Facing Default or in Default?
Facing Default or in Default? There are many circumstances which cause a borrower to go into default or face the prospect of default. Our prior post on Disaster Declarations covered one such event. But more common reasons for default exist. As one would expect, job loss plays a substantial role in many defaults. Divorce and death also play primary roles in defaults. These share a common pillar of losing income support for repaying a mortgage.
On the expense side, medical bills cause substantial unforeseen expenses. But the entire category of unforeseen expenses triggers financial hardship for many. Whether this is a major home repair, car expense, support for a parent or child, these challenges cause a loss of financial reserves and savings. Many times, a credit card provides a short term bridge. But then the borrower becomes trapped with the high interest credit card payments. A third major, but generally avoidable, reason for default comes from borrowing too much. Misunderstanding of the total financial burden of a mortgage and home hurts many borrowers. Winning Mortgage, Winning Home develops a method for borrowers to be in a position to avoid these triggers.
What Is Relevant for a Workout
Regardless of how a borrower is facing default or in default, options exist on the next steps. As with the prior post, the options discussed are for federally owned or backed mortgages. FNMA is used as a guide as it’s the largest player. These mortgages are conventional mortgages. Privately owned mortgages (from a bank, credit union, or other lender), jumbo mortgages, second liens, home equity loans may have a different track and different options.
The unforeseen expense side of the equation may leave flexibility for a servicer to complete a successful workout. As a result, the number one priority of the borrower to avoid default and foreclosure must be on the income side. Divorce and death events make this a very difficult road to overcome unless some continuing cash flow and income stream remains. This might be alimony and child support in the event of a divorce or life insurance/disability insurance in the event of death or disability. Winning Mortgage, Winning Home delves into the key insurance requirements once a home is purchased and a mortgage obtained. In the case of a job loss, finding some income is very important. As one would expect, underwriting a workout or new loan where the income is $0 results in automatic denial. This is why the income side is the most important to address first.
Looking Ahead
FNMA encourages its servicers to look ahead and consider workout options in the 90 days prior to a default. Usually, the servicer won’t have too much ability to do look in the future, so it usually occurs at a time of default. Warning signs may come from difficulty in making payments on time or seeing payment timeliness slip. There is difference between a default covered in disaster events and other events of default. The difference lies in the requirement for borrowers to complete a detailed application for relief in the second instance.
This “Borrower Response Package” must be complete, provided by the borrower, and include all relevant documents. A piecemeal submission creates obstacles for a borrower to get any consideration. A servicer may have reason to believe a potential default is imminent, However, the servicer is prohibited from contacting any borrower who is current or less than 30 days delinquent for a workout option. This doesn’t prohibit the borrower from contacting the servicer though! Special rules apply to service members (military) which are more lenient.
Considering Workout Options
To be initially eligible for a workout, the borrower must be current or less than 60 days late. The property must be the principal residence and a complete Borrower Response Package must be submitted. The borrower submits a Mortgage Assistance Application (for FNMA, this form is Form 710) which shows the non-retirement cash reserves are less than $25,000. Form 710 lists hardships and the borrower must be able to document the specific hardship as the reason for the workout request. An example might be an interest rate increase resulting from a previously modified mortgage loan which causes the total mortgage payment to be unaffordable.
Just because a request is made doesn’t mean a workout can be approved. The servicer must obtain a current FICO credit score (less than 90 days old). In addition, a credit score less than 620 and two or more 30 day delinquencies in the most recent 6 months are required.
Examples of hardship include divorce, death of the borrower or one of the primary/secondary wage earners. Other hardships include long term disability of serious illness of a borrower, co-borrower or dependent. This doesn’t reflect an all inclusive list.
The servicer will take various actions. If the borrower had previously declared bankruptcy, the options become more focused on foreclosure or sale of the property. If not, the borrower should receive a letter which details contact information, lists of options and other information. For FNMA, this is Form 745.
Information is Needed by the Servicer
Generally, a request for permission to obtain tax information from the IRS will be included for the borrower to provide. The servicer will evaluate the information provided by the borrower(s). Information will be verified just as it was at the time of initial loan application. Income verification begins the process to determine the gross income of all borrowers and payers. The servicer reconciles this with IRS data. Additional data in the borrower’s package will be reviewed and verified. However, if the information is incomplete, the foreclosure process may continue and the borrower’s workout will not proceed through review.
A wrinkle to any workout is that Fannie Mae and Freddie Mac may not be the end owner of the mortgage. Both entities routinely bundles and pools large numbers of mortgages together to create Mortgage Backed Securities (MBS) of which there then become many, many end owners of parts of this large pool. The MBS is like a pie. The ingredients are many mortgages which then form one pie. When completed, individual slices of the pie then go to different entities. Mortgages is an MBS many times may not be modified. Often, the loan must go 4 or more payments delinquent before they can be removed from the MBS pool. Once that occurs, a modification can become possible.
Similar options may exist to those outlined in our post on disasters. Another post will cover what options might be available other than those outlined in the prior post.
Timelines
A servicer generally has 30 days from receipt of a complete borrower package to review, evaluate and notify a borrower of a decision on workout options. As noted, the borrower package must have a complete and signed application, a complete set of each and every document requested or relevant, and a signed, complete IRS tax transcript request (IRS form 4506) for every borrower and entity owned by borrowers.
A decision may be a denial or it may offer a workout option. If a workout option is offered, the servicer must detail the workout offer, the steps needed to participate and accept an offer, and a 14 day deadline to accept or decline the offer. The workout offer will only be ones made available by the lender and may or may not be one the borrower wants to obtain. While the servicer may explain all of the potential workout options available, the borrower information may preclude some, or all, from being offered. The borrower must strictly comply with any terms of a workout option offered as to payments, timing, documentation, and any other request. A servicer cannot require an upfront cash contribution to be considered for a workout.
Hardships, Trials and Repayment
A workout usually involves a Trial Payment Period (TPP). If the borrower doesn’t comply with each and every requirement in the TPP, the workout will not move to a permanent modification and may restart default and foreclosure proceedings.
A borrower with a short term hardship (less than 90 days delinquent) can offer a repayment plan to bring the loan current in 6 months or less. In this case, the borrower does not have to provide a complete borrower package. Some limits to this exist. It reflects an exception to the borrower package requirement. A different standard applies if the loan is greater than 90 days delinquent or the time to repay and bring the loan current will take longer than 6 months. This require a complete borrower package. Repayment plans taking longer than 12 months require special circumstances. Such circumstances may be considered. Additional approvals may be needed on the lender side to accept such a repayment plan. In any event the borrower needs to show the financial capability to complete the repayment plan in the time allotted.
This doesn’t cover every option and requirement. Many options are similar to those which result from the current forbearance program. Options rely mainly on a borrower establishing income. Income from unemployment assistance doesn’t rule out a workout, but it rarely is enough to make a dent in the hardship. Options do exist if a borrower is facing default or in default.