What’s the impact of the end of forbearance?

On June 30 of this year, the federal forbearance program is set to end. While it’s been extended a few times before, it appears that given the pace of recovery a blanket forbearance program probably won’t be renewed again. Current data puts somewhere between two million and 2.5 million loans in forbearance programs, representing 4-5% of all mortgages. While the pace of economic recovery has seen that number decline significantly, we could very quickly start running into a group of borrowers facing far more chronic financial issues who can’t be brought out of forbearance as easily.

“The reality is that many there are many borrowers that will be financially distressed for an extended period of time as local segments of the economy – both in terms of geography and market sector – are forced to transform themselves in a post-COVID world,” said Andrew Wang (pictured), CEO of tech-driven servicing firm Valon. “This latent population of chronically distressed loans will likely number well over one million, several times the steady state seen pre-COVID.

“More significant at a national level, we expect this long tail to force transformational change among mortgage companies, particularly servicers, as they are forced to adapt to a new, dynamic paradigm. The ability to apply a flexible framework will be key as there will definitely not be a ‘one size fits all’ solution.”

Wang explained that while these households will challenge the mortgage industry, and servicers in particular, they are unlikely to drive a real crisis in the housing or mortgage markets. He explained that we find ourselves in a very different crisis from 2008 as the primary issue is not inherent in credit. Despite that outlook he expects “plenty of mess” and large local variance between harder hit markets.

Wang expects that the policy solutions and support from the Biden administration will likely come in a more targeted fashion, giving time to particularly hard-hit parts of the job market to recover. Debt forgiveness, Wang said, is unlikely as Biden will pursue more targeted measures to prevent a wave of distressed borrowers crashing into the market all at once. He expects that in this environment, servicers will be kept on a short leash by the federal government, due in part to a negative reputation earned in the 2008 crisis.

“We have yet to see how servicers have reformed their practices in a distressed environment at scale,” Wang said, “and this will certainly be a high-stakes and potentially existential test for the servicing industry.”

Wang believes that this current environment requires dynamic and flexible servicing, integrating new technology, borrower education, and customer support programs. He said that much of the industry is constrained by its older tech and organizational structures, contrasted now against a tech-literate and demanding borrower class. Wang, whose own company operates with more of a fintech philosophy, believes that the addition of regulatory pressure on servicers could cause more trouble as they try to integrate new regulations at a time when they need to upgrade their tech and take a more flexible and nimble approach.

While servicers will be shouldering the biggest burden in a post-forbearance market, Wang explained that originators will be facing challenges of their own, notably in underwriting. The forbearance credit reporting requirements introduced in the CARES Act will give lenders relatively less signal from credit reports in the years following the end of forbearance. Therefore assets, equity and income will play a larger role in the underwriting process. However, Wang sees a financing world post-COVID where mortgage lending and structured debt play an even bigger role in the economy.

“While mortgage underwriting will get more complex, mortgage lending will likely become an even more important segment of consumer debt as unsecured debt tightens relatively more than secured debt,” Wang said. “Depending on the overall path of financial markets at large (which will be influenced in part by the post-forbearance effects), HELOCs and second mortgages could become more prominent in a high-rate environment, while reduced rates could trigger a renewed refi wave.

“The more significant impacts will be the ones from COVID generally. Experience from lockdowns should be a forcing function to loosen restrictions on fully electronic or remote closes, driving additional efficiencies. Similarly, signs point to fewer restrictions on licensed branch requirements for loan officers, which could lead to broader coverage of more areas, particularly underserved markets. Governments, some of which were unable to provide key services like tax certs due to office closures, will be forced to continue to modernize and digitize their services.”