FHA Proposes a 40-year Modification Term
FHA released Mortgagee letter 2022-07 which required servicers to extend the modified term to 40 years from the first payment due on a modification if the target 25% reduction in the principal and interest payment is not achieved with a 30-year term extension for the COVID Recovery modification.
There are several concerns with this option:
While GNMA has approved the inclusion of 40-year terms in specific modified loan pools, some lenders have experienced a loss when attempting to re-pool these loans into a new GNMA security. In other words, the lender may not recapture the full amount of the principal – no less a premium payment that helps to offset their loss mitigation expenses. The amount of the losses varies with market conditions, but for smaller servicers, any loss can produce long-term negative impact on their net worth standings, especially if the volume of 40-year modifications escalates. As it is, FHA does not pay an incentive fee for the COVID resolutions, nor do they reimburse the servicer for actual expenses such as title report fees and recording costs.
Understandably, a pool of loans with 40-year terms and homeowners who have a history of default, is not an attractive investment, so the purchase price would naturally be lower than a pool of newly originated 30-year termed loans. Just how much the servicer will lose when attempting to re-pool these loans still remains to be seen. FHA attempted to offset the potential loss by allowing the modified interest rate to be 50 basis points (.5%) above the current market rate, rounded to the nearest 1/8%. But it is unclear if this rate increase will be enough to erase the entire loss.
Because of the longer repayment period, the 40-year term lowers the homeowner’s monthly payment; however, because the 40-year termed modification has an interest rate that is a half of a percent higher than the 30-year termed modification, the principal and interest payment reduction is minimal – by as little as $10 to $40 a month. Yet the homeowner will be paying thousands more in interest over the life of the loan.
For example – if a loan is modified to a new unpaid balance of $150,000:
5% interest rate
$805.23 Principal and Interest monthly payment
$139,885.10 paid in interest over the life of the loan
5.5% interest rate
$773.66 Principal and Interest monthly payment ($31.57 less, or $378.84 annually)
$221,348.87 paid in interest over the life of the loan ($81,463.77 more)
Given the stark short- and long-term impact to the borrower, it is surprising that there is no requirement to disclose this increase in interest payments to the borrower prior to releasing the documents – that, of course, would disrupt the streamlined nature of the workout. Therefore, are we really operating in the borrower’s best interest?
The target of a 25% reduction in the homeowner’s monthly principal and interest payment is totally arbitrary and is not based on a homeowner’s actual need for assistance. It was based on data from the Housing Crises of 2008-2010, where it showed that a modification performed better if the homeowner’s payment was reduced by 25% or more. However, in the prior crises, the majority of homeowner’s experienced SIGNIFICANT loss of income. The circumstances could not be more different today. If interest rates continue to climb, as expected – there will be more loans qualifying for the 40-year term modification, and more servicers and borrowers could be adversely impacted.
It is the opinion of DLS Servicing that, the drive by large mortgage servicers for the ability to efficiently manage large volumes and manage the scale of their operations, is creating a very poor long-term outcome for most homeowners.
The COVID resolutions previously offered by FHA were far fairer and proved to be structured with more intelligence towards overall market circumstances. Previous to last summer’s Mortgagee Letter 2021-18––where the Recovery Modification and the arbitrary 25% target reduction in the principal and interest payment was introduced––if a homeowner said they could not afford to resume making their monthly payment, and that the initial relief of a partial claim to pay their arrears and subsequent restructuring modification to extend their term for a new 30-year period was also unaffordable, they would need to submit income documentation to prove they needed more assistance. The standard HAMP calculations that were based on a target front-end debt-to-income ratio would apply. This way, the borrower received ONLY the assistance they actually needed. Interestingly, under that program, we found that 57% of those who submitted income documentation had payments that were already below 28% front-end debt-to-income and therefore did not need any additional assistance – some could even afford higher payments.
Are we really helping homeowners? Giving away insurance claim funds only to make it easier for servicers to scale their operations is short-sighted and will reinforce irresponsible debt repayment habits. The cost of an entitled homeowner, who has learned to disregard their most important debt obligation – their mortgage – will come back to bite every mortgage servicer. Small servicers, who do not have the benefit of an economy of scale, will be hurt the worst. If the 40-year modification requirement is extended to the regular waterfall and continues to be required for COVID workouts, FHA may succeed in driving the small servicer out of FHA servicing, which could also lead to the denigration of the FHA insurance fund as well.