Servicers Need To Prepare For A Coming Storm

The mortgage market is in flux now. For example, early-stage delinquencies have been on the rise, which presents a challenging environment for mortgage servicers. So how do they adapt? We talked with Donna Schmidt, the managing director and founder of DLS Servicing, a trusted provider of loss mitigation support services, default servicing consulting, training, and technology for mortgage servicers, about this and other issues impacting mortgage servicers today.

QUESTION: What delinquency trends have you recently observed?

DONNA SCHMIDT: The rate of serious delinquencies, in which borrowers are at least three months past due, has been falling for some time. But for early-stage delinquencies, where loans are at least 30 days delinquent, the rate has recently risen on a month-over-month, quarter-over-quarter and year-over-year basis. This should be concerning for servicers, since a steady rise in the early-stage delinquency rate often precedes a future increase in serious delinquencies and foreclosures.

It’s clear that more borrowers are beginning to struggle with their payments, which could be happening for a variety of reasons. Once a borrower starts missing payments, the chances of them falling further behind increase unless some type of corrective action is taken. While it may not seem like a major emergency, the uptick in early stage delinquencies should motivate servicers to be more proactive about identifying and reaching out to borrowers who are experiencing financial difficulty before it becomes a larger problem.

QUESTION: Are there any more factors suggesting worsening delinquency?

DONNA SCHMIDT: Absolutely. Take America’s collective credit card debt, for example. The Federal Reserve Bank of New York just announced that total credit card debt reached a record $1.13 trillion. It’s a clear sign that many households are experiencing financial strain, which may have been exacerbated by the elimination of pandemic-era relief programs, the resumption of student loan payments, and the persistent bite of inflation. Many consumers have been handling these pressures by turning to revolving debt, such as credit cards and personal loans, to handle basic living expenses.

When mortgage borrowers start relying on credit as a stopgap measure, it leads to a higher debt burden that increases the risk of mortgage delinquency. When you throw in the increasing cost of living, the picture doesn’t look that great for many borrowers.

QUESTION: What about foreclosures?

DONNA SCHMIDT: While foreclosure starts are higher on an annual basis, we’ve been observing a retreat more recently, which suggests a market that is still finding its equilibrium in a post-pandemic environment. According to a recent report from Money Management International, however, the number of delinquent borrowers who sought counseling nearly doubled last year. This is the sort of canary in the coal mine that indicates more defaults, and possible foreclosures, are likely on the way.

The fact that credit debt is rising, and more borrowers are seeking help means that servicers need to brace for an increase in bankruptcies, with last month’s personal bankruptcy filings climbing 17% from January 2023. These trends underscore the need for servicers to stay vigilant and prepare for an increase in demand for loss mitigation options and increased workloads.

QUESTION: How can servicers prepare for an eventual increase in delinquency?

DONNA SCHMIDT: Again, it’s important for mortgage servicers to be proactive. First off, they need to make sure their employees are well-versed in the latest loss mitigation policies and requirements of investors and government agencies at the federal state and local levels. Ongoing training is critical for a servicer’s ability to act swiftly and appropriately when a borrower begins to show signs of financial distress. This not only helps mitigate the impact of potential defaults, but also ensures borrowers receive the support they need to navigate through their financial challenges.

Just as important is knowing the order in which loss mitigation options need to be offered to the borrower. For instance, loans insured by the Federal Housing Administration have a very strict loss mitigation waterfall, and the FHA has regularly adjusted its loss mitigation guidelines as well. Deviating from these prescribed steps can lead to significant financial repercussions for both servicers and investors, including the denial of FHA claims, so it’s extremely important for servicers to stay on top of this issue.

QUESTION: What steps should they take?

DONNA SCHMIDT: First and foremost, they should be constantly educating borrowers about the benefits of prioritizing their mortgage payment and making payments on time, which helps the borrower avoid ever needing to enter the loss mitigation process. Even if a borrower is struggling with other debt, focusing on paying their mortgage on time could help them avoid having to turn to a loan modification, which may be difficult due to the recent increase in interest rates.

Servicers should also make sure they’re able to calculate a borrower’s loss mitigation options quickly and compliantly. Because government agencies and the GSEs continue to adjust their loss mitigation guidelines, it’s helpful to have automated technology that incorporates the latest guidelines so servicers can quickly determine the correct waterfalls accurately. In fact, it’s why our WaterfallCalc application has become so popular, especially among small- and mid-sized servicers, who often lack the staff resources to serve distressed borrowers efficiently.

QUESTION: What kind of rates are you seeing for loan modifications?

DONNA SCHMIDT: As of November, loan modification rates were 7.6% on Fannie Mae loans, while rates for FHA and VA loans and mortgages were between 7.5% and 8.1%. The problem with rates being this high is that most distressed borrowers have mortgages with significantly lower rates, so a loan modification doesn’t necessarily offer them much relief. Even with the FHA’s new 40-year-loan modification, that math doesn’t always work out in the borrower’s favor. For servicers, this means there’s an increased need to carefully assess each borrower’s financial situation and ensure that loan modifications offered to distressed borrowers are sustainable, so they can prevent a potential redefault.

QUESTION: How effective is delinquency prevention?

DONNA SCHMIDT: It is very effective. We’ve seen many instances in which the proactive steps taken by our clients have kept their customers in their homes, even when it didn’t seem likely. That being said, even if servicers do everything right, some borrowers will still default. There are just too many contributing factors at play that are beyond the servicer’s control, including the economy and unexpected life events such as job loss or a health emergency. But that doesn’t mean servicers shouldn’t do all they can.

For most servicers, having a robust and properly trained loss mitigation department and a third party partner that specializes in defaults will be critical to navigate the road ahead.  It’s about creating a safety net that not only protects the health of a servicer’s portfolio, but places the borrower’s well-being first—which is what effective loan servicing is all about.

INSIDER PROFILE

Donna Schmidt is the managing director and founder of DLS Servicing, a trusted provider of loss mitigation support services, default servicing consulting, training, and technology for mortgage servicers. A seasoned professional with four decades of leadership experience in the mortgage industry, she is a sought-after authority on loss mitigation compliance. Donna is also the co-founder of WaterfallCalc, an online loss mitigation decision and calculation tool that enables servicers to streamline loss mitigation calculations while ensuring investor and regulatory compliance. She can be reached at [email protected].