even though the numbers are declining, the prospects for many homeowners continue to be bleak. To prevent a housing collapse, originators and servicers should work together to refinance as many of these borrowers as possible. Without doing so, the results could be catastrophic for homeowners, the nation’s economy and the mortgage industry.
COVID-19 hit the U.S. economy harder and faster than the 2008 housing crisis. From April 2007 to October 2009, unemployment rose from 4.5% to 10%. At the outset of the pandemic, unemployment soared from 3.5% to 14.7% in only a few weeks, forcing more than 36 million people to file jobless claims.
Across the mortgage industry, the pandemic hit both the origination and the servicing sides. Simply capturing the more than 4 million mortgage forbearance requests nearly broke many servicers’ call centers, while the Coronavirus Aid, Relief and Economic Security (CARES) Act didn’t even require documentation.
This past September, the first wave of borrowers in forbearance hit the six-month mark. Although initial forbearance patterns gave hope for quick resolution, data through the latter portion of this summer suggested that it’s going to be complicated:
- After several weeks of slight declines, Ginnie Mae forbearance rates, as well as those of private-label securities and portfolio loans, actually started to flatten or even tick up slightly.
- Weekly unemployment insurance claims saw steep declines early this past summer, but the declines had flatted by September.
- Many states, including those outside of initial virus epicenters, were forced to roll back or slow down their reopening plans.
The early exits from forbearance represented the easiest cases — borrowers who took forbearance out of an abundance of caution or those who had only temporary disruptions to income. Those remaining in forbearance are more likely to require more comprehensive solutions.
Position of strength
Since the 2008 housing crisis, many servicers have developed significant expertise in completing modifications and are starting to rebuild their loss-mitigation infrastructure. Unlike 2008, however, the housing market is not the epicenter of the crisis.
Although the U.S. economy could take a turn for the worse (depending on the course of the virus, the progress toward a vaccine and federal fiscal policy), the housing market started the pandemic from a position of strength and has remained remarkably stable. At the end of 2019, 96.5% of homeowners with mortgages had positive equity. Since then, home prices appear to have increased, although this varies by location.
In a normal situation, this would offer little consolation to distressed homeowners who still want to retain their home, although it would improve opportunities to sell the home, possibly through a short sale. The current situation, however, is anything but normal.
The borrower-protection rules in the CARES Act are unprecedented. In addition to requiring no documentation for borrowers with federally backed mortgages to enter forbearance for up to 12 months, the CARES Act forbids forbearance from affecting the borrower’s credit. This has led to some surprising outcomes: In the middle of the sharpest gross domestic product downturn in decades, delinquency rates for multiple debt categories actually declined.
This covers two of the major requirements for refinancing: positive equity and no delinquencies. Add on the fact that interest rates are at historic lows and putting many people in a position to benefit from refinancing even if they are not in forbearance. The only missing ingredient then is ability to pay, which generally depends on total debt and income levels. For borrowers that recover income (or even partial income) but do not have the savings to bring their mortgage up to date, refinancing can be particularly attractive.
For example, a borrower who has owned a house for 10 years and has 20 years left on a loan with a 4% rate could sharply reduce their monthly payment. They can benefit even more if they’ve built enough equity (due to appreciation and principal payments) to reduce their rate. Consider a borrower who had an initial principal of $200,000, who would owe about $157,000 after 10 years of regular payments. If that borrower could get a rate of 3.25% on a new 30-year loan, they could lower their monthly payment and interest from $985 to $683, which could dramatically improve their ability to maintain payments.
Not only does the borrower escape forbearance and avoid delinquency, they also avoid a credit-score hit. This makes refinancing particularly attractive compared to other options such as modification.
Fortunately, servicers and originators can do a lot to mitigate risk and help borrowers succeed.
Despite the benefits, servicers need to proceed with a bit of care and diligence. First, they need to ensure the borrower is eligible, which can depend on the investor.
Federal Housing Administration loans, for example, offer a unique COVID-19 standalone partial-claim process that places missed payments into a junior lien, which is paid back when the home is sold or the loan is refinanced. The GSEs require that a borrower leaving forbearance make three timely payments on a repayment or deferral plan to qualify for refinance.
Additionally, originators need to be aware of the possibility of a refinanced borrower immediately reentering forbearance or failing to make payments. Fannie Mae, for example, will not purchase loans in forbearance with note dates after June 30, 2020.
Fortunately, servicers and originators can do a lot to mitigate risk and help borrowers succeed. Although it may seem counterintuitive, rushing borrowers to leave forbearance may be the worst thing servicers can do. With a bit of planning and coordination, however, servicers and originators can set up borrowers for success. The key is to prepare borrowers for refinancing by helping them rebuild their emergency savings prior to exiting forbearance so they can safely make three deferred payments and the first few payments after the loan is closed.
Currently, many servicers try to get borrowers out of forbearance as early as possible to mitigate expenses. As the borrower approaches 30 days before the six-month mark, the servicer may offer a list of options that includes a repayment plan, payment deferral, modification, short sale or deed in lieu (cash for keys). Refinancing is frequently not included or explained, and if a borrower accepts a modification or misses a payment while planning for a short sale, this can impair their ability to get a refinance.
Few servicers realize the mutual advantages of extending forbearance to ensure successful transition, but even those that do have difficulty communicating this to borrowers who suffer from all the psychological traits associated with debt collection: ambiguity bias, choice overload, complexity avoidance, procrastination, etc. This is when a borrower-engagement strategy becomes critical.
The aim of frequent and early borrower engagement is to build trust and give borrowers the knowledge and confidence to take action. To do this, servicers should engage early and often, before borrowers face tough decisions.
Servicers also should avoid negativity or punitive dialogue — focus on positive messages, be clear and transparent, and offer empathy whenever possible. Frequent engagement is expensive, but good tools can mitigate costs. Digital engagement can reduce costs by more than 95%, from $4 (or much more under current circumstances) to 10 cents per transaction.
A poorly implemented borrower-engagement program can result in millions of dollars in losses. The success rates of programs to address complex situations during periods of high call volumes are depressingly low.
Fannie Mae studies have shown that more than 50% of borrowers believed they had submitted complete documents for a modification program but only about 5% had actually done so. Following the 2008 crisis, average modification take-up rates were only 20% despite massive subsidies, while even the newer, streamlined modifications had take-up rates of only 29%. This past March, call-center hold times increased exponentially with long waits and dramatic increases in abandoned calls.
Fortunately, technology has advanced tremendously in the past decade. Several platforms offer cost-effective workflow systems that can rapidly integrate with servicing platforms, and some of these even extend their low-code paradigms across the entire technology ecosystem.
Such systems include a configurable content and communication platform that gives borrowers quick, easy contact with their servicers via multiple channels (email, text messages, etc.) that can be tracked and logged securely. These systems also can include online and secure document management; a tested, borrower-friendly education portal to guide them through the process and encourage them to succeed; and back-office work-queue management, rules and reporting to simplify compliance.
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Once the health crisis winds down, these capabilities will continue to pay dividends while drastically reducing overhead costs. Best-of-breed servicers can further develop these capabilities and technologies to enhance their nondelinquent servicing books by improving recapture rates, cutting baseline costs and increasing client loyalty.
Just as the servicers and originators who mastered these tools during the 2008 crisis came out stronger, those that grasp the new processes and technologies will gain both market share and profit margin in the years to come. ●