Escape From Forbearance. How Much Does Forbearance Cost?
Estimates of the number of mortgage borrowers who entered forbearance at some point over the last year range as high as 11 million. Some borrowers used it as a precaution, others had little other choice. Because there were differing reasons for entering forbearance and differing circumstances, many borrowers were able to exit forbearance. The exit would likely be from a sale of the house, reduced payments for some period if possible with an extended period at the end of the mortgage to pay it back, or total forbearance with $0 payment for a period and tacking on an extended period at the end of the mortgage to pay it back.
Alternatively, at the end of the forbearance period, the amount of the payment could increase in order to completely pay back the loan in the time it was originally set to be repaid. The borrowers would need to re-qualify since an increase in payment might create an issue with the DTI—the amount of monthly debts being paid exceeds the percentage of income allowed. It may also create an issue with LTV. Read Winning Mortgage, Winning Home for more information on the DTI and LTV issues.
Impacts of Forbearance on Principal and Interest
The difficulty with forbearance is that it acts as a negatively amortizing loan. In a basic mortgage, some part of the payment goes towards interest and some part goes towards reducing the amount owed on the loan. In this case, the loan amortizes down a little each month until the amount owed reaches $0. With a negatively amortizing loan, during the time period when it is negatively amortizing, the payment made each month is not enough to pay all of the interest.
Instead of part of the payment going towards interest and part towards principal, all of the payment goes towards interest. The interest charge is greater than the amount paid each month. So the amount each month that the payment is less than the interest amount, the unpaid interest gets added on to the principal balance of the loan. The amount owed INCREASES each month until normal amortization begins. During forbearance, if the amount paid each month is $0, all of the interest which wasn’t paid gets added to the amount owed, which must be paid back to the lender at some point.
Other Impacts of Forbearance on the Mortgage
The monthly payment by a borrower probably isn’t just principal and interest. Included in the monthly payment would be escrows for property taxes, property insurance, private mortgage insurance, and flood insurance. It is possible that all of those items get deferred along with the principal and interest portion. The maximum period of initial forbearance is 12 months provided the borrower entered into forbearance prior to March 1, 2021. However, there are circumstances where the lender/servicer can provide up to two extensions of 3 months each. This equates to a total of 18 months of forbearance allowed for FEDERAL mortgages (FNMA, FHLMC, FHA, VA, USDA, BIA).
The foreclosure moratorium ends 6/30/21. However, it is possible that a borrower entering forbearance in early 2021 may get the ability to remain in forbearance past the summer of 2022!
Issues With Forbearance
What’s the issue with remaining in forbearance? The longer a borrower remains in forbearance, the less likely the borrower will be able to restructure and re-qualify for the mortgage. The borrower may be facing a LTV which is too high, a DTI which is too high, escrow catch-up issues, re-instatement of PMI or increased PMI cost, and other obstacles to get back on track. Let’s look at an example of the issues.
Our borrower has a $200,000 mortgage. The borrower has paid on it for only a year, then goes into forbearance. The borrower became unemployed and as a result, was not making any payments on the mortgage. The interest rate on the mortgage was 4.50% when it was made. So the principal and interest portion was $1,013 per month. In addition, the borrower has borrowed more than 90% LTV, so the borrower must escrow taxes, insurance and PMI. Assume property insurance is 0.5% of the mortgage amount, or $1,000 per year. Additionally, assume property taxes amount to 2.00% of the mortgage amount, or $4,000 per year. Assume that the borrower’s credit score required PMI in an amount of about 1.00% of the mortgage each year.
Totaling the PMI and OTher Costs
Winning Mortgage, Winning Home provides more information on how this is calculated. Assume there is no flood insurance required. The property taxes and insurance would actually be more reflective of the value of the home. They are not based on the mortgage amount only. But let’s use the $200,000 mortgage amount for simplicity. The property taxes, property insurance and PMI would total $7,000 per year. The amounts reflect insurance of $1,000, taxes of $4,000 and PMI of $2,000. This equates to paying $583 per month into escrow. Our borrower went into forbearance for 15 months.
Calculate the Unpaid Principal and Interest
As mentioned, there are a few options to exit forbearance. One is to pay all the missed payment amounts in a lump sum and resume the original payment schedule. On the original schedule, the loan amount owed would have been reduced to $192,531 at the end of the 27th month. Remember, the borrower made 12 payments, then went into forbearance, deferring the next 15 payments. In addition, the borrower did not make payments of taxes, insurance or PMI. At the end of the forbearance period, the borrower would owe $208,137 of principal based on the 15 months of missed payments.
Of the original $1,013 in monthly payment, about $750 per month was interest at the time the borrower entered forbearance. That amount gets added on to what the borrower owes and additional interest accrues on that each month also. At the end of 15 months of forbearance, the borrower owes $15,600 more than would have been owed without forbearance. Payment in a lump sum would be extremely unlikely.
Calculate the Unpaid Taxes, Insurance, PMI and Escrow Payments
In addition, the borrower missed $7,000 per year of escrow payments ($583/month), or an additional $8,750 in taxes, insurance and PMI. The CFPB has caused confusion in interpretation of the law regarding repayment of escrow shortages. However, let’s explore how the law is written. The servicer must allow the repayment of the escrow shortage over a period of at least 12 months. Normally, an escrow shortage is calculated by servicers to be repaid in 12 months. Add all those amount together.
The borrower would need to make a one-time lump sum payment of more than $15,000 for principal and interest. The borrower would resume normal monthly payments of $1,013 of principal and interest. Next, the borrower must resume monthly escrows of $563/month. And last, the borrower must add an additional $563/month for 12 months for the escrow shortage to get back on track. This is extremely unlikely, so other options need to be explored.
Summary of the Amounts Owed and Escrows
One important note in exploring all options to come out of forbearance. The amounts which make up the $24,000 owed are likely to be owed to two different companies. The first is the lender. The second is the servicer. Most loans are sold after being made; that is where the servicer comes in. Even if the lender doesn’t sell the loan, the amounts owed may be treated differently. The amount owed the servicer is the $8,750 of taxes, insurance and PMI. Under federal rules, the servicer is obligated to advance funds when needed for escrow shortages.
A shortage occurs when there isn’t enough money I the escrow account to make a required payment, such as the property taxes or insurance. Under other obligations where certain lenders own the mortgage, the servicer is required to protect the asset by advancing money to pay property taxes, property insurance and PMI. So the servicer in this case has advanced $8,750 which needs to be repaid. The lender’s loan has risen to an amount of $208,137 owed now.
Repayment Options – Amounts Owed to the Servicer.
For the $8,750 advanced, there are limited options to bring this current. The CFPB has sowed confusion as to whether this can be repaid in one payment. Normally, a borrower may want to voluntarily make a one-time payment when a small escrow shortage occurs due to a jump in property taxes or property insurance cost. The CFPB has said this money cannot be voluntarily repaid at once at the borrowers option, which is an absolutely stupid interpretation, but par for the course for government bureaucrats. The remaining option is to replenish the escrow account over a period of not less than 12 months.
Fannie Mae and Freddie Mac have developed options to make this period up to 60 months in some circumstances instead of 12 months. For the 12 month option, a borrower would need to make the normal payment into escrow of $583/month, but would also need to pay an additional $729 per month to make up the $8,750 of missed payments. On the 5 year option, the additional payments would equal an added $146 per month. Addressing only the escrow shortage for now and not the principal and interest, the normal monthly payment would have to rise from $1,596 ($1013 PI + 583 TI/PMI) to either $2,325 per month under the 12 month repayment or to $1,742 under the 60 month repayment.
Repayment Options – Repay or Recast the Mortgage for Deferred Principal and Interest
The first option, payment in one lump sum, isn’t very likely. However, there were a number of borrowers who entered forbearance and never missed a payment, or missed few payments. These borrowers probably pre-emptively took a cautionary route fearing unemployment of inability to pay. Supplemental unemployment insurance, no layoffs, or other reasons enabled the borrower to keep repayment current or to repay any missed payments in a lump sum. This was a large group of borrowers who initially entered forbearance early and exited early.
The second option is to enter into a mortgage modification which increases the payments for the remaining life of the loan in order to repay the loan and the end of the originally scheduled term. For our borrower who deferred 15 payments while in forbearance, the new payment would increase from $1,013 of principal and interest to $1,096 of principal and interest. This option may be subject to re-qualifying the new payment just like the original qualifying including DTI, LTV and Credit Score. It will vary by lender. The re-qualification may be an issue as noted below and may result in increased PMI costs and interest rate increases.
Extend the Loan or Add a Second Lien
The third option is to add extra payments to the end of the mortgage term so that it is repaid over a longer period. For our borrower with 15 missed payments and an original 30 year mortgage and a 4.50% interest rate, the term would have to go to 420 months total, adding 5 YEARS to the term. Note that for rates higher than 4.50%, the number of months added to the term of the mortgage increases. At 5.50%, the term would have to increase to 446 months, or an additional 7 YEARS. This option will also vary by lender. Because the payment doesn’t increase, the DTI increase may not be a concern. The LTV increase might result in additional PMI costs and interest rate increases.
A fourth option has been added by Fannie Mae and Freddie Mac. Other lenders may also offer this option. This option provides that the sum of the payments missed may be structured into a non-interest bearing second lien. For our borrower owing an additional $15,000, the original loan may resume and the $15,000 second lien would become payable any time the borrower refinanced, sold the home, or when the original mortgage was paid off. When offered, this appears to be one of the more attractive options due to the non-interest bearing nature of the second lien. Because there may be limited lenders which can offer this forbearance escape plan, it may not be available to any specific borrower.
Re-Underwriting Risks and Costs
Readers of Winning Mortgage, Winning Home are familiar with the underwriting steps and break points for DTI, LTV, and credit score and how these affect the loan interest rate and PMI costs. If we assume that the borrower’s initial loan was the maximum amount the borrower could afford based on DTI, LTV and Credit Score, any one of those three factors might eliminate various options to escape forbearance. What if the borrower’s credit score is impacted by a job loss as the reason for forbearance? Is it likely there might be one or more missed payments also on a credit card or other debt? If so and the credit score falls, the loan may change interest rate upwards.
Our borrower initially borrowed over 90% LTV. Now that the amount owed is greater than the initial amount owed and the LTV is closing in on 100%. This may affect an interest rate to restructure the mortgage. While the borrower likely would never have qualified for a mortgage at that high of an LTV, the restructuring allows a higher LTV. Also, since the LTV is higher, the cost to buy PMI is also higher.
Ability to Repay
Did the borrower become re-employed? If so, is the new income equal to or greater than before? Is it lower than before? Continued unemployment or an income lower than before creates an issue with ability to repay the loan at all, especially if the loan was the maximum the borrower could afford prior to forbearance. All these add up to diligent efforts on the part of the borrower to exit forbearance. It’s not as simple as resuming payments where they left off.
In summary, a snapshot in January 2021 of the mortgages entering forbearance found that about 75% of the mortgages have missed 10 payments since April 2020. These borrowers will be the ones most difficult to be exit forbearance.