Servicers Need to Prepare for the Potential FHA Default Wave
September 7, 2023
Government shutdowns, wild swings of the stock market and changing interest rates—these harsh realities are causing anxiety for many Americans. In fact, a consumer confidence survey in January showed that more than half of Americans assume their personal finances will get worse in 2019 rather than better.
This fear has seeped into the housing market: According to a survey from Fannie Mae, fewer people are buying homes, as they no longer think they can afford what is on the market. These fears aren’t unwarranted. Home prices have boomed over the last few years, yet an economic downturn could increase the risk of defaults on mortgages, including Federal Housing Administration (FHA) loans.
FHA loans are designed for borrowers in lower income brackets, and they require smaller down payments and lower minimum credit scores than traditional loans. These loans are insured by the FHA (an entity under the U.S. Department of Housing and Urban Development) and come with a premium, which protects lenders if a borrower defaults. Yet as the volume of these loans has increased, so has the risk of default—the FHA simply doesn’t have a large enough cash reserve for all of the defaults that could potentially occur during a catastrophic economic event.
Fortunately, there are ways for servicers to navigate any future wave of FHA defaults.
Jarad Bernotavicz, Director of Product Management at Equator, shares more.
America’s “silent crisis”
“America has a silent crisis in which a high percentage of people don’t have a sufficient rainy day savings fund,” says Bernotavicz. Combined with the fact that the government is the largest employer in the United States, this means that a single event such as a government shutdown can cause a setback to the housing market. With many people living paycheck to paycheck, even a temporary loss of income can cause issues for homeowners.
“Servicers will work with borrowers to try to keep them in the home,” says Bernotavicz, “but when people are operating on such tight personal budgets, it can be very hard for them to get fully caught up on payments. This is the sort of slippery slope that leads to higher rates of defaults on loans.”
Bernotavicz believes that FHA loans are particularly risky, yet 18 percent of servicers find them to be a big market opportunity. In fact, most of Equator’s customers have engaged with this sort of loan. Therefore, it was crucial that the company design tools that could help mitigate the risks associated with loan default even during periods of sharp economic downturn.
Technology to help servicers ahead of the wave of defaults
It’s hard to predict when the next big negative economic downturn might occur, but modeling tools can help servicers figure out the best approach for treating FHA assets. Equator’s default servicing platform was conceived soon before the large wave of defaults occurred in 2007. Its FHA Modeling Tool is a customizable solution used not only for market analysis, forecasting outcomes and record-keeping, but also to provide data that helps servicers develop actionable responses to market changes and re-optimization throughout the post-sale lifecycle. In addition, Bernotavicz says the tool “is meant to be used multiple times as FHA assets progress through various stages of defaults, from the earliest to the latest.”
What the FHA Modeling Tool does, says Bernotavicz, is “summarize any of the costs or losses that servicers have already incurred, and then it projects future losses that could be incurred depending on various plans of action.” In short, the tool assesses many different opportunities and thoroughly examines the financial implications for each of them.
Even when volumes of default aren’t high, they are still difficult to deal with. Bernotavicz says this is largely due to multiple departments needing to handle them. There might be one department for preservation work and another department to manage the foreclosure process. Coordinating between various departments can be tricky. A strong modeling tool, however, allows servicers to access bundled, customizable services to help streamline default processes. This means that even during a big economic downturn, servicers can not only more easily scale up to handle higher default volumes—they can also ride the default wave rather than be trapped beneath it.