Many mortgage companies are nonbanks that don’t have deposits or other business lines to cushion them amid the coronavirus pandemic.
Ann Winn called her mortgage company to see about pausing payments in late March, soon after she had to shut down the salon she owns in a suburb of Austin, Texas.
What followed, she said, were hours of tense calls and emails with Freedom Mortgage Corp. The company agreed to let her skip a few payments—but only if she would repay them all in a lump sum this summer. Ms. Winn didn’t know when she would be back at work, so she declined.
“I’m just not going to pay my other bills,” she said, “because I don’t want to lose my home.”
The coronavirus pandemic has delivered a gut punch to the economy and the mortgage market is particularly exposed. The virus has forced millions of homeowners to suddenly stop making payments. At the same time, many mortgage companies aren’t built to handle an economic collapse or help their customers through it.
Many of them are nonbanks that don’t have deposits or other business lines to cushion them, and they have raised concerns that fronting payments for struggling borrowers such as Ms. Winn will quickly drain them of capital.
Years ago, the financial crisis revealed the folly of churning out “liar loans.” Regulators cracked down, and mortgages made today are generally more conservative. What regulators didn’t focus on was the strength of the mortgage companies themselves. Though the loans are sturdier, the infrastructure largely didn’t change.
Over the past decade, the business of originating and servicing mortgages has moved back toward nonbanks such as Freedom Mortgage. Nonbanks made 59% of U.S. mortgages last year, the highest level on record, according to industry-research group Inside Mortgage Finance. They also made a large proportion of U.S. mortgages before 2008 but many went bust when the crisis hit.
Many nonbanks, like United Wholesale Mortgage and loanDepot.com LLC, are barely known outside the industry but dominant inside it. Quicken Loans Inc., one of the few with wide name recognition, ranked as the largest mortgage lender by originations for the first time this year, elbowing out Wells Fargo and JPMorgan Chase.
As big banks have refocused their mortgage operations on wealthier borrowers, nonbanks have stepped into the void, often representing the only path to a mortgage for buyers of lesser means. Their retreat could lock many would-be borrowers out of homeownership and make it harder for the economy to bounce back.
Nonbanks also have expanded in the crucial business of servicing mortgages. They now service roughly half of them, five times their share from a decade ago, according to the Urban Institute.
In good times, that task involves collecting payments from borrowers and handing them to investors that own the loans, plus handling odds and ends such as taxes. In exchange, the servicer gets a slice of the interest. In bad times, servicers are supposed to create new payment plans for struggling borrowers, which takes much more work and expense. When all else fails, servicers initiate foreclosures.
For years after the crisis, regulators, mortgage executives and consumer advocates discussed how to improve this market. They floated ideas about changing the way servicers are paid so they collect a bigger fee when a loan becomes delinquent. They also considered having the servicers fund a central utility to handle defaulted mortgages. But those ideas never gained much traction, according to people involved.
“There was a big focus on the consumer experience,” said Michael Bright, the former head of government mortgage corporation Ginnie Mae, which backs Federal Housing Administration loans. “But there wasn’t much focus on the quality of a servicer.”
The structure of the U.S. mortgage market is much the same as it was before the crisis. Pools of mortgages are packaged and sold to investors around the world. When a borrower stops paying, servicers are caught in the middle, forced to front payments to the investor, even though they aren’t receiving money from the borrower.
The servicer will eventually get reimbursed if the mortgage is one of the roughly two-thirds guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. But that is a slow process and in some cases can take years.
Lawmakers recently outlined how struggling borrowers can request so-called forbearance plans, by which they pause their monthly payments. If the mortgage is government-backed, then companies are generally supposed to grant the request.
That has thrust both banks and nonbanks into the position of cushioning the blow for their customers. Nonbanks, which depend on short-term bank loans to fund their daily operations, are struggling to do so.
“This is a systemic problem,” said Karan Kaul, a senior research associate at the Urban Institute.
About 7.5% of borrowers had obtained forbearances as of April 26, according to a survey by the Mortgage Bankers Association, or MBA. That means about 3.8 million homeowners are skipping their monthly payments with permission.
If forbearance rates reach the mid-to-high teens, few servicers are expected to have the cash to meet their advance obligations, according to Warren Kornfeld, who covers nonbank mortgage companies at Moody’s Investors Service. As a result, many are now trying to gain access to additional cash.
Mortgage servicers, both banks and nonbanks, were on the hook for about $4.5 billion a month in servicing advances on government-backed loans because of forbearances as of Thursday. That is roughly 25 times more than they were on the hook for at the end of February, according to Black Knight Inc., a mortgage-data and technology firm.
Ms. Winn and her husband bought their Leander, Texas, home in 2014 using the FHA loan program, which is meant for first-time and modest-income buyers. Later, they learned their lender had passed the servicing rights to Freedom.
Ms. Winn had little interaction with Freedom until calling in March. A representative told her she could skip payments for April, May and June, but would then have to pay four months all at once. Another representative told her that she could later ask to tack the missed payments onto the end of the loan, but that there was no guarantee she would be approved.
In late April, she received a letter saying she had been automatically opted into the first plan. She intends to keep making her monthly payments anyway, since she doesn’t want to pay for four months at once.
Chief Executive Stanley Middleman said in a statement that Freedom is “managing a great deal of unplanned activity” but plans to fix any issues that arise.
“We are doing the best we can and will continue to do so,” Mr. Middleman said.
The stimulus bill provided little detail on when borrowers would have to make up deferred payments. But the regulator that oversees Fannie Mae and Freddie Mac, the government-sponsored mortgage companies that back conventional loans, clarified recently that its homeowners won’t have to make up their missed payments all at once. The FHA program has made similar comments.
Industry representatives say that forbearance plans were rolled out on a vast scale very quickly, which led to confusion among both servicers and borrowers. Bob Broeksmit, CEO of the MBA, acknowledged that there have been issues between servicers and borrowers but said that recent guidance is likely to bring more clarity.
The borrowers the nonbanks serve are often the ones that most need help. Last year, nonbanks made 86% of FHA mortgages. As of Thursday, roughly 13% of FHA loans had forbearances, according to Black Knight.
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Nonbanks say they have spent significant time bolstering their businesses for a downturn. Some said in recent earnings reports that they now expect the coronavirus fallout to be smaller than they initially feared. Still, Ginnie Mae has set up a lending facility to help companies that are out of options. Fannie Mae and Freddie Mac are only requiring servicers to advance four months’ worth of payments.
The health of nonbanks ultimately depends on keeping their funding. Worried about the surge in borrowers seeking relief, some banks have recently curtailed this lending.
Mortgage companies, both banks and nonbanks, are also pulling back on some lending to borrowers. Credit availability in April fell to its lowest since 2014, according to the MBA.
Lenders are cutting back in particular for borrowers with lower credit scores, according to the Urban Institute. But the contraction in credit is spreading to all types of loans—from jumbo mortgages to cash-out refinances.
Beverly Harris was in the process of buying a home in the Palm Springs, Calif., area in March when the type of unconventional loan she had been pre-approved for suddenly became unavailable.
The retiree, who has a high credit score and was planning to put 20% down, was expecting to use a loan that qualifies the borrower based on assets rather than income. She estimates she checked with 15 different mortgage companies and banks. All of them had stopped making those types of loans.
For now, Ms. Harris is staying put in her rental.