The mortgage industry needs a modernized disaster recovery toolkit
As news of the devastation caused by recent hurricanes broke, mortgage market stakeholders—regulators, housing agencies, servicers, consumer advocates, and nonprofits— offered immediate assistance to affected households.
Fannie Mae, Freddie Mac, and the Federal Housing Administration (FHA) announced an automatic 90-day forbearance (with possible extensions) for affected borrowers and temporary moratoria on foreclosure and eviction to give affected families time to gather and rebuild. The agencies have also instructed mortgage servicers to waive late fees associated with delayed payments and suspend credit bureau reporting for the time being.
As affected homeowners begin putting their lives back together, the moratoria on forclosure and other assistance announced by the agencies will help. But if we don’t enhance our existing toolkit, we won’t be able to ensure that borrowers receive the assistance they need quickly.
The limits of forbearance and loan modification as disaster recovery tools
Borrowers affected by the hurricanes will have access to forbearance (temporary payment relief) and loan modification (permanent reduction in monthly payment). In general, forbearance works best during financial disruptions, such as job loss or a temporary increase in expenses. Deferring a few mortgage payments gives households time to stabilize their financial situation (e.g., by finding a new job) before resuming monthly payments.
Natural disasters, on the other hand, can be a long-term affair. It can take several months for homeowners to get a decent understanding of the extent of the damage, sort out insurance coverage (including flood insurance), and file a claim, and it can be years before homes are rebuilt. Temporary forbearance is unlikely to help many of these homeowners.
Borrowers can apply for loan modification after forbearance. But any reduction in the monthly payment will be offset by the added cost of rebuilding. And after disasters of this magnitude, rebuilding costs and delays are likely to increase because of price gouging and a shortage of insurance adjusters, home inspectors, appraisers, building contractors, and materials, all of which will be in high demand.
The double financial burden of resuming monthly mortgage payments while assembling funds for repair will be felt by many families, forcing some to abandon their damaged or destroyed homes. Families with less equity in their homes or those with significant uninsured damages are at a higher risk of doing so.
Further compounding the problem is the recent rise in mortgage rates. Unlike the 2008 housing crisis, when loan modifications helped delinquent borrowers achieve significant payment relief thanks to falling interest rates, most borrowers today hold ultra-low-rate mortgages. Therefore, rate reductions won’t play a big part in reducing monthly payment. Instead, today’s modifications will be heavily reliant on capitalization and term extensions. Although still useful in achieving payment reduction, term extensions are expensive for borrowers in the long run because of additional accrued interest. And for many homeowners with substantial damage, a term extension may not yield a sustainable reduction in monthly housing expenses.
Still, government-sponsored enterprise (GSE) borrowers are likely to have access to better loan modification options than borrowers with FHA, US Department of Veterans Affairs, or privately owned mortgages. The GSEs’ loan modification toolkit is more flexible and easier to use for borrowers and servicers. Accordingly, GSE borrowers could receive better and faster assistance than other borrowers, even if the damaged homes are next to each other.
A policy change that might help: As policymakers take note that neighbors witnessing similar damage to their homes will receive varying forms of assistance, I hope the importance of working toward a more efficient loss mitigation toolkit—under which assistance is based on borrower and property circumstances as opposed to who owns the mortgage—will become apparent.
Access to rehabilitation financing is critical
Recovering from Harvey, Irma, and Maria will also underscore the need for an efficient market for rehabilitation financing, which is neither easy to obtain nor affordable. Borrowers whose properties have suffered substantial damage and who cannot afford the cost of repair may walk away, exposing lenders, servicers, and agencies to losses.
The FHA offers lending products geared toward repair and reconstruction, while the GSEs have home renovation products. Borrower awareness of these programs, however, is limited, and underwriting these products often requires specialized skills not every lender has in house. For instance, these loans come with additional cost burdens and restrictions on lenders (e.g., monitoring and documenting the repair work) and elevated repurchase risk.
A policy change that might help: Under current agency disaster guidelines, servicers are not instructed to evaluate borrower eligibility for rehabilitation financing in conjunction with a loan modification. Many affected homeowners won’t be able to afford repairs and may decide to abandon their home, a loan modification notwithstanding. But access to efficient rehabilitation financing—in conjunction with a loan modification—may lead homeowners to rethink abandoning their homes. A pilot program that requires servicers to educate and evaluate borrowers for rehabilitation financing options and makes this financing easier to access is worth considering.
Helping affected homeowners get back on their feet is not the only reason we need a better loss mitigation toolkit for natural disasters. A well-developed loss mitigation toolkit that minimizes defaults and foreclosures can help everyone, as we learned from the last crisis.
The eventual financial cost of these hurricanes directly related to housing will be borne by many stakeholders, including affected homeowners, lenders, servicers, insurers, agencies, and federal, local, and state governments. Every damaging storm that strikes takes us one step closer to a world where this cost will begin to get priced in, through higher mortgage rates, higher insurance premiums, and possibly curtailment of credit in coastal communities. The mortgage ecosystem, together with policymakers, will have to figure out how to work through these issues.
Volunteers, from right to left, Trent Hartman, Colten Roberts and Brock Warnick help clean up the home of Julia Lluvia, which was destroyed by floodwaters in the aftermath of Hurricane Harvey Monday, Sept. 4, 2017, in Houston. Photo by David J. Phillip/AP.