Servicers can mitigate fallout from the more than one million foreclosures expected during the next few years by improving early contact with delinquent borrowers, working with nonprofit counseling groups and identifying the prospects most likely to recover, according to a federal regulatory report.
Best practices used by servicers were outlined in the Foreclosure Prevention: Improving Contact with Borrowers report recently announced by the Office of the Comptroller of the Currency.
Of nearly $1.5 trillion in adjustable-rate mortgages scheduled to reset this year, between $500 billion to $800 billion will actually reset with new interest rates, according to the report. Defaults on loans originated over the past few years with adjustable rates, introductory teaser rates, and payment options could lead to as many as 1.1 million foreclosures with losses nearing $11 2 billion throughout the next six years or more.
The report presented strategies that involve partnerships developed by banks, nonprofit organizations, state and local governments, and others who have a stake in keeping borrowers in their homes. In many of the partnerships, banks act as loan servicers and nonprofit organizations provide financial counseling.
"One of the most significant factors we discovered was that early contact and communication with lenders and trusted advisors to develop alternatives to foreclosures increases the likelihood that troubled borrowers will find solutions that enable them to stay in their homes," said Comptroller of the Currency John C. Dugan in the announcement.
The regulator described the increase in foreclosure rates as the unintended consequence of the mortgage industry's ongoing effort to extend credit access to less creditworthy borrowers. As lenders tried to keep pace with the demand for mortgage-backed securities, some, particularly in the subprime market, started combining the underwriting of such borrowers with other higher risk elements, including higher loan-to-value ratios and incomplete income documentation, the report explained.
"The rising number of subprime mortgage foreclosures has the potential to undermine the significant homeownership gains made over the past two decades," Dugan added. "Prudent attempts to work out loans of homeowners who have defaulted on their contractual obligations are often in the best interests of both the lender and the borrower."
Banks risk their reputation through the negative publicity they face over rising foreclosure rates and over individual loans they made or are servicing and are going bad. And if a significant number of loans in an investment pool go into default, an institution's ability to sell new loans on the secondary market is negatively affected. Additionally, besides foreclosures entailing a reduction in cash flow in securities and possible reduction in securities' market value, servicers incur significant expenses attempting to resolve problem loans and their income decreases as loans are removed from pools backing securities issues.
The interviewed banks could not provide a cost on a per-loan basis for their foreclosure prevention programs, but research has shown that lenders lose an estimated $58,759 per loan. The business "rationale underlying foreclosure prevention is that restoring a delinquent borrower to a current status on his or her loan is preferable to the potential losses inherent to foreclosure."
Direct losses on a foreclosure for loans the bank holds in its portfolio are an estimated 20 to 60 cents on the dollar, according to the report. On the servicing end, which faces having to hire additional staff when loans go delinquent and making advances on principal and interest to investors even if borrowers do not make payment, one bank reported that servicing a loan in foreclosure is at least three times as costly as servicing a current loan.
The report states servicing subprime loans is more expensive overall than handling prime loans because it requires frequent calls to borrowers who may also be receiving calls from other collectors. Plus, subprime borrowers also are more likely to send in partial payments that require additional resources to process. Servicers have found that approximately 80 percent of 90-day past due subprime loans roll into foreclosure. More frequent contact lowers the number of cases an employee can handle. Prime loan servicers generally call a borrower who has missed a payment 15 to 20 days after the payment was due, if that borrower typically makes payments on time, but subprime servicers will call as soon as one to two days after a payment was due, and sometimes even before a payment is due.
"All of the banks interviewed for this report described increasing the contact rate as the key to success of their foreclosure prevention initiatives," the report read. "As a result, the strategies banks have developed all focus on methods of increasing their ability to make contact with borrowers who are either behind on payments or alerting them earlier of impending loan rate resets."
Traditional collection methods are no longer producing satisfactory results.
"The old method was to flood borrowers with letters and telephone calls, hoping that the borrower would contact the servicer, but knowing that only a small percentage would do so," the office wrote.
Each of the surveyed banks have found that delinquent borrowers often do not respond to mail notifications from the servicer, and screen calls from lenders through answering machines and caller ID. Plus, cell phones are increasingly replacing land line phones, and many servicers are finding it difficult to obtain a phone number for borrowers who only use mobile phones.
The report shows that the main reason borrowers avoid lender contact is that they did not know the lender might be helpful. This was followed by the assumption that they would be able to make the payment in a few days, and the third most popular answer was that they didn't think the lender would care. Fear that the lender would foreclose on the loan faster, embarrassment about the problem and fear that they'd be charged a fee or penalty were other popular answers.
While letters and phone calls remain the main means of contacting delinquent borrowers, servicers have adapted these measures by training their loss mitigation staff to convey a number of positive messages early in the call. Many use software that can propose a workout solution with a payment schedule based on such factors as the borrower's income and expenses, and that also incorporates investors' requirements into the servicing agreement. The software packages script the call for staff.
The three main models for reaching delinquent borrowers are direct servicer contact, direct contact by counseling agencies and national toll-free number for borrowers to call.
Behavior scoring is one of the five most common strategies banks are using to improve their contact rate.
It involves the use of scoring models, that incorporate borrower-specific factors like credit scores and local unemployment rate trends, to help determine which late paying borrowers are priority contacts. The main purposes of the models are to streamline collection calls by risk-ranking delinquent accounts to identify loans most likely to benefit from early intervention and to identify loans most likely to create a loss without an intervention.
After behavior scoring, banks are also commonly contacting borrowers at non-standard call times, such as weekends and weekday evenings. They are also using borrower-friendly messages in their letters and phone messages, with the three most common being that the loan servicer does not want to take the home, is not judgmental, and would like to help the borrowers keep the home. They have developed options that do not require conversations, including sending a foreclosure prevention DVD and providing Web sites that outline information about payment and other workout options and the information that must be provided to take advantage of the options.
The fifth most common form of direct servicer contact is having "door knocker" staff visit borrowers to speak about their workout options and put them in direct contact with the loss mitigation and collections departments.
Some servicers realized that counseling agencies are more trusted by borrowers and found that partnering with an agency has increased their contact rates with delinquent borrowers. Agencies issue letters with a toll-free phone and Web site and let the borrower know they will be contacted through phone if it does not hear from the borrower. When contact is made, the counselor can collect documentation and information to evaluate loss mitigation options or if no feasible plan can be developed, help create a detailed plan for selling the property. Overall, some servicers have concluded that fees paid to counseling agencies are considerably lower in comparison with the costs of foreclosure.
The national toll-free model consists of several national nonprofit organizations who have partnered with mortgage servicers to provide 24-hour, seven days a week, no cost telephone counseling to delinquent borrowers. In about 25 percent of the counseling sessions, the borrower is recommended for loan workout, and the counselor works with the servicer on a loan modification.
The regulator suggested implementing a disclosure that authorizes the servicer to provide borrower information to nonprofit counseling agencies if the borrower is in danger of default.
However, foreclosure procedures vary by state, with
Obstacles facing servicers include state mandated judicial foreclosures, disincentived borrowers whose home value has fallen and safety and soundness issues that banks also address as part of offering foreclosure prevention programs.
The greatest roadblock to foreclosure prevention is the inability to contact borrowers, as research has shown an estimated 50 percent of foreclosed borrowers never talk to their servicer.
Three other big obstacles include borrowers not seeking help from credit counseling agencies; some MBS' pooling and servicing agreements containing restrictions on actions servicers may take in conjunction with loan workouts; and the disclosures that a servicer who is a debt collector under the Fair Debt Collections Practices Act must use in all correspondence to delinquent borrowers, both written and verbal.
The act's language that must be used in the disclosure, "This is an attempt to collect a debt and any information obtained will be used for that purpose," may lead to the unintended consequence of delinquent borrowers not being forthright in revealing their current financial condition due to intimidation and fear, the report states.
Nonetheless, the "federal bank, thrift, and credit union regulatory agencies are encouraging financial institutions to work with homeowners who are unable to make mortgage payments," the report stated. "Institutions will not face regulatory penalties if they pursue reasonable workout arrangements with borrowers."