While technological change has transformed ways of working in nearly every corner of financial services, US mortgage servicing stands as a stark outlier. In recent years, there has been a shift from banks to non-bank mortgage servicers, which operate in a competitive, low-margin, and highly fragmented industry. Non-banks typically lack the resources that banks have to make meaningful investments in technology and innovation. While many back-office processes are automated, there are few examples of non-bank servicers using technology to improve interactions with borrowers.
This shortage of investment presents significant challenges for both borrowers and servicers when mortgages require some sort of modification due to changing borrower circumstances. The COVID-19 pandemic has brought this need for innovation further into focus, as the industry grapples with the significant increase in mortgages in forbearance.
A lack of support for borrowers
The CARES Act allowed borrowers of federally backed mortgages to request and receive forbearance for up to 180 days. For borrowers experiencing financial hardship due to the pandemic, this was welcome relief. But where borrowers go from there is far less obvious.
When confronted with forbearance period expiration, borrowers are faced with a wide range of workout options, such as balloon payments or modifications to the loan’s term, interest rate, or monthly payments. However, there is little available in the way of digital decision support services that help borrowers evaluate the financial impact of each of these options. With the 180-day forbearance deadlines fast approaching and lockdowns continuing to limit access to personalized support, each individual borrower in forbearance is presented with a potentially challenging exit route.
Moreover, the process of modifying mortgage terms is paper-based and time-intensive – often requiring extensive data entry and in-person meetings. During lockdown, borrowers have been unable to access this personalized support, instead facing hurdles and uncertainty on how to best exit forbearance.
Forbearance workout is a collaboration between servicer and borrower, one that is made all the better with an informed borrower.
The challenge for servicers
The dilemmas facing borrowers represent a major problem for mortgage servicers as well. Performing loans typically have an annual servicing cost of less than $200, whereas non-performing loans can cost servicers around 10 times more a year. Historically these non-performing loans made up less than four percent of a mortgage servicer’s outstanding loans portfolio, so servicers could perform a delicate balancing act where the increased cost of non-performing loans was covered by profits from the servicing of performing loans.
The pandemic has tipped the scales. Despite forbearance rates dropping to a three-month low of 7.7% at the end of July, this still represents a volume several times higher than historical non-performing loan volumes. In addition, non-performing loans have increased to roughly 8% of outstanding loans. While loans in forbearance are technically performing loans, the costs associated with working out loan modifications to exit forbearance are closer to that of a non-performing loan.
This has two key implications for mortgage servicers. Firstly, there are currently around four million loans in forbearance. All of these will soon require borrowers to either extend the forbearance period for an additional six months – as permitted under the terms of CARES Act – or work with their servicers to agree an exit plan. To illustrate how time-intensive this upcoming workload will be for servicers relying on existing processes and tools, a conservative estimate of 20 minutes per call translates to 160,000 man-days industry-wide. The cost of exiting forbearance is going to be high for servicers in an industry with razor-thin margins.
Secondly, while the cost of servicing loans in forbearance is significant, it is still less than the expenditure on a non-performing loan. Failure to offer effective recovery packages will increase the risk that loans will fall into delinquency, at a great cost to both servicers and borrowers. It is therefore in servicers’ interest to offer tools that effectively inform borrowers of their options, provide ongoing decision support throughout the exit process, and facilitate open communication.
Forbearance workout is a collaboration between servicer and borrower, one that is made all the better with an informed borrower. But while there are a vast range of technology solutions available to help achieve this, it is important to recognize that many borrowers will still want some level of human interaction. To go from a highly personalized, high-touch process to one that is entirely digital would likely be a mistake. A combination of strategically applied technology along with human interaction at key points in the process would optimize borrower outcomes while minimizing operational risk and costs. For example, self-service interfaces that help borrowers understand the range of available options, modify financial assumptions, and analyze various scenarios would remove this burden from servicer staff. Staff would then be positioned to help borrowers execute their workout decisions, freeing them from extensive phone support.
The volume of loans in forbearance is far larger than the mortgage servicing industry has experienced in years and working loans out of forbearance will be prohibitively expensive using the processes and tools available today. If mortgage servicers are to effectively manage the huge volume of forbearance loan extensions and workout requests, they need to bring in the expertise to help them redesign existing processes and strategically embrace technology. This support will ultimately deliver better financial outcomes, both for borrowers and servicers.