Banking

The mounting costs of protracted mortgage forbearance

Banks and mortgage servicers have been expecting an avalanche of requests for loan modifications when federal mortgage forebearance rules were announced last year. But the further out the deadline gets, the bigger the writedowns that banks and servicers will have to swallow.

The FHFA’s decision last month to further extend forbearance relief until September 2021 — giving borrowers with federally-insured loans a total of 18 months’ reprieve on mortgage payments — has scrambled the response by mortgage servicers. Extending forbearance also has upended the calculus of losses for investors and further exacerbated racial disparities.

“We were budgeting for these loans coming out of forbearance in September 2020, then December 2020, and now it’s March 2021 and we keep moving the date out,” said Tom Millon, CEO of Computershare Loan Services, a third-party mortgage servicer. “It’s not going to be a small task to modify these borrowers.”

Servicers say it is unclear how many of the roughly 2.7 million borrowers currently in forbearance will be able to resume making mortgage payments once the pandemic is over.

The forbearance extension is helping many low-income and minority borrowers with loans backed by the Federal Housing Administration. But it is hitting nonbank mortgage servicers particularly hard since they must continue making payments on behalf of the borrowers for a longer period of time.

“Servicers are just swamped,” said Scott Buchta, head of fixed-income strategy at Brean Capital. “It’s very time-intensive to service non-performing loans, and nobody was staffed to handle this level of delinquencies. The forbearance extension will continue to have a significant impact on nonbank servicers.”

Congressional relief allows borrowers in forbearance plans to defer mortgage payments, without added fees, typically by extending a loan’s terms and tacking the missed payments on to the end of the loan. Borrowers with FHA loans had to be in forbearance before June 2020 to get an additional three months’ extension.

The hope is that borrowers who have lost their jobs will return to work and resume making mortgage payments. But many borrowers currently in forbearance will need loan modifications that reduce principal and interest by between 20% to 30% to be successful, experts said.

“The big question is how are all these servicers going to handle all of these requests? What are they going to do?” said Larry Cordell, senior vice president of risk assessment, data analysis, and research at the Federal Reserve Bank of Philadelphia.

The Philadelphia Fed estimated in a recent study that payment reductions of 20% to 30% would cost between $11 billion and $33 billion for all borrowers currently in forbearance. Investors would bear significant costs from interest rate reductions and principal deferrals that lead to lost interest income, the study found.

But those calculations are a worst-case scenario — some borrowers at least will resume making payments. The last financial crisis prepared most servicers for long-range solutions to keep borrowers in their homes and out of foreclosure. Moreover, unlike the 2008 housing crisis, most borrowers have substantial equity and could sell their homes into an incredibly strong housing market to cover the missed payments.

“If borrowers can get their jobs back and their incomes recover, it’s a much better situation for the borrower to deal with,” Cordell said.

Roughly 18% of loans currently in forbearance plans could become current simply by adding payments to the end of the loan, the Fed study found.

“It may be as simple as the borrower missed a year’s worth of payments and then— boom! — put that at the end of the term of the loan. That’s the easy way to do it,” Millon said.

The big concern is that roughly 80% of loans in forbearance would need an interest rate reduction to make the payment affordable while another 2% would need a combination of term extension, interest-rate reduction and principal deferral, the Fed found.

The off-ramp from forbearance can be further complicated depending on the types of loans coming out of forbearance. Fannie and Freddie allow a homeowner to refinance if three consecutive payments are made after exiting forbearance — loans held by private mortgage-backed security investors or held on a bank balance sheet may not be so easy to refinance.

“For those who lost their jobs, refinancing is just not an option for them. So getting forbearance is absolutely better than falling into delinquency,” said Xudong An, assistant vice president of supervision, regulation, and credit at the Philadelphia Federal Reserve Bank.

FHA servicers hit hard

When a borrower stops making mortgage payments, their servicer is contractually obligated to advance principal and interest payments to investors on their behalf. Servicers maintain reserves to cover these advances for loans backed by Fannie Mae, Freddie Mac, or Ginnie Mae. Ginnie guarantees timely payments to investors on loans backed by the FHA, U.S. Department of Veterans Affairs, U.S. Department of Agriculture’s Rural Housing Program and Public and Indian Housing that primarily support low- and moderate-income homeowners.

Nonbank servicers currently dominate the market for FHA and VA loans. That’s a problem, because Ginnie does not directly reimburse servicers for advances when a loan goes delinquent. Instead, the servicer has to buy the loan out of the securitized pool to stop paying the advances, which requires even more cash.

This year, many nonbanks — including Lakeview Loan Servicing and PennyMac Corp. — have ramped up purchases of delinquent FHA loans, following in the footsteps of banks like Wells Fargo and U.S. Bank, who began buying distressed mortgages last year.

Banks were on the forefront of purchasing loans out of Ginnie pools once the loans were 90 days delinquent, an approach banks like Wells have taken for the past several years and throughout the pandemic.

“Nonbanks are opportunistically buying out loans so when a borrower comes to the end of the forbearance period, they can get the borrower reperforming with a refi, a loan modification and re-securitize the loan at a profit,” said Buchta. “The challenge is going to be, what they do about those borrowers that haven’t made a mortgage payment for 18 months, and how do they get them back on track?”

In February, Lakeview, a third-party servicer based in Coral Gables, Fla., purchased $1.9 billion in delinquent FHA loans from Ginnie pools, bringing down its total balance of delinquent FHA loans to $17.9 billion, according to Ginnie data from Brean Capital. The buyouts include VA, USDA and PIH loans as well.

PennyMac, a large mortgage lender and servicer in Westlake Village, Calif., bought $1.2 billion of delinquent loans in February that were 90 days past due, bringing its total balance of delinquent loans to $17.5 billion, according to Brean.

Over the past six months, Lakeview and Pennymac have bought approximately $15 billion and $9 billion delinquent loans out of Ginnie pools, respectively.

Many servicers credit the Department of Housing and Urban Development for creating a wider range of options that aid both distressed borrowers and servicers. Once a borrower exits forbearance, the servicer can offer a so-called streamlined loan modification, streamlined refinance or a partial claim, in which the servicer gets reimbursed for missed payments by submitting a claim to HUD.

Servicers generally could only submit an insurance claim to HUD after foreclosing on a borrower and realizing a loss on the liquidation of the property. Now, HUD allows servicers to recapture their advances once the borrower can resume making their old monthly payments. Disaster-related partial claims were first introduced after hurricanes hit Texas, Florida and Puerto Rico in 2017.

Servicers with loans backed by Fannie and Freddie are not as impacted by the forbearance extensions because they only have to advance four months of interest, with the government-sponsored enterprises picking up the tab thereafter.

When the pandemic first hit a year in March 2020, many borrowers went into a forbearance and then realized they couldn’t refinance. Some continued paying while in forbearance. The Philly Fed estimated that seven million loans were placed into forbearance during the last eight months of 2020.

Low-income and minority households took up forbearances at significantly higher rates. While that helps with payment difficulties, the Philly Fed found that the pandemic has significantly worsened racial and income disparities in the mortgage market.

“Pre-pandemic there were very few racial and income disparities in terms of mortgage performance and what happened was the pandemic really exacerbated this whole thing,” said Cordell.

But while forebearance is posing difficulties for servicers and banks, it’s better than the alternative, An said. The Philadelphia Fed’s paper estimated that more than 2.5 million borrowers that did not take advantage of forbearances right away became delinquent. Some of those 2.5 million applied for forbearance later, but they could have avoided any delinquency by doing so sooner.

Some borrowers didn’t take forbearance because they didn’t understand it well, and some thought they had to pay back all of the missed payments at once, which is a misunderstanding,” said An. “Foreclosure is a painful and costly process, and my hope is that over time more people will realize forbearance is an option.”



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