Enhancing the FHA’s loss mitigation toolkit can improve borrower outcomes
When a mortgage borrower becomes delinquent, a loan modification can be key to reinstating the loan and helping the borrower avoid foreclosure. For loans insured by the Federal Housing Administration (FHA), the agency prescribes loss mitigation guidelines that servicers of delinquent FHA loans must follow.
These rules assist borrowers and minimize the FHA’s losses, but some rules create a cumbersome loss mitigation process for borrowers and increase costs for servicers. The Urban Institute’s Mortgage Servicing Collaborative agrees that the FHA could improve outcomes for borrowers and mitigate costs for servicers by simplifying some of these requirements.
Documentation of household expenses and hardship
Before delinquent FHA borrowers can be approved for loan modifications, they are required to provide information about household finances, including monthly income and expenses. Unfortunately, the US Department of Housing and Urban Development’s (HUD) requirements concerning expense documentation—which may include physical receipts for day-to-day purchases such as groceries, gas, and pharmaceuticals—are overwhelming for most borrowers.
Households typically don’t save these receipts, and those that do face the added burden of mailing, faxing, or scanning them to the servicer. The receipt requirement can delay or even prevent a borrower from receiving a modification for which they might otherwise qualify, and it adds unnecessary costs for the servicer.
Also burdensome are documentation requirements for establishing borrower hardship. Although servicers have delegated authority to request documentation they deem necessary, borrower hardships are often complicated, with multiple causes that happen over an extended period, some of which are nearly impossible to document.
Borrower advocates and servicer members of the Mortgage Servicing Collaborative agree that these documentation requirements have erected unnecessary barriers for struggling borrowers seeking mortgage assistance and have increased costs for servicers. With a few simple fixes, HUD could ease this burden.
The most straightforward approach would be for HUD to eliminate the need to consider borrower expenses in a loss mitigation evaluation. Borrower expenses play a minor role in HUD’s waterfall, as servicers consider expenses only to determine whether to evaluate a borrower for a loan modification. Moreover, borrower expenses are not used to calculate the postmodification monthly payment.
But if expense analysis must remain in the waterfall, HUD could adopt the Internal Revenue Service’s (IRS’s) Collection Financial Standards, which provide monthly allowances for specific living expenses such as food, personal care, apparel and other items that the IRS considers to be reasonable and do not require any documentation from taxpayers.
HUD’s 2016 guidance refers to the IRS standards in discussing borrower expenses but does not instruct servicers to use these standards. To avoid the need for documents in most cases, HUD should instruct servicers to use the IRS standards. This policy would obviate the need for documents in most cases and provide much-needed clarity for borrowers and servicers.
To collect evidence of borrower hardship, HUD should use the government-sponsored enterprises’ standard hardship affidavit (Form 710), which provides 10 options for hardships and allows borrowers to explain complicated situations. The Treasury Department’s Home Affordable Modification Program used a similar form for the 10 years the program was in effect.
HUD’s loss mitigation documentation requirements are well-intentioned guidelines to help struggling borrowers while minimizing losses for the FHA. At the same time, the massive scale of the FHA program necessitates policies that maximize the number of borrowers assisted. The Mortgage Servicing Collaborative believes that adopting the changes described in this blog post would be a positive step in that direction.
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