The CARES Act Offers Homeowners the Option of Forbearance
Best intentions frequently have unintended consequences. The CARES Act is the third of four pieces of legislation passed thus far, to mitigate the economic impact of COVID-19. It has a forbearance provision designed to help homeowners to stay in their homes. Under this provision, borrowers with federally insured mortgages automatically qualify for forbearance if they face economic hardships due the pandemic. Therefore, they may elect to defer their mortgage payments for up to a year. Also, to protect the credit of homeowners who request forbearance, lenders will continue to report their mortgages as current.
Impact of Forbearance on Mortgage Servicers
An important issue not addressed by the CARES Act is the impact of forbearance on mortgage servicers. Most such entities have contracts with mortgage investors which require them to continue to make payments. This provision is independent of whether they are receiving payments from borrowers or not. At last count, approximately 8.8% of all mortgage borrowers are now in forbearance, creating serious problems for servicers.
In the past, banks serviced most federally guaranteed mortgage loans. Fortunately, these financial institutions have a business model that includes many sources of cash flow. Among them are bank accounts, certificates of deposit, investments and borrowings from the Federal Reserve. While forbearance can put a strain of a bank’s balance sheet, these sources can provide the funds needed to keep payments to investors current. But today’s mortgage loan market has evolved. As a result, non-bank entities like Quicken Loans now service nearly 86% of such loans.
However, these mortgage lenders are not subject to the same liquidity and reserve requirements as banks. Further, they do not have similar cash flow options available. Therefore, they are less prepared to handle the dilemma created by the forbearance provision of the CARES Act. Since unemployment is continuing to rise, many more borrowers are likely to request forbearance of their loan payments in the coming months. Therefore, non-bank lenders find themselves in a precarious position. Since they do not have sufficient capital reserves, most will be unable to meet their contractual obligations to investors in this environment.
Governmental Agencies Take Action To Help Mortgage Servicers
The Federal Reserve is taking steps to ease this crisis by purchasing large amounts of mortgage based securities. GNMA has also stepped up and created an emergency facility from which servicers can draw funds. Realizing that these steps will not be enough, a bipartisan group of legislators has also implored secretary Mnuchin to intervene to defuse this crisis. Finally, various industry groups have lobbied for the creation of a larger liquidity fund for servicers to draw from.
Other government agencies have been less willing to help. They have argued that servicers unable to handle the burden created by Congress should be allowed to fold since it is likely that larger, better funded companies would step in to take over their loan portfolios. But this reasoning seems counter intuitive. Why would a large lender want to take responsibility for a portfolio of non performing loans? These are exactly the kinds of loans mortgage servicers generally wish to avoid.
The Potential Impact on the Mortgage Industry
What would the impact on the mortgage industry be if our government fails to rescue mortgage servicers? Firstly, it is hard to imagine that a liquidity facility sufficient to protect mortgage loan servicers will not be created. Clearly, the current state of affairs was a result of the unintended consequences of an act of Congress. Therefore, it would be blatantly unfair to allow the victim to drown. Certainly, legislators may believe it would serve our economy best if they enact liquidity and reserve requirements for non-bank lenders as well. However, the right time to address that issue would be after the pandemic and its deleterious impact are behind us.
If nothing is done, many lenders and servicers will fail. That would stress the mortgage market and make loans much more difficult to obtain. However, allowing another negative force to effect our economy at this time is not rational. After all, the pandemic is already impacting the world economy in ways not seen since the Great Depression. I sincerely hope and expect that government agencies will opt for a wiser course of action.
Effects of Forbearance on the Credit of Borrowers
One final thought. Lenders and servicers are complying with the requirement that they maintain the “current” status for loans under forbearance. However, many are taking advantage of a loophole and flagging loans with a “current, but in forbearance” classification. Some believe that this “crimson letter” will make it more difficult for borrowers in forbearance to obtain new mortgage loans in the future. This is contrary to the intent of the legislation, but most expect the impact to effect borrowers for only one year after a forbearance ends.
On the other hand, federal guarantors have acted to protect borrowers. They have dictated that after the forbearance period is over, no lump some payments will be required. Instead, accrued interest will be added to the loan balance and the amortization period will be extended. As a result, homeowners will not face higher monthly payments either. This directive ensures that as many people as possible will be able to hold on to their homes.
Stay positive and have confidence. This too shall pass.
Andrew Kruglanski, Broker