Mortgage interest rates are elevated relative to the interest rate environment of the last five years.1 Refinance volumes have dropped from their highs in 2021.2 The federal funds rate is continuing to increase.3 While it may feel like we are back in the mid-2000s, we are firmly in 2023 and there are no signs of these conditions abating any time soon. In this rapidly changing mortgage environment, a related rule that needs to be revisited is the Servicemembers Civil Relief Act (SCRA).
Under the SCRA, servicemembers on active duty are afforded a variety of legal and financial rights, chief among them an interest rate cap of six percent on pre-service debt obligations from the time of entering active duty service until termination from that service. The law is even friendlier to servicemembers’ mortgage obligations, with the interest rate relief extending for one year past the end of active duty. Other mortgage-related protections afforded servicemembers and their dependents include prohibitions on evictions without a court order, extended redemption periods, and prohibitions on entries of default judgments without filing an affidavit indicating the active duty status of each defendant.
Since the latter protections are required throughout the default servicing lifecycle of a mortgage loan irrespective of interest rate environments, the focus of this article will be on the interest rate relief benefit and how mortgage servicers should prepare themselves for an uptick in SCRA requests amid higher interest rates.
Remembering the Distinctions for National Guardsmen and Reservists
A common pitfall across the financial services industry is the incorrect application of SCRA benefits for National Guardsmen4 and Reservists. Under the law, the effective date of interest rate relief is generally the date on which the servicemember reports for active duty (the “active duty start date”). For National Guardsmen and Reservists, however, interest rate relief starts on the date on which the servicemember is notified of being called to active duty (the “notification date”). This distinction is afforded to National Guardsmen and Reservists because of the nature of their service—they often maintain civilian jobs that they must leave at a moment’s notice to serve their country. As such, the SCRA provides relief starting at an earlier date than for regular active duty military.
The SCRA provides no exceptions to the amount or duration of interest rate relief based on the servicemember’s type of service. If a National Guardsman or Reservist is on qualifying active duty and submits a written request for interest rate relief with a copy of their military orders (or other acceptable documentation), then the mortgage servicer is required to apply the six percent interest rate cap from the notification date to one year following the completion of military service.
When considering that the cost of residential real estate remains relatively high, as do interest rates, the cost of mistaken benefit period start dates for National Guardsmen and Reservists can also be significant. Additionally, Treliant has observed within the industry that SCRA data generally does not include detailed data points including the servicemember’s type of service. Not having this data readily available would negate the ability to perform a targeted review of National Guardsmen’s and Reservists’ benefit periods, and may require a full re-review of all SCRA requests for benefits.
Retroactive Interest Refunds
Servicemembers can submit orders to their financial institution from the date on which they receive them up to 180 days following the end of their active duty service. As such, mortgage servicers may have to provide a refund of any interest paid in excess of six percent retroactive to the start date of the benefit period, depending upon the date on which the SCRA interest rate relief request is effective.
For example, let’s assume that Sergeant Marty McFly originated his mortgage on January 1, 2000. If he is an Army Reservist and notified of a call to active duty on January 1, 2022, with service starting February 1, 2022 and ending December 31, 2022, then Sergeant McFly’s benefit period is January 1 (the notification date) through December 31, 2023 (one year following his separation from active duty) for his mortgage obligation. If he submits his military orders on July 1, 2022 and requests interest rate relief, the mortgage servicer is required to 1) reduce the interest rate to six percent for all future payments through the end of the benefit period, and 2) provide a refund of any interest paid in excess of six percent from the start of the benefit period.
Of equal importance to getting the dates right is considering the method by which retroactive interest refunds are provided to a qualifying servicemember. Mortgage servicers should resist any temptation to apply refunds directly to the principal balance of the loan without first asking the servicemember how they would like to receive the refund. While the SCRA does not have any proscriptive requirements surrounding this, it is generally understood that the intent of the law (as it relates to interest rate relief) is to provide monetary relief to servicemembers. As such, mortgage servicers should try to ascertain a servicemember’s preferred method of receiving the retroactive interest refund and, if the servicemember cannot be reached in a reasonable amount of time, default to attempting to send a check (or other means of providing liquid funds) for the amount owed.
Originations During the Early Alert Period
Continuing on the topic of National Guardsmen and Reservists, there is a unique scenario that mortgage servicers (and all financial institutions) should consider and control as a matter of policy. As discussed, the benefit period for a National Guardsman or Reservist on qualifying active duty is the notification date as opposed to the active duty start date. The time in between those two dates is known as the “early alert period.” What happens if a National Guardsman or Reservist originates a loan during that early alert period? Do they qualify for SCRA?
Let’s bring back Sergeant Marty McFly. As we know, Sergeant McFly was notified of a call to active duty on January 1, 2022 and began active duty on February 1, 2022. Therefore, his early alert period consists of the month of January. However, on January 15, 2022, Marty McFly took out a home equity line of credit (HELOC) at seven percent interest. Since the loan was originated in the early alert period, it is not possible to apply SCRA interest rate relief on the notification date; however, choosing to apply such relief on the active duty start date leaves a 16-day window in which the servicemember is technically on notice of a call to active duty but is paying interest in excess of six percent.
The SCRA is silent as it relates to originations during the early alert period. That said, the spirit of the law is to provide civil relief to those serving on active duty. At a minimum, mortgage servicers should set a policy statement surrounding this scenario to ensure that all borrowers are treated the same when this scenario occurs. As a best practice, mortgage servicers should consider providing as much relief as possible to the servicemember and applying the interest rate relief starting on the origination date of the loan.
Lines of Communication Between the Sub-Servicer and Owner of Servicing Rights
When servicemembers are being deployed across the globe on active duty, submitting active duty orders to their financial institution is likely not the highest priority. To make the process as simple as possible for the servicemember, regulators expect financial institutions to apply SCRA interest rate relief to all qualifying products at the institution upon approving SCRA requests.5 For example, if our Sergeant Marty McFly has a mortgage, a credit card, and a personal loan with the same institution and submits one written request and associated orders, the expectation is that, if he qualifies, the interest rate relief will be applied to all three products.
This is a particular operational consideration in the mortgage space, where servicing is often performed by a sub-servicer that uses different systems or is a completely different entity from the owner of the loan. For example, consider that Sergeant McFly’s HELOC was originated with DeLorean Bank, which contracts with Doc Servicing as the sub-servicer of the loan. If the sergeant requests SCRA interest rate relief through the company with whom he corresponds regularly about his mortgage payments (Doc Servicing), the servicing company may only have awareness of the HELOC that it is servicing and not the credit cards and personal loans that Sergeant McFly has with DeLorean Bank. It would be burdensome for the servicemember to have to submit another request with his financial institution when it technically still owns the HELOC. As such and as stated, regulators expect clear lines of communication between sub-servicers and owning entities, and (within financial institutions) lines of business that own different products. A servicemember’s one-time written request for SCRA interest rate relief should be sufficient for application across all products within the institution’s purview.
Conclusion
The SCRA is deceptively short and concise. But what it lacks in volume, it makes up for in nuance. These nuances, if not considered carefully, can create operational difficulties that cost money in a variety of ways (from system upgrades to remediation to, in some cases, regulatory or legal enforcement). With interest rates on the rise, mortgage servicers should consider reviewing the control environments in place to mitigate SCRA interest rate relief risk and making necessary enhancements before the requests start coming in.
1 https://fred.stlouisfed.org/series/MORTGAGE30US
2 https://www.freddiemac.com/research/insight/20220425-trends-mortgage-refinancing-activity
3 https://fred.stlouisfed.org/series/FEDFUNDS
4 National Guardsmen only qualify for federal SCRA benefits if they are serving under federal orders for a period of 30 or more consecutive days.