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 (CFPB), such as the Fair Debt Collection Practices Act, along with the Telephone Consumer Protection Act and other relevant laws. The use of artificial intelligence (AI) to automate tasks and streamline collection practices, aimed at driving efficiencies, can also present additional regulatory challenges. In addition to following established legal precedent, consumers are required to be notified that they are speaking with AI and consent to the use of it. The CFPB is also focused on potential decision bias, which means servicers need a defensible audit trail if decisions are questioned and must stay aligned with evolving privacy and AI laws, including state-level requirements.

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 a forbearance plan 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.  

FHA has noted the success of the current COVID-19 Recovery Loss Mitigation Options, however, with the increase in interest rates from 2022 through 2024, there is a subsection of borrowers where servicers and originators are not able to assist their customers who are not able to resume their regular monthly payments. To help combat this, effective May 1, 2024 (required no later than Jan. 1, 2025) FHA issued a new loss mitigation option, which includes a payment supplement combining a SAPC with a Monthly Principal Reduction (MoPR) payment. This loss mitigation option provides temporary relief over a three-year period, without the need to modify the mortgage. Upon completion, borrowers are expected to resume the full principal and interest (P&I) payments. The payment supplement is supported by a zero-interest note and subordinate mortgage, which isn’t repaid until termination of the FHA insurance, maturity or repayment of the mortgage, or sale or transfer of the property. With the rollout of the new loss mitigation option, FHA extended the COVID-19 Recovery Loss Mitigation Options through April 30, 2025. 

Following the implementation of the payment supplement loss mitigation option, FHA issued a Mortgagee Letter in January 2025 that phases out the temporary COVID-19 Recovery Options and introduces a new set of permanent loss mitigation tools designed to streamline processes, offer more balanced borrower solutions and reduce the need for home dispositions. This was subsequently amended to modify some of the guidelines under this permanent loss mitigation requirements, including adjusting the effective date to Oct. 1, 2025. This amendment also extended the timeframe for borrowers to receive a permanent loss mitigation option from once every 18 months to once every 24 months, canceled the increases in borrower compensation for Deed-in-Lieu of foreclosure and pre-foreclosure sale program dispositions.  The home retention options include: repayment plans, forbearances, SAPC, standalone loan modifications, combination loan modification and partial claim, the payment supplements and outside the waterfall loan modifications (permanent change in one or more terms of the mortgage that results in a reduction of the monthly P&I payment).The COVID-19 Recovery Options, the COVID-19 ALM, and the FHA-HAMP programs expired on Sep. 30, 2025.  

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.   

• On April 10, 2024, the VA released its Veteran Affairs Servicing Purchase (VASP) program, effective May 31, 2024. This program was created as a final loss mitigation waterfall option for those experiencing significant financial hardship. Under this option, the VA may purchase the loan from the servicer and restructure it to achieve a more affordable payment for the borrower, which may include adjusted interest rates and extended terms. A trial payment period may be required prior to purchase. 
• Effective July 24, 2024, the USDA issued their Payment Supplement Account (PSA) program as a new loss mitigation home retention option, aimed to help borrowers with financial hardship where they struggle to pay their obligation and have a below market interest rate. The program allows servicers to pay standalone Mortgage Recovery Advance on behalf of the borrower to cover arrearages, reduce the principal balance of the loan, among other costs. 
• 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.  
• On May 29, 2024, the FHFA directed both FHLMC and FNMA to augment their Flex Modification program to provide a solution reducing payments for borrowers who no longer can make normal monthly mortgage payments. By reducing the borrower’s interest rate, extending the term, or forbearing principal for borrowers with mark-to-market loan-to-value ratios greater than 50%, the revised program aims to reduce the monthly P&I payment by 20%. 

For Non-QM loans, while there is typically no uniform servicing guidelines, servicers generally will also pursue forbearance, repayment plans, loan modifications or deferral. Depending on the investor guidelines for non-QM, loan modifications are typically flexible and can include extending the term (although new 40-year terms present new additional challenges), modifying the rate and capitalizing delinquent balances. 

There are additional loss mitigation options including home disposition options, including short sale or deed in lieu of foreclosure. 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 (P&I) 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 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 environment and labor market uncertainty, 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. As interest rates decrease, this could increase the amount of refinancing and restart the GNMA buyout programs. The effectiveness of the buyout program is highly contingent on the breadth of interest rate decreases for these delinquent borrowers, where the amount and timing of the interest rate cuts is very uncertain. 

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. During the onset of COVID-19, the GSEs 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. FNMA still has a stop delinquency advance process for scheduled/scheduled MBS mortgage loans that become four months delinquent. As payments are collected, there is an application hierarchy before the stop advance process is lifted. Similarly, FHLMC stops requiring scheduled interest to be remitted once a mortgage loan becomes 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  

Nonrecoverable 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   
• Nontimely or inaccurate claim submissions ineligible for cure   
• Potential instances where the mortgage insurance was not maintained  
• Inaccurate assignment of liens for down payment assistance programs or for instances where the borrower has both a first and second lien, such as a home equity loan 

The transfer of servicing can lead to nonrecoverable 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 nonrecoverable 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. Clear, documented operating procedures that support differing investor guidelines for non-QM loans are also necessary. 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 nonrecoverable 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. We could also see new operational strain with increased delinquencies on larger servicing portfolios. While originations slowed on higher interest rates and the lower housing supply over the last couple of years, servicers acquired and retained more servicing to offset origination income. 

Some of the critical vendor services include tax service, insurance service and property preservation 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  
• Engage a property preservation provider to maintain a property in orderly shape for liquidation 

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. When property preservation is required, if a vacant, foreclosed or defaulted property is not maintained, the ultimate liquidation proceeds could be significantly less. Proper monitoring of these vendors is critical in preserving the claim and value in the property needed for liquidation, in the event liquidation is needed.  

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

• Monitoring product 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  
• Monitoring concentrations where other debt such as credit cards, student loans, and auto loans are experiencing higher delinquencies 
• Monitoring geographic areas that are experiencing higher levels of employment slowdown 
• Monitoring concentrations of the portfolio that have taken on second liens 

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.  Companies can also leverage new technologies such as AI to support the early-stage collection activities and leverage this technology to perform predictive analytics to support vendor and staffing needs.