During the COVID-19 pandemic, federal agencies—including the Federal Housing Administration (FHA), the Veterans Administration (VA), and Fannie Mae, Freddie Mac, and Ginnie Mae (the government-sponsored enterprises, or GSEs)—offered mortgage borrowers who were experiencing financial difficulties forbearance for 12 to 18 months. Borrowers exiting forbearance could access a waterfall of options to ease the resumption of payments. The borrower could

• repay the funds immediately if able,
• make higher payments for a limited period,
• defer the missed payments to the end of the mortgage, or
• reduce payments through a mortgage modification.

If the borrower couldn’t qualify for any of the loss mitigation options, the agency would refer the mortgage for foreclosure or a foreclosure alternative.

With pandemic-era emergency powers and funding ending, the GSEs and the FHA have made versions of this waterfall strategy permanent, but the VA is struggling to put together a loss mitigation package within its existing authority. The VA has proposed an alternative—the VA Servicing Purchase (VASP) program—but this option is imperfect and came under fire at a recent House hearing. But the program is the best that can be done with the agency’s limited authority.

Policymakers who want to support veterans and active-duty service members who run into payment difficulties should consider providing the VA the tools (through legislative action) and the funding to sustain a loss mitigation program on par with the GSEs and the FHA.

The differences in federal loss mitigation strategies

The GSEs and FHA were able to apply lessons from the pandemic to improve their loss mitigation programs, but the VA faces statutory obstacles to doing the same. The GSEs have the flexibility to execute the pandemic-era waterfall easily because they maintain a portfolio. The GSEs buy mortgages out of securitized pools, place them in their portfolio, and then decide what path preserves the borrower’s ability to remain in the home and minimizes their losses.

The FHA also has the latitude to use up to 30 percent of the mortgage amount for loss mitigation. This “partial claim” authority, in conjunction with low interest rates, allowed FHA borrowers to access a very similar waterfall to GSE borrowers during the pandemic and continuing through April 30, 2025.

The partial claim covers arrearages, which allows the borrower to defer payments. After covering the arrearages, the remaining balance on the partial claim can be used to further lower payments. But the FHA doesn’t have a portfolio, so when the lender pulls the loan out of the pool to affect a mortgage modification, they must offer the borrower the prevailing market interest rate. As rates rose, it became more difficult to give borrowers a sizable payment reduction. The FHA resolved this issue through its Payment Supplement loss mitigation program, which keeps the loan in the pool, allowing the borrower to keep their original interest rate if it’s lower than the market rate and using the remaining partial claim after arrearages to subsidize the mortgage payment for three years.

The VA has even fewer tools than the FHA. Established in 1944, the VA mortgage program was designed as a guarantee product, which would protect lenders for a portion of the losses on the home if a borrower defaulted. The VA was not supposed to play a major role in managing the loan.

Although the VA has historically not had partial claim authority, it acquired funds to allow for this flexibility during the pandemic, but those funds expired in October 2022. Because the VA also doesn’t have a portfolio, its COVID-19 Refund Modification program, like the FHA’s, relied on lowering a borrower’s interest rate. But as interest rates have risen, it has become more difficult to give the borrower a modification. Currently, VA borrowers do not have a deferral option (which would allow them to hold payments constant) or a modification option that works in a high-rate environment. On November 17, 2023, the VA extended its COVID-19 Refund Modification program until May 2024 and has asked servicers to not foreclose on any borrower, hoping to create a more permanent solution.

Analyzing the VA’s proposed loss mitigation plan

The VA has a plan, VASP, in which it will purchase the defaulted loans from the servicer and lower the interest rate to 2.5 percent, subject to the borrower receiving at least a 20 percent payment reduction. If lowering the interest rate to 2.5 percent does not meet the 20 percent reduction requirement, the VA will lengthen the loan term to 40 years. This plan would allow veterans and active-duty members to benefit from a home retention program that is more generous than the one the GSEs offer.

This plan has two major weaknesses. First, program costs may increase by offering a one-size-fits-all approach. Without a deferral option, borrowers who need relief but with the ability to resume their original payments will be provided the more generous payment reduction option, which could increase the number of borrowers who elect loss mitigation and the costs of providing it. Second, all loans the VA acquires must be transferred to a single VA servicer, who could have capacity issues, which would both delay and increase the likelihood of lending errors to veterans and active-duty members.

A more satisfactory loss mitigation waterfall would require the VA to receive congressional approval and an appropriation for a program similar to the FHA’s. But any program must be cognizant of the differences between the government guarantors. Unlike for FHA mortgages, where the FHA is responsible for 100 percent of the loss, the VA covers only the first 25 percent of the loan amount. Programs can’t count the amount covered in forbearance options toward the 25 percent cap because it will leave servicers vulnerable to losses.

As policymakers consider further loss mitigation options, the VASP—while imperfect—can offer veterans and active-duty service members loss mitigation at least as generous as GSE and FHA alternatives.