The Payment Supplement Agreement (PSA) will be the next significant loss mitigation policy instituted by FHA and HUD. The Mortgagee Letter is still in the late drafting phase but will be implemented sometime in 2024 or early 2025. This new regulation will be unparalleled and may cause serious strain on mortgage servicers that are not prepared for the staffing and logistical changes required for the impending transition.
What is the PSA?
The function of the FHA Payment Supplement is to use partial claim funds to bring the borrower current and then use additional claim funds to reduce their principal and interest (P&I) by at least 5% plus $20.00 and up to 25% for a period of 36 months. This is referred to as the monthly principal reduction (MoPR). However, the servicer can only offer this option if the borrower does not already qualify for a recovery modification that reduces the P&I by at least 15%. This is viewed as a better option since it is considered a long-term aid for the borrower.
Who Qualifies?
At DLS we have taken a sample of default loans from 2023 and reviewed them using an early mockup program for the Payment Supplement. The results were quite informative. The sample consisted of only loans that were designated as a waterfall Step 7, meaning the original modification partial claim combo did not achieve the targeted 25% P&I reduction. In lieu of the offered recovery workout, we looked to see if the borrower would have qualified instead for the Payment Supplement. The chart below shows the results.
Of the default loans that were Step 7, 40% would have qualified for the PSA. 24% of the loans achieved at least a 15% P&I reduction and, so, would have stayed as recovery partial claim combos. The remaining 36% did not achieve a -15% P&I reduction and did not have sufficient partial claim funds to qualify for the Payment Supplement.
The most significant determining factor for whether a loan qualified for the PSA was previous partial claims. Our loan sample showed that 24% of borrowers had a previous claim, and this statistic doesn’t even include borrowers who used up their entire lifetime funds (as these loans were left out since we obviously knew that they would only qualify for a straight loan modification). This is a stark difference from the 5% of borrowers who had a previous partial claim in 2022.
As the below chart reveals, if a borrower had a previous claim, they most likely would only qualify for a recovery modification that didn’t meet the -15% P&I reduction. The chance of meeting that reduction is statistically improbable considering the current state of interest rates. Only 20% of borrowers with a previous partial claim could be considered for the PSA program. In this case, we saw that in most circumstances the amount of the previous claim was less than half of the maximum lifetime amount.
Those that did qualify for a Payment Supplement would not have even utilized half of the claim funds (45%). The amount of funds used across the whole loan sample ended up being 78%, meaning that the PSA would have saved HUD 22% in the amounts paid for partial claims. This would also provide the borrower left over funds to tap into if they had another future hardship.
What about the Rest of the Waterfall?
Although we did not see any in our tests, there is a very small possibility that a loan may qualify for a stand-alone partial claim, if it doesn’t meet the 15% P&I reduction or have enough funds for the PSA. This is because the amount needed for a stand-alone partial claim is, as one would expect, less than the amount needed for at least a 5% P&I reduction Payment Supplement. The difference, however, is minute, and we expect less than 1% of default Step 7 loans to fall within this small margin.
Interestingly, most PSA loans met the targeted 25% P&I reduction. Most of the partial claim funds are used to bring the borrower current. This means that there is a small difference between the additional remaining amounts needed to achieve the 36-month 25% P&I reduction and a 5% one.
The early draft of the Payment Supplement also explains that if the borrower qualifies for a supplement plan, reaching at least 5% P&I reduction + $20.00, but the recovery modification offers a lower P&I, the servicers must offer the latter option. However, we did not run into any of these cases, especially since the amount of 5% PSA’s were not well represented as stated. It will be interesting to see if this scenario is a factor at all in the new waterfall.
Are there other Determining Factors?
There are a couple other key determining factors for whether a loan fell into one of the above workout options. One is the length of delinquency. The chart below illustrates the marked difference in delinquency length. The average delinquency for the whole review sample was 15 months. However, once that was broken down, we found that the average delinquency for PSA qualifiers was 7.7 months. If outliers with larger delinquencies are taken out, the average becomes closer to 7 months. This means that if the loss mitigation process is initiated and completed within the expected time frame, borrowers have a higher chance to be reviewed for the Payment Supplement Agreement.
Borrowers that meet the -15% P&I reduction recovery modification were less delinquent, 5.8 months. Again, if we took out the outliers, average delinquencies dip below 5 months. We expect that borrowers in imminent default and those with larger partial claim funds are more likely to fall within this category. Lastly, borrowers that did not meet a -15% P&I reduction for a recovery modification and did not have enough partial claim funds for the PSA, would still be offered a recovery modification, using whatever claim funds are available. Their average delinquency was 28.6 months, significantly more than the other cases.
Another key indicator was the interest rate differential. The important factor is not simply what the new interest rate would be but the difference between it and the borrower’s original rate. The average differential for the whole loan sample was -2.45%, which is due to the high interest rates in 2023. Loans that didn’t meet the -15% P&I reduction or qualify for the Payment Supplement had the highest interest rate differential at -2.74%. The difference becomes more significant when we compare the Payment Supplement Agreement (-2.61%) and the recovery modifications that do meet the -15% reduction (-1.65%), with a total difference of about 1%.
Who’s the PSA for?
Based on the data, the type of borrower that would benefit the most from this new FHA program are first time homeowners that undergo hardship. A borrower who has low pandemic level interest rates and ran into some financial difficulties is a prime example. The PSA would be a better option than a recovery modification because the borrower would keep the same low interest rate and have more claim funds leftover for the future.
On the other hand, the over 5 million 2023 homebuyers who may have overextended their finances buying a high-cost home at 23-year record high interest rates will be more likely to qualify for a recovery modification that meets the -15% P&I reduction. The interest rate differential will be negligible, and the borrower will likely have all their lifetime partial claim funds to reduce their P&I. These borrowers are only more likely to slip into the FHA Payment Supplement if they become significantly delinquent.
What about Servicers?
The PSA is a good program for both HUD and the borrower. The option allows the borrower to keep their original mortgage terms while at the same time reducing their mortgage payments. In most cases, also, FHA will not need to cover as large a partial claim cost as with modifications. While the program is beneficial, it requires more work on the part of mortgage servicers.
Systems need to be efficiently programmed to consider this new waterfall structure. Borrowers who can afford their payments will still receive a stand-alone partial claim. At DLS, 78% of the 15,000 FHA loans we reviewed in 2023 were partial claims. It is the other quarter of loans that have additional steps in the waterfall calculations for those who need a payment reduction. In summary, the steps in this case are abbreviated as follows:
- 30-year Recovery Modification with 25% P&I reduction.
- 40-year Recovery Modification with at least 15% P&I reduction.
- PSA with 25% P&I reduction for 36 months.
- PSA with at least 5% P&I reduction + $20.00 for 36 months, or:
- Recovery Modification if P&I is less than step 3.
- Stand Alone Partial Claim.
- Recovery Modification with available claim funds.
Servicers will find some relief in that most of FHA loans are reviewed for standalone partial claims. The waterfall processes are also still streamlined, so servicers still won’t need to keep track of full packet applications. However, this doubtfully offsets the complexity involved in programming and monitoring borrowers within the PSA program. The amount of logistics necessary to stay fully compliant with FHA regulations is significant. It is also known that USDA may adopt a similar program once FHA releases the PSA.
Servicers are strongly encouraged to begin discussing the steps necessary to make sure they have the systems and staffing in place to tackle the next wave of loss mitigation programs. Click here to listen to how we help spearhead this discussion in our December webinar. We would be delighted to continue this conversation with you.
Edit: Click here for the final version of the FHA Payment Supplement Agreement.
