Impact of COVID-19 on the Mortgage Industry

By now, we are all aware of the impact of the novel coronavirus “COVID-19” on our lives. Travel is restricted, businesses are closed, many are quarantined, and when we do go out, many of us wear face masks and stay at least six feet from other people.

But what has the impact of COVID-19 been on the mortgage industry? Surely, it’s been a benefit after the Fed cut rates to near zero. People all over the country must be refinancing and saving money. However, that is not necessarily the case. The pandemic has changed the dynamic of several markets that impact on the availability and affordability of residential mortgage loans.


How Did COVID-19 Affect the Mortgage Market?

To understand the impact of COVID-19 on the mortgage industry, you must first have a working knowledge of the players and their roles. When you get a mortgage, you are a Borrower. You go to a Lender (or a broker that brings your loan to a Lender) who originates your loan. That Lender may or may not service your loan. They may sell the loan to a Servicer who collects your payments and administers your escrow account. The Servicer may in turn sell your loan to Fannie Mae or Freddie Mac. The loan then gets bundled together with other loans by an Investment Banker, who converts those loans into Mortgage Backed Securities (MBS), which can be sold to the public like any other investment. These MBS can be part of your mutual funds, IRAs, or other investment accounts.

The value of a servicing portfolio is based on the quality of the loans in that portfolio, and also on the expectation that you and other borrowers will continue to make your payments in a timely fashion.

How Did COVID-19 Impact Servicing Portfolios?

COVID-19 shuttered thousands of businesses, creating unprecedented levels of unemployment. When people lose their jobs, they can’t pay their bills, including their mortgage. When people don’t pay their mortgages to their servicer, the value of the servicing portfolio decreases.

Moreover, a Servicer is required to make payments to the investor who purchased the underlying asset (mortgage) from them, whether or not the servicer receives those payments. Under normal business conditions, servicers maintain enough of a cushion that they can handle a small percentage of loans being delinquent and they can still pay their investor. But the large scale devastation caused by the novel coronavirus means many servicers are experiencing dire repercussions and will continue to do so as the virus keeps businesses closed and people out of work.

Lastly, in an attempt to help homeowners who are out of work because of the corona virus, the Government has offered “forbearance” of mortgage payments for individuals experiencing financial hardship. This well meaning provision is like government-endorsed bad news for servicers, who rely on borrowers making regular monthly payments.

How Do Servicing Portfolios Affect the Mortgage Market?

When the value of a servicing portfolio decreases, that means servicers will not be willing to pay as much as they did before, to purchase mortgage debt. And for the debt they did purchase, if a borrower fails to make their first payment, the servicer is often in the position where they can’t sell the loan at all. In good times, the mortgage market is extremely liquid. Sellers can sell, buyers can buy. But now, if more and more loans become unsaleable assets because of first payment default, the seller (Servicer) can’t replenish their credit lines. They’re being used up by the purchase of assets they are then unable to sell. Liquidity dries up, which is what has ground the market to a halt.

But Aren’t Banks Still Lending?

Yes, but with new restrictions. Across the board, lenders have scaled back certain programs and increased credit requirements. Maximum loan-to-values and loan amounts have been reduced, credit score requirements have increased, and some programs now require additional reserves.

Certain programs aren’t available any more, like “non-QM” loans. This segment of the market had been growing over the past five years. Non-QM loans (or non-qualified mortgage loans) offered an alternative to traditional full doc loans that are sold to Fannie Mae and Freddie Mac. These loans would rely on the analysis of deposits into a borrower’s bank statements to qualify, compared to using tax returns or other forms of income verification.

The market for jumbo loans has also all but dried up.

But Didn’t Rates Just Drop?

Yes, but the Fed Funds Rate is different from a mortgage rate. The Fed acted to reduce that key interest rate to almost zero, but you can’t take out a mortgage at 0%.

Rates have come down, but not as low as they should be. Why not?

With the fall in stock prices, money has fled to the safe haven of bonds, which normally causes rates to go down. But as the value of servicing portfolios has decreased, so has the value of Mortgage Backed Securities (MBS). Before COVID-19, an investor would have paid “X” for a servicing portfolio of 30-year fixed mortgages with an average coupon of 3.75%. Now, in light of the devastating impact on the economy, that same investor would pay much less than “X” for that same portfolio, because they know the payment stream is not stable and there may be loans in the group that he cannot sell. Thus an investor would require a higher yield (interest rate) to offset the loss of income and liquidity today’s portfolios represent.

In an attempt to slow down origination volume, many lenders have kept their rates higher than they should be. This also enables them to recoup some profit that was lost through the servicing portfolio, and manage their pipelines in a time when many of their employees may be out sick or quarantined.

When Will the Mortgage Market Go Back to Normal?

While it seems that the volume of new cases is peaking or slowing, it may be months before servicers and investors cease feeling the negative impact of the corona virus. Certain programs like non-QM loans may not come back in their original form, but alternative forms of underwriting serve a real niche and thus will probably come back in modified form. When unemployment stops rising and business resume operations, people will go back to work and the economy will stabilize. And soon, servicing portfolios will return to profitability.

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