By: Makenzy Mohrman, Capstone Financial Services Analyst

November 6, 2022 – Nothing in life is free, a lesson we expect the mortgage industry will learn following government intervention during the pandemic. 

At the end of March 2020, Congress signed into law the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which established guaranteed borrowers of government-insured mortgages 12 months of forbearance while the nation weathered the economic impacts of the COVID-19 pandemic. It then was extended by provisions passed under the American Rescue Plan (ARP) Act of 2021. Thanks to these measures, most borrowers were able to easily obtain a forbearance by verbally attesting to COVID-related hardship without providing detailed supporting documentation.

As of September 6, 2022, 9 million borrowers had entered into COVID-19 forbearances since March 2020. Federal agencies also established flexible loss mitigation options to help borrowers begin repaying mortgages once their forbearance programs end—including reductions in monthly payments, a loan term extension, refinance opportunities, and other customized loan adjustments. These measures gave mortgage companies—that faced the biggest wave of delinquent loans since the subprime mortgage crisis—preferred alternatives to foreclosure proceedings by keeping borrowers in their homes and making payments long term.

These measures gave mortgage companies…preferred alternatives to foreclosure proceedings by keeping borrowers in their homes and making payments long term.

Capstone expects housing regulators to incorporate “lessons learned” during the pandemic into permanent loss mitigation policies that can help keep borrowers paying and reduce costly foreclosures—a benefit to mortgage servicers. However, we also expect this to attract new levels of regulatory scrutiny to servicer practices.

In April 2021, the Consumer Financial Protection Bureau (CFPB) enshrined many of these policies into a mandatory loss mitigation waterfall under Regulation X of the Real Estate Settlement Procedures Act of 1974 (RESPA) that mortgage servicers of both private and federally insured loans were required to comply with. The CFPB made it clear through multiple public releases that mortgage servicers were expected to strictly comply with the new pandemic-related federal protections for borrowers, which would be vigorously enforced.

However, a key question continues to loom over the mortgage industry: Will the pandemic-related borrower protections help borrowers sustainably resume payments—a desirable outcome for mortgage servicers—or will the measures simply increase compliance costs as servicers prepare to handle a massive spike in costly foreclosures, as was the case following the 2008 financial crisis?

It has now been more than two and a half years since the onset of the COVID-19 pandemic, and most borrowers have exited COVID-19 forbearance plans. Of the 9 million borrowers who entered into COVID-19 forbearance since March 2020, 92% have so avoided foreclosure or redefault after loss mitigation so far with only 1% of all borrowers remaining in plans. While foreclosure starts did rise sharply to 56,000 after January 1, 2022, when the federal foreclosure moratorium ended, they dropped again shortly after to a range of 24,000 to 37,000 and continue to trail pre-pandemic levels from 2019—a year of record-low foreclosure starts. This compares favorably to the performance of loans that went through loss mitigation following the 2008 financial crisis. Of the 5.2 million loans modified under federal mortgage relief measures following the financial crisis, 45% were 60 days or more delinquent six months after loan modification. There are some notable macroeconomic factors today that are likely contributing to the differing outcomes, including lower unemployment levels and record-high home price appreciation versus the aftermath of the 2008 crisis. But the measures so far seem to be working as intended. 

Housing regulators have largely viewed their pandemic response as a success—though perhaps prematurely given the remaining population of borrowers still in forbearance—and a testament to the flexible forbearance and loss mitigation measures implemented.

But these gifts do not come without a cost for the mortgage industry. The increases to loss mitigation regulation come with increased risk to lenders and servicers of scrutiny from regulators, particularly the CFPB, which could mean more enforcement actions with costly penalties and headline risk.

The increases to loss mitigation regulation come with increased risk to lenders and servicers of scrutiny from regulators…

There is now discussion of making some of these measures permanent parts of the regulatory loss mitigation “toolkit.” At an industry conference Capstone attended on October 24^th, Federal Housing Finance Agency (FHFA) Director Sandra Thompson and Federal Housing Administration Commissioner Julia Gordon both declared that implementing permanent loss mitigation policies for struggling borrowers is a top priority. Prior to this, on September 22^nd, the CFPB issued a request for information (RFI) on ways to support automatic short-term and long-term loss mitigation for homeowners experiencing financial disruptions.

Mortgage industry advocates have flagged risks posed by the CFPB under its current director, Rohit Chopra, who has proved to be aggressive in terms of rulemaking and enforcement. At its recent annual convention, Mortgage Bankers Association CEO Bob Broeksmit spoke fiercely about the threat the CFPB poses to the industry saying its director has been acting as the “judge, jury, and executioner, all in one.”

While future reforms to loss mitigation policies remain uncertain, Capstone expects the changes will come with an increased focus on compliance and treatment of borrowers—an underappreciated risk that industry participants and stakeholders should not overlook.