Are Mortgage Servicers Ready for the Loan Mod Rush?

On May 4, the CFPB issued a report sharing information the agency had gathered about mortgage forbearances and delinquencies. One notable takeaway is that Black and Brown homeowners, as well as low-income homeowners, are very prevalent among those in forbearance. A large portion of those in forbearance also have loan to value ratios north of 60%. All of this suggests that many who face chronic financial struggles and are most at risk of losing their homes, are also those currently benefiting from the forbearance programs. 

This makes me immediately think: what happens when the forbearance periods are over? (which most believe will happen between September and November of this year) Specifically: what will their loan modifications look like?

In looking for the answer to these questions, there are two things that are notable and, I think, positive. First, unlike the post-2008 crisis, there won’t be a large amount of subprime, private label loans in default. Today the mortgage market is almost completely dominated by the federal government mortgage agencies, with only a small portion of mortgage loans being portfolio-held.

Second, the federal mortgage giants have instructed their servicers to offer a menu of pre-designed loan modification packages. As of this writing, the VA, USDA, FHA, Fannie Mae, and Freddie Mac have all issued loan mod guidance for mortgage servicers to work through with borrowers.  For example, Freddie and Fannie’s primary loan modification plan is the COVID-19 Deferral Program. With this plan, if the homeowner is financially able to resume normal monthly payments, then up to a year’s worth of missed payments will simply be added as a zero-interest lump sum payment due at the time the loan is to be paid off. 

Fannie and Freddie are also offering the Flex Modification, which is designed for homeowners who decline the COVID-19 Deferral Plan and for those who are otherwise is ineligible. Under this flex plan (which is similar to the HAMP program of the Obama era), the homeowner goes through a three-month trial period where the loan is temporary modified. These modifications can include capitalizing the missed interest and escrow payments, lowering the interest rate, extending the loan term, and lowering the amount of principal on which interest accrues. 

The FHA will also offer its own menu of waterfall-like modification options: the COVID-19 Standalone Partial Claim (will give the homeowner a zero-interest second mortgage loan payable at the end of the loan term); the COVID-19 Owner-Occupant Loan Modification (missed payments will be capitalized into the principal and the term will be extended); the COVID-19 Owner-Occupant Loan Modification (a combination of the partial claim second mortgage and the owner-occupant capitalization of arrears and term extension); and the COVID-19 FHA-HAMP Combination Loan Modification and Partial Claim with Reduced Documentation (similar to the prior plan except there will be no trial period and the eligibility documentation burdens will be reduced). 

One thing common to all of these agencies, however, is that the guidelines they are issuing to servicers for use in determining which of these menu items to offer or grant a homeowner are quite complicated. Servicers have to walk through various matrices and make crucial decisions based on what can be very confusing conversations with borrowers. This complexity could significantly undercut the positive effects of these streamlined servicing guidelines for handling modifications. Making matters worse, homeowners are rarely represented by counsel or other professionals in these loan mod negotiations. Without representation, there is a real concern that individuals may agree to something that they do not sufficiently understand. 

The other problem is with the servicing staff. As I’ve written about before, the mortgage loan servicing market has shifted significantly from banks to nonbanks. In 2019, about 48% of all Fannie/Freddie and Ginnie Mae mortgage loans were serviced by nonbanks. Over 2/3 of FHA loans are now serviced by nonbanks. These nonbank mortgage servicers are thinly capitalized and not subject to the same kind of capital or liquidity requirements as bank mortgage servicers. This means that they are less likely to already be (and less likely to have money on-hand to become) sufficiently staffed up to deal with a flood of loan modifications. 

Really, this speaks to an unresolved issue from the 2008 financial crisis and the law reform that followed. What to do with the nonbank or “shadow bank” sector? 

The CFPB’s recently proposed amendment to RESPA’s regulation X would force servicers to wait to foreclose (and ostensibly prepare for carefully processing loan mods) until 2022, which could help. It would give these firms some forced room to breathe and staff up. However, it will only help if servicers prepare now for what is to come and have the access to funding to do so. Let’s hope that aside from telling servicers which mods they should offer, the mortgage giants will also be monitoring their loan servicers to ensure they are financially capable of meeting their obligations. 

For much more on loan mods (in mortgages and more), keep an eye out for a forthcoming essay by Dalié Jiménez, Pamela Foohey, and yours truly later this summer!