With vaccination rates rising and public health restrictions lifting around the country, the COVID National Emergency appears to be coming to an end. One more sign: President Biden is expected this week to announce a final foreclosure moratorium through the summer. The Consumer Financial Protection Bureau (CFPB) will follow with guidelines allowing servicers to initiate foreclosures as early as September.
The Administration has made clear, though, that sustainable homeownership is a key domestic policy objective. As a result, the Federal Housing Administration (FHA) and Veterans Administration (VA) are likely to establish aggressive loss mitigation requirements to support the more than a million borrowers still in forbearance.
More than 5 percent of government-insured loans are still in forbearance, and the large majority are in extended forbearance; that is, they have more than six months (and possibly more than 12 months) of mortgage payments to catch up. Certainly, with real estate prices rising in many areas, some will be able to exit forbearance through sale or refinance, but many will need substantial assistance. Borrowers with higher credit scores and incomes tended to exit forbearance early. Those that remain may be challenged to resume their prior payment, much less to catch up arrearages.
Using ‘Partial Claims’ to Resolve Arrears
Both FHA and VA have already announced loss-mitigation options (“partial claims”) that would allow servicers to effectively roll arrearages into a separate, second lien that does not require repayment until the original loan is paid off. VA borrowers can resolve all arrears with a partial claim; for FHA, the claim is limited to 12 months of payments. In either case, the borrower must be able to resume making the original mortgage payment. For borrowers who can’t manage the payment, or who have more than a year of FHA payments to catch up, additional assistance is needed.
In these cases, servicers must offer loan modifications, reducing rates or extending the mortgage term to achieve a more affordable payment, combined with partial claims to address the back payments. Many of the borrowers still in foreclosure will need this more aggressive option; however, the challenge will be to achieve a sufficient reduction in payment.
Past research has shown that for modifications to be successful over time, the mortgage payment needs to be reduced by at least 20 percent. Given that mortgage rates in the last couple of years have been at or near historic lows and have begun to rise this year, borrowers might very well be facing higher interest rates on their modified loans, making it impossible to achieve the required reduction. In the current interest rate environment, new modification options will likely be required.
A 40-Year Mortgage Term?
In talks with industry, the agencies have proposed options including subsidized interest-rate buydowns and modification to a 40-year term. Some industry stakeholders have suggested that a temporary suspension or reduction of FHA’s monthly mortgage insurance premium could also help achieve a significant payment reduction.
One more wrinkle: Ginnie Mae, the agency that pools government-backed loans into securities, does not currently accommodate 40-year loan terms. A new security type could be developed but is not likely to be available until late in the fall, and it’s not clear how such a security would be received by investors. It will be difficult for investors to accurately model the likely performance of these securities. It’s also possible that issuance of 40-year securities will drop to a minimal level once this crisis is past. These uncertainties will impact pricing assumptions, and investor appetite may be tepid.
There is no doubt that these potential options would help more borrowers retain their homes, but they make an already complex situation even more challenging for servicers. FHA, VA, CFPB, and state attorneys general have already put the industry on notice: Ensure that impacted borrowers are offered the most appropriate option to save their homes—and be able to demonstrate how that determination was made. There is much work ahead for servicers and for policy makers, and not much time to spare, as borrowers begin to exhaust the COVID-19 forbearances and extensions in September.
Need more information about post-COVID loss mitigation? Contact Stephanie Schader, Vice President, SitusAMC Residential Consulting & Advisory, at firstname.lastname@example.org.