Most Americans are homeowners, and mortgage payments generally represent their biggest financial burden. Mortgage forbearance—when a mortgage provider agrees to let the homeowner pause or reduce his payments for a certain period—thus has a direct beneficial impact on struggling household finances. Forgiving mortgage debt, however, imposes a significant financial burden, which must be borne by lenders or taxpayers. The federal CARES Act tries to strike a balance between the benefits of household mortgage relief and its costs by imposing a temporary moratorium on foreclosures and allowing forbearance on government-backed mortgages (primarily those by Fannie Mae, Freddie Mac, and the Federal Housing Administration). This is a valuable measure that limits costly foreclosures in a sensitive time and provides payment relief for some households.
Yet the likely depth and severity of the forthcoming economic turmoil calls for further measures. Another way to balance the needs of borrowers and lenders is to let all borrowers defer the principal component of their mortgage payments by simply lowering the amount on the check that they mail every month, to be repaid later. Doing so would benefit borrowers, the federal government—and lenders.
Borrowers would benefit by being able to stay in their homes, reduce their monthly payment, and ensure that they can resume spending as the lockdown ends, when consumer spending will be badly needed. Though existing forbearance options are useful, they require that individuals demonstrate financial hardship and work through busy mortgage servicers, who often require that they wait hours on the phone. It is perhaps for this reason that Fannie and Freddie are finding few takers for forbearance options so far, relative to the enormous spike in unemployment claims.
A more direct solution would allow borrowers to postpone their payments automatically, by simply mailing in a smaller check amount, without having to demonstrate need or talk to a mortgage servicer. This policy could deliver large savings to households immediately and support consumer spending without any direct fiscal outlay. The federal government would benefit because borrowers with smaller obligated payments would be more likely to meet those payments, helping to avoid costly mass defaults. Ample research from the 2008 financial crisis demonstrates the impact of payment shocks on default rates. The federal government, through its conservatorship of Fannie and Freddie and control over other government entities, is obligated to cover mortgage defaults. Thus, lowering mortgage payments can reduce the overall cost to taxpayers, addressing an important concern raised by many critics of federal intervention.
While borrowers would trade off a payment pause today in exchange for slightly higher mortgage payments in the future, this would provide welcome relief to mortgage holders during this critical time. And borrowers would remain free to refinance their mortgages, as they are currently able to, if they wanted to take advantage of low rates, as well as pursue forbearance options if they prefer. This would provide an additional, low-hassle means of payment deferral.
The more difficult party to address here is investors in these mortgages, which are typically packaged and sold as mortgage bonds. After all, investors have put money into these bonds with a reasonable expectation of repayment. Here, the limitation of the policy to the principal part of the payment is important. When mortgages are securitized into pools, the resulting cash flows are divided into interest cash, which repays the mortgage interest, and principal cash. The principal cash consists both of scheduled repayments of mortgage principal—which could be temporarily halted under this proposal—and unscheduled repayments of principal (prepayments) that typically happen when people refinance their mortgages.
Low interest rates are driving up refinancing volume. This is bad for investors, who are seeing a wave of cash come back to them in a low-interest rate environment in the form of the mortgage principal prepaid by people who are refinancing. If investors were to reinvest this cash in newly issued mortgage bonds, they would generally receive lower returns on their investment than they currently enjoy, because new mortgages are being issued at lower interest rates than prevail for outstanding mortgages. Investors would rather let mortgage debt accrue interest at rates that exceed alternate investments they have access to, and instead receive this money later in the cycle, when interest rates are likely to be higher.
Letting homeowners pause their principal payments—effectively, a “post-payment”—would lower cash flows paid to investors in the form of scheduled amortization payments. This would offset the other prepayments that they’re currently receiving and so result in a smaller total principal cash-flow amount. It would be relatively straightforward for investors to model the impact of this post-payment policy; investors in mortgage pools already carefully track principal payments resulting from a variety of factors, and this would be one additional factor that will work in their favor. Mortgage-bond cash flows are also commonly repackaged into structured products called collateralized mortgage obligations, frequently based on interest and principal cash flows. This policy would mean a different amount of principal cash flows and would pass through to investors accordingly.
Some investors, with little liquidity, may prefer to receive cash to address other financing needs, even in a low-rate environment. But to address those needs, they can simply sell their mortgage bonds. A low-interest-rate environment means high prices for these bonds, which have been supported by substantial Federal Reserve intervention. Remaining investors holding mortgage bonds—such as life-insurance companies, pension funds, foreign central banks, and other banks—likely have longer horizons and would be well served by post-payments.
Mortgage servicers, responsible for the timely forwarding of interest and principal to mortgage investors, would be affected by this strategy, too. Current forbearance plans have left a large unfunded liability, with mortgage servers still on the hook for missed payments. Many are facing liquidity crunches and possible bankruptcy. Removing the principal payment liability of mortgage servicers would help encourage their continued viability.
Post-payment may be a rare win-win deal in public policy. Ensuring that mortgage holders have the option of choosing to lower their payments temporarily may act as a critical support tool for the economy, while also serving the interests of taxpayers and investors.
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