September 12, 2007
A significant number of adjustable-rate mortgages are scheduled to reset in the coming months. These resets may result in a significant payment shock to the borrower, which can increase the likelihood of default.
In order to deal with this increased risk of default, servicers of residential mortgages should consider prudent workout arrangements. Prudent workout arrangements are consistent with safe and sound lending practices.
Many residential mortgages are retained by state chartered banks and other state-supervised entities. However, many subprime and other mortgage loans have been transferred into securitization trusts. Servicing for these securitized loans is governed by the terms of contract documents, typically referred to as Pooling and Servicing Agreements.
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. Servicers are encouraged to use the authority that they have under these governing securitization documents to take appropriate steps when an increased risk of default is identified. These steps include: proactively identifying borrowers at heightened risk of delinquency or default, such as those with impending interest rate resets; contacting borrowers to assess their ability to repay; assessing whether there is a reasonable basis to conclude that default is "reasonably foreseeable" and exploring, where appropriate, a loss mitigation strategy that avoids foreclosure or other actions that result in a loss of homeownership.
Loss mitigation techniques that preserve homeownership are generally less costly than foreclosure. Several prudent loss mitigation strategies may include, alone or in combination:
- Loan modification, deferral of payments or extension of loan maturities;
- Conversion of adjustable-rate mortgages into fixed-rate or fully indexed, fully amortizing adjustable-rate mortgages; or
- Capitalization of delinquent amounts.
In summary, the Commissioner of Financial Regulation encourages servicers to pursue strategies to mitigate losses while preserving homeownership to the extent possible. Such strategies may include the referral of delinquent borrowers to qualified non-profit and other homeownership counseling servicers and/or government programs which may be able to work with all parties to avoid unnecessary foreclosures. In addition, 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.