I. INTRODUCTION
The Federal Financial Regulatory Agencies and the Conference of State Bank Supervisors (CSBS) issued a statement encouraging federally regulated institutions and state-supervised entities that service mortgage loans (collectively referred to as “servicers”).
II. LOSS MITIGATION STRATEGIES
Servicers of securitized mortgages should review the governing documents for the securitization trusts to determine the full extent of their authority to restructure loans that are delinquent or in default or are in imminent risk of default. The governing documents may allow servicers to proactively contact borrowers at risk of default, assess whether default is reasonably foreseeable, and if so, apply loss mitigation strategies designed to achieve sustainable mortgage obligations.
A significant number of adjustable-rate mortgages are scheduled to reset throughout the end of this year and the next. It is anticipated that these resets will cause payment shock to the borrowers, and therefore, increase the likelihood of default. Many subprime and other mortgage loans have been transferred to securitization trusts that are governed by Pooling and Service Agreements. Servicers are encouraged to use the authority that they have under the governing securitization documents to take appropriate steps when an increased risk of default is identified, including:
Loss mitigation techniques that preserve homeownership are generally less costly than foreclosure, particularly when applied before default. Prudent loss mitigation strategies may include loan modifications; deferral of payments; extension of loan maturities; conversion of adjustable-rate mortgages into fixed-rate or fully indexed, fully amortizing adjustable-rate mortgages; capitalization of delinquent amounts; or any combination of these. As one example, servicers have been converting hybrid adjustable-rate mortgages into fixed-rate loans. Where appropriate, servicers are encouraged to apply loss mitigation techniques that result in mortgage obligations that the borrower can meet in a sustained manner over the long term.
In evaluating loss mitigation techniques, servicers should consider the borrower’s ability to repay the modified obligation to final maturity according to its terms, taking into account the borrower’s total monthly housing-related payments (including principal, interest, taxes, and insurance, commonly referred to as “PITI”) as a percentage of the borrower’s gross monthly income (referred to as the debt-to-income or “DTI” ratio). Attention should also be given to the borrower’s other obligations and resources, as well as additional factors that could affect the borrower’s capacity and propensity to repay. Servicers have indicated that a borrower with a high DTI ratio is more likely to encounter difficulties in meeting mortgage obligations.
Some loan modifications or other strategies, such as a reduction or forgiveness of principal, may result in additional tax liabilities for the borrower that should be included in any assessment of the borrower’s ability to meet future obligations.
When appropriate, servicers are encouraged to refer borrowers to qualified non-profit and other homeownership counseling services and/or to government programs, such as those administered by the Federal Housing Administration, which may be able to work with all parties to avoid unnecessary foreclosures. When considering and implementing loss mitigation strategies, servicers are expected to treat consumers fairly and to adhere to all applicable legal requirements.
III. DEBT-TO-INCOME RATIOS
In a related issuance, the federal financial agencies and CSBS have cautioned supervised institutions regarding debt-to-income (DTI) ratios above fifty percent when applying loss mitigation techniques intended to achieve long-term sustainable obligations to provide stability to borrowers, investors, and the marketplace. Absent mitigating circumstances, DTI above fifty percent increases the likelihood of future difficulties in repayment and delinquencies or defaults.
The agencies note that in developing the appropriate loss mitigation strategy for individual borrowers, it is essential to consider the borrower’s ability to repay the modified obligation. Attention should also be given to the borrower’s other obligations and resources, as well as additional factors that could affect the borrower’s capacity to repay. The DTI ratio should include the customer’s total monthly housing-related payments (e.g., principal, interest, taxes, and insurance, or what is commonly known as PITI) as a percentage of their gross monthly income.