May 26, 2020|Consumer Behavior, Credit, GSEs, Mortgage Industry
With all the group Zoom calls that make you look like you’re on the Brady Bunch intro, some of my readers may be feeling a little like Jan Brady: tired of hearing about forbearance in these Musings just like Jan was sick of always hearing about her sister Marcia. Forbearance is all I seem to be talking about, but that’s because RESPA and LO Comp aren’t what mortgage people have been calling me about lately. Likewise, martini advice, like “stir gin/shake vodka”, can wait.
Trust, transaction costs and credit scores
First, another brief economics discussion. Trust lowers the transaction costs in society. For example, it costs you virtually nothing to know if your mother is going to make a good babysitter for your child[1] (or not). But, compare that to the actual transaction costs of interviewing and vetting a nanny. With trust, however, parties can proceed in a transaction with significantly lower transaction costs.
Creditworthiness is another word for the trust that a lender has in someone to repay their debts. Lenders look at the credit behavior of borrowers to assess their future creditworthiness. If you want a mortgage loan, you need to reveal your past credit behavior (credit report) to your lender (which otherwise would be private) so they can assess whether or not to trust you to repay the loan based on that past behavior. The advent of credit scores enabled lenders to move beyond a binary assessment of credit (good or bad), to fine tuning loan pricing and products around various score levels. In other words, credit scores lower transaction costs by objectively measuring the trust that different people deserve to repay their loans.
The need for forbearance
I’ll get back to trust in a minute. Borrowers who need forbearance during the COVID crisis have nothing to be ashamed about. The pandemic has devastated the economy, hitting the lowest wage sector the hardest. A Pew Institute study published in late April, reported that income losses have been estimated to impact 43% of the workforce. Coupled with foreclosure moratoria, the forbearance program was a timely government safety net to not only address financial distress caused by the virus impact, but also to keep people safe in their homes during government ordered stay at home periods. As of May 19, 2020, Black Knight and National Mortgage News reported that 4.75 million borrowers representing 9% of eligible loans are now in forbearance.
Yet, If only 9% of eligible loans are in forbearance while over 40% have experienced income loss, the vast majority of people have adjusted their spending and/or are using savings to continue to pay mortgage debts.[2] As of my writing this, we are only two payments into this economic disaster (April and May), but given how easy it is to obtain forbearance, this is truly a testament to most borrowers’ (i) rainy day planning and spending habits as well as (ii) commitment to honor their agreements and maintain creditworthiness (trust).
What’s really going on with forbearance?
I was recently quoted in Rob Chrisman’s Commentary as saying, “Given what has happened to the economy (especially for hourly wage workers), it is likely that the vast majority of the borrowers seeking forbearance are in real need. Those people should not have to fear being asked about it the next time they try to get a loan.” Turns out, I was totally wrong about that “vast majority” comment. According to a recent Forbes Magazine article, 70%of people in forbearance surveyed by Lending Tree claimed they didn’t actually need it. Moreover, other reports indicated that approximately 30% of people in forbearance remained current on their payments. That’s a whole lot of unnecessary forbearance for a program designed to help people in need.
So, why would so many people claim that they need the help offered by forbearance when they didn’t need it? According to the Forbes story, “they just wanted a break from payments”. Meanwhile, why would some people ask for forbearance and then make payments anyway? Perhaps some folks want the psychological comfort of knowing that forbearance is available if they need it; but 30% of them? In crafting the forbearance program, however, the government wanted to make forbearance easy to obtain and to shield forbearance users from negative consequences on their credit by requiring that use of forbearance shall not “negatively impact credit”.
Is forbearance without need OK?
I’m not an underwriter but if I was, I would find use of forbearance without need by a borrower to reflect poorly on someone’s creditworthiness and it comes down to trust. Some might argue, on the other hand, that forbearance is merely like using an extension to file your taxes, but it’s not that harmless since someone else (servicers, GSEs, taxpayers, shareholders etc.) has to cover the payments in the interim to the investors even if the borrower will eventually pay it all back.
While I fully support the government’s efforts to avoid negative credit consequences for people who legitimately need to use forbearance due to COVID related income loss (esp. in light of that 43% figure noted above), I don’t think it’s right for borrowers without need to use forbearance as a payment holiday ultimately paid for by others. I addressed the “free lunch” question of forbearance in my last edition of the Musings, (spoiler alert-there is no such thing as a free lunch), and there will be at least some (poorly understood) consequences for forbearance users . It won’t negatively impact their credit score, but, they still have to be current for 3 months before they will be able to refinance or get a new loan from the GSEs based on the recent guidelines provided by the Agencies.
Most borrowers deserve an “attaboy”
As noted earlier, credit bureaus and scoring models are prohibited from using forbearance as a negative to consumer creditworthiness. But, with 43% of people in the US suffering income losses, it is clear that, at least so far, vastly more borrowers chose not to exercise forbearance than those who did or could have. Even though forbearance can’t be used as a negative to credit, the limited use of forbearance in relation to the overall universe of eligible borrowers says something remarkable about the trust and creditworthiness of the vast majority of people who did not use forbearance.
In fact, if you want to get technical, the government didn’t say anything about the people who didn’t use forbearance possibly getting a higher credit score. That is, why shouldn’t your credit score increase if you didn’t use forbearance: especially if you suffered COVID related income loss? Those people deserve to be recognized in a positive light. Who would you rather trust with a loan? Of course, on the other hand, for those of you who remember the Brady Bunch, perhaps I am making the same sort of mistake as Greg did in this episode involving living by “exact words”, but I’m a lawyer and we sometimes do that.
[1] I’m talking about transaction costs only. Having your mother (or mother-in-law) babysit is no free lunch.
[2] I realize that income losses from the pandemic probably impact renters at a much greater percentage than homeowners, but the numbers among homeowners alone are probably more than enough to make my point.