What happens in the servicing process when a loan becomes delinquent?

In order to pursue loss mitigation, it is necessary for servicers to establish comprehensive collection policies and procedures that comply with the guidelines and regulations established by the Consumer Financial Protection Bureau, such as the Fair Debt Collection Practices Act, along with the Telephone Consumer Protection Act, and other relevant laws. Prior to foreclosure, servicers will follow a loss mitigation hierarchy based on investor/program requirements and borrower circumstances. Servicers will try to utilize repayment plans to recover past due balances. They could also pursue forbearance plans which is an agreement with the borrower on specific repayment terms. If the borrower cannot repay their past due balances, a servicer could perform a loan modification and capitalize the past due balances into the loan. The modified loan balance could increase the first lien. 

At the height of COVID-19, Standalone Partial Claims (SAPC) became a prevalent loss mitigation program that was utilized for Federal Housing Administration (FHA) loans. Under SAPC there is no modification, but the payment arrearages are placed on the back of the loan and a claim is filed. The borrower has a non-interest bearing second lien that is due at the end of the first lien term. In some instances, the servicer will modify the loan and complete a partial claim where a second lien is due after the first lien is paid. Effective April 30, 2023, the FHA updated their loss mitigation guidelines where they temporarily paused their home affordable modification program and provided updated loss mitigation options. In addition to forbearance, the update includes the Advance Loan Modification (ALM) for both owner and non-owner occupant borrowers where the modification results in a permanent change in the borrower’s terms, resulting in a reduction of the borrower’s monthly payment. The update continues to utilize SAPC but with a higher partial claim cap and includes a recovery modification which extends the term of the mortgage to 30 or 40 years at a fixed rate, targeting a reduction of the borrower’s payment. Both the Department of Veterans Affairs (VA) and the U.S. Department of Agriculture (USDA) offer various loss mitigation programs including loan modifications that extend the term of the mortgage and deferred payment arrangements.  

For conforming loans, the GSEs also offer modification programs and deferred payment plans. On March 29, 2023, the Federal Housing Finance Agency (FHFA) declared that the GSEs will enhance their deferred payment program to allow borrowers who are facing a financial hardship to defer up to six monthly mortgage payments. The deferred payments are put on the back of the loan and the borrower has a non-interest bearing second lien that is due with the settlement of the first lien. 

There are additional loss mitigation options including home disposition options. Servicers should refer to the specific program guides for eligibility and requirements for the various loss mitigation programs. 

GNMA servicers must continue to make all scheduled principal and interest payments to MBS (mortgage-backed securities) investors, regardless of the performance of the underlying mortgage. When you buy out delinquent GNMA loans, the buyout proceeds get applied to the GNMA principal and interest (P&I) requirement, so buying the loans out before the P&I remittance date could reduce the amount of P&I that is required to be advanced. Excess funds collected in the P&I custodial account could also reduce P&I advance requirements. However, excess funds need to be returned timely to pay security holders or maintain custodial account requirements, and before they can be treated as a recovery of previously funded advances. Given the current rate and present-day inflationary environment, we could see more P&I advances if delinquencies increase. There are fewer prepayments of loans and refinancings, which could result in a smaller number of collections, potentially requiring more P&I advances.  

For conventional loans, the obligation of the GSEs to advance P&I is limited by the timing and type of the total payments required to be made. In some cases, sellers and servicers must only pay based on the actual payments, meaning payments from the underlying borrower that are received. Further, the sellers and servicers are generally not required to make advances beyond a certain time period. During the onset of COVID-19, the GSE’s aligned policies where they ceased requiring servicers to advance any P&I on loans serviced on a scheduled/scheduled (scheduled interest and principal payments) servicing payment basis on behalf of defaulted borrowers who were four or more months (120 days) delinquent.   

For private label securitizations, servicers often have the option to stop making P&I advances or use loan level and pool level proceeds for advancing obligations. Reimbursement of these advances is usually senior to cash payments to investors and these loans generally have the highest reimbursement priority and are the top of the reimbursement waterfall.  

While a servicer may be able to stop remitting P&I advances, they typically need to continue to make tax and insurance escrow payments to preserve title on the property. The requirements for advancing could change, so servicers need to stay current with the applicable servicing guides. 

Other than recovering advances from borrower payments and through liquidation, advances are also recovered through the claims process. This process entails a unique set of claim requirements for each insurer and investor. Compliance with the collection and loss mitigation hierarchy strategy is foundational in supporting this process, while inefficient or inaccurate claim processes can increase the need for additional reserves if it creates operating errors. Some considerations for the claim submission process include: 

• The timing and type of claim, where there could be both primary and supplemental claims, or partial claims 
• What advances or expenses can be claimed and any thresholds for these items 
• The dollar amount of the claim 

Non-recoverable losses directly or indirectly tied to claims stem from a variety of reasons, some of which include: 

• The transfer of servicing  
• Incomplete or imprecise payoff quotes 
• Post liquidation losses  
• Non-timely or inaccurate claim submissions ineligible for cure  
• Potential instances where the mortgage insurance was not maintained  

The transfer of servicing can lead to non-recoverable advances if there are post-transfer expenses and payments made by the transferor, or if prior capitalized advances are not permitted to be subsequently claimed. For paid off loans, residual invoices, amounts incorrectly paid after the payoff, and inaccurate payoff quotes can lead to excess non-recoverable advances that may need to be expensed and not recovered through a claim. Once a loan is transferred or paid off, it can be difficult to recover any remaining differences. Incorrect escrow payments and unnecessary expenses made after liquidation can also be challenging to recover.  Further, the insurers and investors have claim submission requirements and timelines. If these are not followed, the insurer and investor may elect to not reimburse the claim. If the mortgage insurance on a loan lapses, there is a greater probability that the loan will not be insured against losses. 

Reviewing claim performance and advance loss history can identify the basis for these operating losses and highlight potential issues occurring within operations, along with opportunities to refine reserves. Having processes to ensure the correct application of claim payments and the related claim reporting will enhance the precision of the claim performance review. Tightly controlled claim processes will support higher levels of recoveries and tighter reserves. 

Servicers have several vendors that they rely on to support their servicing operations.  The monitoring of these vendors is important to reduce non-recoverable operating losses. Receiving late or inaccurate invoices or deficiencies in vendor responsibilities could impact what is recovered from the borrower, insurer, or investor.  The prompt monitoring of vendors needs to be done routinely and thoroughly to ensure that the vendors are operating in accordance with their contractual terms. Servicers should also assess if their vendors have the appropriate controls in place to meet their requirements and if the vendors can handle increased volume and concentrations of services, which were evident during the COVID-19 pandemic. 

Some of the critical vendor services include tax service and insurance service contracts. A servicer can:   

• Engage a tax service provider to confirm the tax liability on the mortgaged property and pay the appropriate amount of the liability 
• Engage an insurance service provider to confirm the property insurance liability on the mortgaged property and pay the appropriate amount of that liability 

If taxes are not paid, the owner may not be able to claim title to the property in the event the property needs to be liquidated. Further, if insurance is not maintained on the property and the property is damaged, proceeds from liquidations may not be enough to cover the mortgage. In situations where the borrower pays the escrow requirements directly, these service providers will verify the tax payments and insurance coverage or will make the appropriate payments and obtain coverage. Proper monitoring of these vendors is critical in preserving the value and claim in the property needed for liquidation, in the event liquidation is needed. 

Servicers should consider using analytics or encourage their subservicers to provide analytical reporting that foreshadows potential problem areas. For example, some of the monitoring could include: 

• Monitoring loan types or geographic areas that are showing spikes in mitigation activity  
• Monitoring recent government loan vintages with low down payments and higher interest rates to anticipate potential problem loans as the economy changes 

With analytics, servicers and subservicers can weigh whether potential problem areas are an anomaly or a need for additional resources and vendors with the appropriate skill set to support the collection of payments, help keep borrowers in their homes, and ensure the highest levels of recovery in the event of any necessary liquidation and claim filings.