The Great Recession pitted lenders against borrowers in a financial crisis that produced an estimated 3.8 million foreclosures between 2007 and 2010. There were no winners. People lost their jobs, their homes, and their creditworthiness. The financial services industry was decimated by non-performing loans, bad publicity and the cost of litigation. This can’t happen again, and it doesn’t have to.
One thing is clear – the COVID-19 pandemic is devastating families and communities across the country. But it doesn’t have to lead to the next foreclosure crisis if we join forces now. In the context of the current crisis, lenders and borrowers must share in the responsibility of preserving the mutually beneficial lender/borrower relationship.
Lenders, like other businesses, have found it necessary to pivot in light of state orders asking workers to stay at home. The safety of employees has required a shift to remote work and the resulting inability to close loans with traditional levels of personal contact has caused closing delays.
These logistical challenges put lenders in a vulnerable position. They must close loans to generate revenue, loan servicers must meet obligations to investors regardless of interruptions in payments, and future business will be determined in large part by the ability to maintain customer service relationships.
Substantial efforts have already been made to assist borrowers affected by the pandemic. The Department of Housing and Urban Development (HUD) and the Federal Housing Finance Agency (FHFA) have announced moratoria on foreclosures and evictions. State governments have done the same. The Consumer Financial Protection Bureau (CFPB) has encouraged lenders to provide affected borrowers with access to forbearance plans. FHFA forbearance programs allow mortgage payments to be suspended for up to 12 months. But lenders should not limit themselves to the mandates issued by government agencies. They should also consider the following as beneficial to their own businesses:
- Offer all possible loss mitigation solutions, because the alternative will inevitably be non-performing loans. The foreclosure crisis of the late 2000s saw an alarming number of strategic loan defaults, forcing lenders into years of costly litigation in states like Florida, which require judicial action in order to complete a foreclosure. Successful foreclosures resulted in a high numbers of lender-owned properties (REO).
- Communicate with borrowers. The key to maintaining industry continuity will lie with a lender’s ability to maintain some level of confidence with the public. The pandemic is not the fault of the financial services industry, but the foreclosure crisis is too recent a memory for borrowers to emotionally separate their hardship from perceived past failures of mortgage lenders.
- Proactively identify borrowers who are vulnerable to default. Borrowers who have a history of late payments are subject to a higher probability of relapse. Early communication about creative solutions returns power to the lender to prevent a defaulted loan, and making efforts to help borrowers avoid default also reduces the need for negative credit reporting. Borrowers who have not suffered negative credit reporting will have the ability to borrow again, and they will remember lenders who were willing to be part of the solution when they struggled.
- Extend new loans. Lenders should not be afraid to continue lending. Borrowers who qualify for loans in the midst of the pandemic are generally those who have a degree of security, possibly because they are employed in essential services or because they have work environment flexibilities that allow them to maintain productivity. Growing your portfolio should be viewed as an opportunity to compensate for some losses with new revenue sources.
The Great Recession revealed that in many cases, loans were extended based on stated income, which meant approval for loans well beyond the means of the borrower. This was partly the result of lax lending practices, but also reflected an absence of personal responsibility on the part of consumers who overstated their income and borrowed beyond their means. In the wake of that crisis, lenders improved methods for loan approval.
Homeowners were generally in great shape going into 2020. Credit quality (based on origination credit scores and loan performance) was at an all time high at the beginning of the year. The challenges faced by homeowners in light of the COVID-19 pandemic are not the result of subprime loans that contributed to the level of foreclosures during the recession. This is an important distinction because homeowners play a critical role in the eventual rebound of the real estate and financial services markets.
Looking back at 2019 reveals record levels of homeowner equity (due to increasing home values) and low interest rates. According to Black Knight, refinance transactions accounted for 57% of lending in the fourth quarter of 2019. The purchase market was also strong.
Borrowers should resist the urge to equate today’s crisis with that of the Great Recession, because they have much greater power to be part of the solution. There are some simple considerations that afford borrowers (both current and prospective) greater opportunities:
- Purchase a home at a lower budget level. Staying within a budget is always wise, but the ability to ride out economic interruption caused by job reduction (or loss) is much easier when a home loan doesn’t reflect the maximum amount a family can afford. In the case of a two income household, consider financing a mortgage based on just one income.
- Communicate early with your lender. If you already own a home and experience financial disruption as a result of the pandemic, do not wait to explore your options. It is in your lender’s best interests to maintain a performing loan, but they cannot provide you with options for loss mitigation if they do not know you are in trouble.
- If you can afford to pay, do not resort to a strategic default. During the foreclosure crisis, many borrowers who could otherwise afford to pay their mortgages elected to cease payments. This was largely a result of low home prices and a lack of equity, but it resulted in a flood of foreclosures and ruined credit ratings. You have very little to gain and much to lose through a strategic default during the current crisis.
- Take advantage of low interest rates, but don’t be foolish. Interest rates are somewhat volatile and if you have the ability to lock in a rate at which you’d be comfortable, don’t wait in the hope that you’ll get a slightly reduced rate. This kind of risk may backfire. For example, analysis by Mortgage News Daily reflects that on March 5, 2020, borrowers who qualified for a $1,075 per month mortgage payment would have been able to purchase a $313,000 home with 20% down. Less than two weeks later, on March 19, the same homeowner would only qualify for a $276,800 home because of interest rate volatility. This is more than a $36,000 reduction in buying power.
The greatest unknown element in determining the future of the financial services industry is consumer behavior. Such behavior cannot be entirely predicted or controlled, but it can be guided by a joint effort to quell anxiety and explore workable solutions. Lenders and borrowers do not need to find themselves in contrary positions if both camps agree to join in solidarity now. Doing so will promote future lending, reduce the risks associated with loan defaults, and instill a greater level of confidence that will carry through as the economy recovers from the COVID-19 pandemic.