The Growing Liquidity Squeeze in FHA Servicing
The aftereffects of pandemic-era mortgage relief programs are now becoming increasingly visible—and concerning. What was once a lifeline for struggling homeowners is evolving into a complex challenge for servicers, lenders, and the broader housing finance system.
As industry leaders begin to assess the fallout, one thing is becoming clear: the next phase of stress may already be underway.
A System Built for Relief—Now Under Pressure
During the COVID-19 pandemic, programs like forbearance, partial claims, and loan modifications helped millions of borrowers stay in their homes.
Initially, they worked.
But as interest rates climbed, many of those solutions became less effective—and in some cases, counterproductive.
“We’re going to see a pretty large pipeline, and I think it’s only going to go up from here, with more loans being pushed through foreclosure,” said Donna Schmidt, Founder and CEO of DLS Servicing.
Her perspective reflects a growing consensus across the servicing industry: the relief phase is ending, and the consequences are now surfacing.
A Cycle of Re-Default
Loan-level data shows a troubling trend—borrowers repeatedly entering and exiting delinquency without achieving lasting stability.
Many FHA borrowers have:
- Cycled through multiple partial claims
- Temporarily cured delinquencies
- Fallen behind again within months
According to Schmidt, part of the issue stems from how pandemic-era relief programs were structured.
“The post-COVID loss mitigation framework allowed borrowers to obtain payment relief with little to no documentation,” she explained. “We never got to the root of the problem.”
In some cases, borrowers received multiple partial claims over a short period, creating what she describes as a “constant recycling” of distress rather than a resolution.
The Impact of Rising Interest Rates
As rates increased, loan modifications became far less effective.
Borrowers who were previously paying historically low rates often found themselves modified into significantly higher ones—sometimes adding hundreds of dollars to their monthly payments.
Even when servicers used partial claims to reduce balances, many borrowers:
- Failed to achieve meaningful payment reductions
- Quickly exhausted their available relief options
- Remained financially strained
The result: a system that stabilized borrowers temporarily but failed to provide long-term sustainability.
Underwriting and Affordability Challenges
The issue isn’t limited to servicing—it also traces back to loan origination practices.
Schmidt points to a major shift in borrower risk profiles, particularly around debt-to-income ratios.
“In the past three years, a significant portion of FHA loans had DTIs at or above 50%,” she said. “That’s stunning. All it does is set somebody up to fail.”
When borrowers are already committing half their income to housing, even minor financial disruptions can lead to delinquency.
“When you’ve got somebody at 50% DTI, a small event—like a car repair or insurance deductible—can immediately impact their ability to pay their mortgage,” she added.
This lack of financial cushion has made many borrowers especially vulnerable in today’s economic environment.
A Potential Liquidity Challenge for Servicers
Behind the borrower experience lies another growing concern: liquidity pressure on mortgage servicers.
Servicers are required to continue advancing payments to investors—even when borrowers stop paying. As delinquencies rise, those obligations increase.
And according to Schmidt, the industry may not be fully prepared for what’s ahead.
“You can’t train somebody quickly to respond to what’s coming, It’s sheer volume.”
– Donna Schmidt, Founder and CEO of DLS Servicing
Nonbank servicers, in particular, face heightened risk due to their reliance on external funding sources and thinner liquidity buffers.
As foreclosure timelines extend and delinquencies grow, the strain on servicing operations could intensify significantly.
What Comes Next
While the broader housing market remains stable, the growing pipeline of distressed FHA loans signals a shift in the risk landscape.
For Schmidt, the path forward starts earlier in the process.
“I would prefer to see it from FHA themselves—to say we’re not allowing these loans to go through anymore,” she said, pointing to the need for stronger upstream controls in underwriting.
At the same time, servicers must prepare for increased volume, operational strain, and liquidity demands as legacy relief programs run their course.
The long tail of pandemic-era assistance is now fully visible—and how the industry responds will define the next phase of mortgage stability.
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