A potential wave of coronavirus-related loan sales by cash-strapped mortgage servicers could result in botched borrower paperwork and unnecessary foreclosures, consumer advocates and policymakers say.
With millions of U.S. mortgage borrowers obtaining forbearance or simply skipping payments themselves, concerns about liquidity at small servicing companies in particular have raised alarms at the Consumer Financial Protection Bureau, and among consumer advocates and industry attorneys about a potential wave of asset sales and servicing transfers.
Such transactions can be bumpy for borrowers in normal economic times. It isn’t uncommon for loan files to get misplaced or have errors in mortgage servicing transfers, complicating routine functions such as a borrower’s ability to make monthly payments.
The sheer volume of transfers that could result from the economic distress caused by the pandemic would make things “even bumpier,” said To-Quyen Truong, a partner at Stroock & Stroock & Lavan LLP.
“It will become a major headache for everyone in the chain going forward,” Truong, a former top Consumer Financial Protection Act official, said.
No Payments, No Fees
The CARES Act allowed borrowers with federally-backed mortgages to get up to a year’s worth of mortgage forbearance if they are suffering financial hardships due to the coronavirus outbreak. Around 3.5 million U.S. homeowners—nearly 7% of borrowers—have entered forbearance programs, up from 5.95% the week before, the Mortgage Bankers Association said Monday.
Those forbearance plans mean mortgage servicers aren’t collecting their fees, and could be hitting financial distress. Moves from the Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac, have stabilized larger servicers’ finances for at least a little while.
But so far, the government has shown no appetite for creating a liquidity facility to bail out struggling servicers.
As the coronavirus economic slump continues and mortgages go unpaid, problems for even the bigger servicers could mount, potentially leading to rushed asset sales. Mortgage servicers are not required to maintain the same levels of capital to protect against shortfalls as banks.
“There is a viable concern that servicing transfers could be difficult in this environment and, even more importantly, could lead to borrower disruption,” said Isaac Boltansky, an analyst with Compass Point Research & Trading.
The sale and transfer of mortgage servicing assets is a regular, if complicated, feature of the mortgage market. In those transfers, one servicer will purchase the right to collect payments and serve as a go-between for homeowners and the investors in mortgage bonds, in exchange for a small fee.
Those transfers can be plagued with paperwork problems. Companies can have filing systems that do not speak to each other and other technical issues frequently arise, said Jason Bushby, a partner Bradley Arant Boult Cummings LLP.
Technical problems can lead to real damage for homeowners, who may not receive the proper notices from their new servicers and may end up sending payments to the wrong place, he said.
“To some extent, it does not really matter how robust and tight your servicing transfer process is. A servicing transfer is just disruptive,” Bushby said.
In the mortgage servicing context, a disruption can lead to a foreclosure, according to consumer advocates.
Borrowers at Risk
Problems transferring loan files are even more pronounced in situations where one of the mortgage servicers is distressed or bankrupt. A bankruptcy judge stopped Ditech Financial Inc.'s proposed sale of servicing assets in August 2019 amid objections from homeowners who said their files were riddled with errors.
When a servicer carries a large number of loans that have been modified to help the borrower, such as forbearance, the problem is even worse, Bushby said.
A traditional loan modification that alters the terms or principal due on a mortgage requires a great deal of paperwork, with copies given to the borrower. A forbearance is often a verbal or otherwise informal agreement that might be hard to prove if loan files have errors or are misplaced in a servicing transfer, he said.
“The risk of these forbearance plans getting lost in the shuffle is just a lot higher than other, more permanent loss mitigation programs,” Bushby said.
The CFPB on April 24 put out guidance for mortgage servicers to formulate and test loan transfer and communication plans before assets are placed with another company.
Servicers should also conduct quality control reviews of preliminary data transfers, to make sure loan files are up to date and properly recorded by the new servicer, among other guidelines, the CFPB said.
Mortage servicers should have already been doing those sorts of checks under CFPB regulations put in place after the 2008 financial crisis, consumer advocates said.
“If they could manage servicing transfers, this would not be anywhere near as big a deal,” said Diane Thompson, an attorney with the National Consumer Law Center and a former top CFPB attorney.
The testing and other measures in the April 24 guidance also do not take into account the current economic environment, added the NCLC’s Alys Cohen.
“It is not clear how the standards the CFPB recommends for preventing borrower harm, including long planning periods, fit with rapidly rising unemployment and exploding mortgage forbearance and delinquency rates,” she said.
The CFPB also said that it would be sensitive to “good faith efforts” by servicers to transfer loan files without harming borrowers when considering potential enforcement actions, leaving advocates wondering how consumers would be protected from botched transfers.