In the mortgage lending world, the concept of risk is no stranger. With the possibility of default something every lending institution dreads, yet must inevitably confront. An unpredictable economy, fluctuating interest rates, and even borrowers’ unforeseen personal circumstances can lead to an increased rate of loan defaults, which can severely affect both lending institutions and the economy at large. This is why proactively managing mortgage loan default risk with a solid risk mitigation strategy is not only recommended, but vital. Velocity Servicing^™, a LoanCare^® division, brings powerful tools and strategies that help mortgage lenders empower their risk avoidance strategy.

In this blog, we delve into the importance of proactive default risk management and how it can serve as a buffer against potential shocks in the mortgage industry. As we discuss the ins and outs of risk mitigation, you will realize that understanding and managing default risk is not merely a component of a healthy lending strategy, but its very backbone. We’ll review risk reduction strategies, tools, and technologies used by leading mortgage lenders (such as the solutions available from Velocity Servicing) and explain how these practices can promote resilience, protect profitability, and ensure sustainable growth in the face of uncertainty.

Understanding the Distressed Loan Landscape

Loan servicing can be a very beneficial way for lenders to generate a steady revenue stream while diversifying their offerings and building strong customer relationships. However, servicing is not without risk, and lenders must be prepared to proactively manage distressed loans and clearly understand how distressed loans can have a negative impact on lenders, servicers, and borrowers.

But first, what is a distressed loan, and what kind of internal and external factors can affect the performance of a loan? As you will see, many businesses face difficulties in managing identified risks and then are challenged to monitor risks to reduce non-performing loans.

The short answer is that a mortgage loan is classified as “distressed” when a borrower falls behind on their loan payments, placing the loan into a state of default. Several borrower-related factors can drive this change in status. First, a significant change in the borrower’s financial condition, such as loss of employment or unexpected medical expenses, can severely impair their ability to maintain payments toward their loan. Additionally, a lack of financial planning or insufficient understanding of loan terms can contribute to such scenarios. A sudden life change like divorce can also impact borrowers’ ability to meet their financial obligations. In addition, if a borrower has overextended themselves by borrowing beyond their capacity to repay, it can cause a loan to become distressed. It is understood and inevitable that borrower-related finances change over time;  the key is how to approach this inevitability through the lens of risk reduction. Velocity Servicing provides timely insights which  improve your risk management strategy.

External factors, separate from the borrower’s circumstances, can also play a pivotal role in increasing the risk of mortgage loan default. The primary external factor is the state of the economy. An economic downturn or recession can lead to job losses and reduced income levels, increasing the likelihood of defaults. Even recent high inflation has increased insurance and other homeowner costs, raising potential risks. Fluctuations in the real estate market can cause property values to decline, potentially leaving homeowners with negative equity (owing more than the property’s worth), which places those loans at high risk of default.

Additionally, changes in government policies or legislation can affect both lenders and borrowers, potentially leading to an increased likelihood of default. And natural disasters or global events like pandemics that lead to large-scale disruptions can also cause an increase in distressed mortgage loans. While individual financial behavior plays a role, the overall economic situation and other external factors are equally instrumental in shaping the mortgage loan default risk landscape.

Distressed loans pose substantial risks and repercussions for all parties involved – lenders, servicers, and borrowers can all lose money. For lenders and servicers, a high level of distressed loans can lead to significant financial losses due to non-recovery of principal and interest, increased operational costs associated with managing and recovering these loans, potential depreciation in the value of held real estate, and a negative impact on their reputation, potentially eroding trust among customers and investors.

On the other hand, borrowers who default on their mortgage face severe consequences, including damage to their credit score, difficulty securing future loans, increased financial strain due to potential legal proceedings, and even the loss of their home to foreclosure. The fallout can also cause emotional distress, underscoring why mitigating the risk of mortgage default is both a financial and holistic consideration.

Assess Borrowers’ Financial Situations

As lenders strive to help borrowers bring their mortgages out of delinquency or default, a comprehensive assessment of the borrower’s financial situation becomes critical. This includes evaluating the borrower’s income stability, existing debts, other financial obligations, and overall financial behavior. Closely examining their monthly cash flow – understanding their income sources and comparing them with recurring expenses – can shed light on their repayment capacity. And understanding the borrower’s assets, such as savings or other forms of real estate, can provide insights into their financial resilience. A sound mitigation plan needs the resources and tools to understand your borrower’s financial condition clearly.

Additionally, it’s essential to consider any recent life changes which bring other risks that impact the borrower’s financial health, like job loss, divorce, or medical emergencies. Based on this evaluation, the lender can then propose tailored solutions, ranging from loan modifications to refinancing options or repayment plans, that are designed to align with the borrower’s financial reality and help them navigate their way out of default.

The Road to Performing Loans

Lenders can utilize various loan workout options to help borrowers restore their mortgages to good standing and escape delinquency or default. The appropriate solution will depend on the borrower’s circumstances and ability to meet the new terms, keeping in mind that the long-term goal is for the loan to become current and stay current. The most common options are:

• Forbearance – Lenders can temporarily reduce or suspend mortgage payments for a specified period, allowing the borrower some breathing space to recover financially.
• Repayment Plans – A repayment plan can be established where the borrower agrees to repay the missed payments in addition to their regular payments over a certain period.
• Loan Modifications – Loan modifications alter the loan’s original terms to make payments more manageable – and could include extending the loan term, reducing the interest rate, or even deferring a portion of the principal.
• Short Sales – In extreme cases where a borrower can’t afford to keep the property, lenders might offer a short sale or deed-in-lieu of foreclosure, both of which are more favorable options than foreclosure for both parties.

In addition to the options listed above, there may be other alternatives offered by government agencies or industry-specific programs that can help borrowers refinance into a loan that better suits their needs. By partnering with a specialized servicer like Velocity Servicing, lenders can gain access to as many tools as possible to mitigate default risk while reducing costs and exposure. Your risk mitigation plans are most effective when you have identified risks early enough that prioritizing them has the best chance of success for you and your borrower.

Combining Analytics, Compliance, and Communication to Reduce Risk

You may have every option available to help your borrowers come out of delinquency or default, but if you do not have open lines of communication with your borrowers and a clear picture of your servicing portfolio, you are at risk.

Having real-time access to data analysis tools can help you identify trends and patterns in your loan portfolio. One such tool is a proprietary, all-in-one portfolio management solution called LoanCare^® Analytics™  developed by and available through LoanCare. LoanCare Analytics accelerates portfolio optimization analysis with extensive views and filtering, enabling lenders to connect the dots across their portfolios and act down to the loan level.

When lenders can easily track payments, identify at-risk loans, and ensure workout options are compliant, they will be equipped to provide the support and guidance that borrowers will need during what is likely a very stressful time in their life. Showing compassion and empathy and providing solid options that will give borrowers a great chance to get back on track is a win/win scenario for all parties.

Knowledge and Partnership – A Recipe for Successfully Mitigating Default Risk

The importance of proactively mitigating mortgage default risk should not be overlooked as lenders look to build their servicing portfolio. While there is no way to guarantee that every borrower will make every loan payment on time, tools are available to help lenders prepare for the eventuality of delinquency and default. Understanding how borrowers can become delinquent or how external factors can affect your portfolio is a critical first step in arming your organization with the tools needed to protect your assets.

Partnering with a specialized servicer such as Velocity Servicing will give you insight into your portfolio and the expertise needed to effectively manage your distressed loans and turn them into performing loans faster. Velocity Servicing offers clients the ability to leverage the scale of LoanCare, its robust compliance and risk management infrastructure, and its operational capabilities, while also providing the talent and process rigor proven to address the unique challenges of specialty loan servicing. They have invested in and developed tools specific to this strategy and they utilize a robust loss mitigation data model, Portfolio Arc^™.

 

Questions and Answers

Why is Loan Portfolio Monitoring the New Standard for Banks and Mortgage Lenders?

In the banking and mortgage lending industries, getting new loans closed and on the books is only step one to creating a profitable loan portfolio. Lenders must also use loan portfolio management afterwards to track whether their loans meet performance expectations. This is why loan portfolio monitoring has become the global standard for mortgage lenders, as it provides them with real-time insights into which loans need closer attention.

Portfolio monitoring includes regularly tracking automated data from the borrowers’ systems for essential financial information like cash flow and repayment status, as well as capitalized amounts and expenses. By having this continuous loan activity data available at all times, lenders can identify any issues early on, take corrective action when needed, and prevent potential losses in their portfolios. It is also an invaluable tool for monitoring KPIs such as cost of carry, risk-adjusted return on capital, loan quality trends over time, and other metrics that make up a strong portfolio. Loan portfolio monitoring is key to your risk mitigation strategies.

What is Portfolio Monitoring, and Why is it Important for Mortgage Lenders?

Portfolio monitoring is a key tool banking institutions and mortgage lenders use to identify and mitigate risk. This process involves the ongoing evaluation of loan portfolios, analyzing several financial and performance metrics, including the creditworthiness of borrowers and changes in financial data since the origination period. This helps minimize losses and promote regulatory compliance, as it allows them to accurately assess their customers’ financial situations over time as part of their risk mitigation process.

By properly monitoring their portfolios, mortgage lenders can also identify any potential opportunities within them that come with potential rewards. For example, if a borrower’s financial situation has significantly improved, the bank may be able to negotiate lower interest rates on an existing loan or modify repayment terms for a better outcome for both parties. Similarly, early identification of risk factors or risks associated with existing loans gives lenders more time to take corrective action, averting further danger down the line.

How Can You Manage Credit Risk in a Portfolio Context?

Direct lenders increasingly realize the benefits of expanding their credit risk management processes by implementing portfolio-level measures that enable them to understand better and respond to real-time risk exposures. Over the past few decades, mortgage loan servicers have created sophisticated processes and technologies for assessing potential borrowers’ creditworthiness. However, a lack of operational risk data has prevented middle-market lenders from implementing portfolio-level risk analysis similar to those commonly employed by institutional investors in public debt and equity markets. By leveraging existing trends and datasets within loan portfolios, lenders can better examine the distribution of loans within an overall portfolio context to identify portfolio risks and minimize potential losses while simultaneously boosting total returns. This will allow lenders to make more informed decisions about upgrading their common risk mitigation strategies while managing overall exposure levels across multiple loans.

By providing the skillset and high touch service necessary to move distressed loans into performing portfolios sooner, their partners experience better resolution times with significant reduction in losses.

What is “Credit Risk Mitigation”?

Credit Risk Mitigation (CRM) is a fundamental part of lending activity, as it helps to reduce the risk of loss incurred by lenders when borrowers default on their loan payments. CRM strategies act as safeguards that can be applied to minimize this risk and avoid adverse impacts on financial performance and business reputation.

Effective credit risk mitigation starts with a basic understanding of the types of risk each mortgage loan faces. Each loan is assigned a risk profile, and the lender will continuously monitor each loan. Such measures are designed to ensure that if a borrower begins missing interest or principal payments, the lender will not suffer extensive revenue losses due to the defaulted loans. By taking proactive steps like these, lenders can feel more confident in their decision making process and have better control over their financial health in general.

Why Partner with Us?

At Velocity Servicing, we understand the importance of maximizing mortgage performance and increasing customer retention. That’s why our proprietary data analytics platform provides unparalleled servicing transparency, allowing you to identify opportunities and different risks across your portfolio. We manage over $350 billion in assets and are a part of Fidelity National Financial (NYSE: FNF). With that support, we have been able to build a highly-rated team of experts that provide service beyond expectations to our business partners and homeowners. In addition, our cutting-edge LoanCare Analytics technology gives you real-time access to insight into how your individuals loans are performing, providing you with up-to-date information on industry trends and opportunities.

We strive to ensure that every partner knows they can trust us regarding their loan services needs. Outstanding customer service is priority number one for us at LoanCare. Our knowledgeable staff is here to assist you with any questions or concerns you may have regarding loan performance, and regulations changes both quickly and efficiently so that you can focus on growing your business. With our top-quality solutions, let us help make managing your loan portfolios and risk assessment easier than ever.

Contact Velocity Servicing, a LoanCare division, today to learn more!