COVID-19’s Effect on Early Payment Defaults

Expert Perspectives: ACES CEO, Trevor Gauthier

Published December 02, 2020

Early payment defaults (EPDs) are on the rise due to the pandemic. In what ways will the large volume of EPDs affect lenders and servicers?

Trevor Gauthier: It’s fair to say that COVID-19 has transformed the way business is done across the industry and has caused changes that we don’t typically see in the market. A rise in early payment defaults is one such change, which are defined as loans that go 60-days delinquent within the first six contractual payments due. As unemployment began to rise in early 2020, loans originated in August of last year were still within their first six payments due, which gives us an idea of the sheer volume of loans we’re dealing with.

Typically, EPDs can cause concern that something went wrong shortly after origination, sometimes involving the underwriting process and triggering higher repurchase risk. Our Mortgage QC Industry Trends Report for Q1 2020 estimated a 30% increase in EPDs overall, but we’ll get more clarity on that number in our upcoming QC Trends Report for Q2 in December.

How should lenders handle the QC reviews of EPDs?

TG: The significant rise in EPDs increased the need for lenders to invest in quality management and control software. Lenders have often handled lower volumes of EPDs with one-off QC reviews through spreadsheets, which doesn’t scale well when they’re required to review such a high volume of EPDs. That’s why ACES released an audit module designed for handling EPDs earlier this year to mitigate the risks involved in managing these complex reviews.

The Agencies haven’t provided any relief from repurchase risk, so it’s up to lenders to invest in the right QC tools to manage it effectively. ACES has added functionality enabling lenders to keep a watchful eye on EPDs, as they could easily turn into longer-term defaults or even foreclosures.

What effect has the CARES Act had on EPDs?


The CARES Act allowed borrowers to receive “no questions asked” forbearances for up to six monthly payments, which means that a borrower on a newly originated loan could have gone into EPD status regardless of whether or not they suffered from a hardship caused by COVID-19. We believe the decline in forbearance is largely attributed to improving unemployment number and borrowers coming out of forbearance who requested one out of an abundance of caution. However, the long-term default probabilities with loans still in forbearance are concerning.

The question is whether or not automatic reviews of EPDs will lead to increases in repurchase and indemnification demands, which could end up uncovering underwriting issues. Though Fannie Mae and Freddie Mac have both stated that EPDs won’t trigger an automatic repurchase demand, loans will still undergo QC reviews.

Liquidity and lenders’ ability to deliver newly delivered loans in forbearance to the Agencies is another concern. While the Agencies have alleviated some of the problems by permitting CARES Act loan deliveries, risk is still present as lenders are expected to follow strict protocols and timelines. Cash-out refinances would be a major exception.

As the end of forbearance periods quickly approaches, what areas of CARES Act compliance will regulators be examining from a servicing perspective?

TG: A significant portion of borrowers may not be able to resume payments at the end of their forbearance period because of continued unemployment and/or other financial hardships caused by the continuing waves of the pandemic.

The CFPB and state regulators are closing monitoring servicers as they handle CARES Act forbearance requests, making sure they did not condition forbearance approval, add extra fees or vary from the number of payments permitted by the CARES Act. They will be watching payment histories and checking incoming borrower calls to call centers for any attempts to steer borrowers away from forbearance or fees charged to borrowers, which are prohibited by the CFPB. Because servicers are required to treat borrowers as if all payments were made in full and on time, they must be actively evaluating their call scripts for compliance with loss mitigation requirements.

Digital closings present themselves as a social distancing-approved tool, but are they as compliant as we might think? What concerns do you see?

TG: There has been positive news regarding digital closings this year. Many lenders are eager to implement digital closings for the convenience they present, especially since most personnel are not working from their offices, and there’s a feeling that, in many ways, digital closings employ more secure methods than traditional closings, thereby upping the safety factor considerably. From a quality control standpoint, there shouldn’t be a rush to adopt digital closings so early on that the industry undermines risks that have yet to be uncovered, which in the end could raise QC defects.

Remote online notarization (RON) has also made headlines this year. 26 states are now permanently allowing RON and others are allowing it temporarily due to restrictions posed by the pandemic. Because some states have yet to pass any RON measures at all, the country lacks a universal on this front. The fact is that the industry is struggling to implement guidelines even as RON transactions are happening in both lending and servicing. To ensure a consistent standard across all 50 states, the entire industry will need to get behind legislation, such as the MBA-ALTA model bill, which aims to create a national RON model.

In what other areas might we see quality issues?

TG: Reverifications have been further complicated by COVID-19, as the process relies heavily on employees working from a centralized location to handle the associated paperwork mailed to and from the office. As the number of confirmed COVID-19 cases climbs even higher, it’s unlikely that employees will be returning to their physical offices anytime soon.

Though the Agencies have relaxed many of the requirements surrounding reverifications, lenders are responsible for tracking incomplete reverifications and including them in a targeted sample for the future. They need to have an organized method of tracking these reverifications and a plan to perform them when the time comes.

Though we are seeing plenty of volume for the rest of 2020, do you foresee unemployment recovery for the close of 2020? What will that mean for 2021?

TG: Though volume has hit record highs this year, the manufacturing process has been more complicated, and costs have increased. It also shouldn’t come as a shock if we see a modest increase in defect rates in the near future. As far as unemployment recovery, it all comes down to whether or not low interest rates will lift the economy enough to offset unemployment, though it’s likely that unemployment recovery might actually take place into 2021. It will also be interesting to see how the incoming administration’s approach to COVID-19 might affect employment recovery in the coming year. Despite a pandemic, mortgage lending and servicing are still supporting hundreds of thousands of jobs, which could label 2020 as the year that pushed the industry towards much-needed innovation.

How is ACES helping lenders stay compliant with the uncertainty surrounding COVID-19 and EPDs?

TG: Our team is always helping lenders stay ahead of the curve by adding functionality that arms them to handle all of the change that has come with COVID-19. The release of our audit module prevents them from drowning in risk and makes it easier and more secure to manage the high volume of EPDs. We publish comprehensive quarterly Mortgage QC Industry Trends reports providing lenders with an insider’s look at the industry and advising them on the areas they’ll need to focus on from a compliance standpoint. Our report for Q2, which is coming in December, will provide significant intel on how the industry has fared in terms of unemployment and EPDs due to the pandemic and the new trends surrounding compliance since our last report on Q1. We’re always keeping consumers up to date on the latest breaking news and important changes in our free Compliance NewsHub and Compliance Calendar.

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