Mortgage Forbearance: A Sign of the Times?
Why the COVID-19 pandemic might not lead to a wave of foreclosures
The U.S. economy dropped by almost 32% in the second quarter of 2020, leading 55 million Americans to file for unemployment. Under normal circumstances, the disastrous economic consequences of the COVID-19 pandemic would lead to a massive wave of foreclosures. But if anything is true of 2020, it’s this: The phrase “under normal circumstances” simply doesn’t apply.
Historically, there’s been an unfailingly strong correlation between unemployment and foreclosures: Job loss results in income loss, which results in mortgage delinquencies, which lead to defaults and, ultimately, to foreclosures. So, it’s not surprising that many people may be expecting to see foreclosure activity reach, or possibly even surpass, the record levels seen during the Great Recession.
But this recession is different from prior recessions, and there’s strong evidence suggesting the resulting level of foreclosure activity may be quite different as well.
Unemployment and Default
The COVID-19 recession is unlike almost any other recession in recent history. It stopped a strong economy in its tracks. Unemployment rates went from 50-year lows to record highs virtually overnight, not because of weakness in the economy, but because the government essentially shut the economy down in an effort to limit the spread of the coronavirus.
Like the cause of the recession itself, unemployment trends are far different than usual. This time, certain industries were hit much harder than others (e.g., travel and tourism, hospitality, retail, restaurants and personal services). These industries are made up of relatively low-earning, hourly wage employees who tend to be renters, not homeowners.
Homeownership rates are lower for young adults, adults without a college education and households earning less than the median income—all fairly typical traits of employees within the most affected industries. What this means is that homeowners and the pool of potential homeowners are less likely to be unemployed than renters, unless the recession is longer and more severe than expected.
Second, many of the jobless claims made this year were filed as “temporary” job loss. This is a huge distinction compared to prior recessions, where virtually every job loss was permanent. More than 20 million jobs were lost in the first few months of the pandemic, but over half of those jobs have already been reinstated. Unemployment claims, while still very high, appear to have peaked. Continuing claims have fallen off significantly, and job growth has been stronger and faster than most economists had predicted. Unlike a more typical recession, it’s likely that many workers will be back at work sooner rather than later.
Mortgage Forbearance: A Sign of the Times?
Is mortgage forbearance a sign of a massive future wave of foreclosures?
The CARES Act provided a safety net for homeowners whose income had been impacted by COVID-10. The law called for lenders to provide forbearance—deferral of loan payments—for up to 180 days, with an option for another 180, if needed. By mid-June, the percentage of homeowners in forbearance had swelled to 8.55%, or almost 4.3 million borrowers.
A look inside the numbers tells a slightly less desperate story, however.
First, the number of borrowers in the program peaked at 8.55%. That number has been coming down steadily over the past few months. The Mortgage Bankers Association (MBA) recently reported that the percentage of borrowers in the program stood at 7.02%.
Second, the number of borrowers entering the program has gone down on a weekly basis since the end of March, just before April mortgage payments came due. Instead of seeing a similar spike in forbearance applications at the end of each subsequent month, entrance into the program has steadily declined every week.
Still, 3 or 4 million people asking for forbearance is a large number. Isn’t it reasonable to assume that many, perhaps most, of them will simply default at the end of the forbearance period?
Again, the MBA numbers suggest not. As borrowers have exited the forbearance program, fewer than 8% have gone delinquent on their loans. According to a study conducted by LendingTree, some 70% of the borrowers in the program didn’t necessarily need to be in forbearance, but had opted in to hedge their bets, just in case they did fall on hard times economically. And interestingly, 24% of borrowers in forbearance have made on-time, monthly mortgage payments while in the program.
Finally, the nature of the repayment plans for borrowers in the forbearance program are designed to minimize default. For all government-backed loans, the deferred payments are simply tacked on to the end of the mortgage. They are due when the loan is paid in full, refinanced or the property is sold. Borrowers won’t have to go to extreme measures to “catch up” on payments when they exit the forbearance period.
Market Dynamics Favor Distressed Sellers
First, let’s be clear: there will definitely be an increase in foreclosure activity. To suggest otherwise would be irresponsible and a bit foolish. The question isn’t whether default rates will rise, but how much. It seems unlikely we’ll see as much default activity as we did in 2008, but we’ll absolutely see more delinquencies and foreclosures than what we’ve seen the past few years.
Not all homeowners will escape from an economic downturn as severe as this one. But homeowners entered the pandemic with a record level of equity—over $6.5 trillion. ATTOM Data reports that over 70% of homeowners have more than 20% equity in their homes.
Equity gives borrowers options that help them avoid foreclosures. Historically, more distressed properties are resolved through a traditional sale than via foreclosure, and it’s likely this is what will happen again post-COVID-19. Current conditions in the housing market—extremely limited supply of homes for sale combined with strong demand fueled by historically low mortgage rates—definitely favor this sort of disposition strategy for distressed sellers.
Another factor weighing against a huge influx of foreclosures is that loan quality today is far superior to loans on the books during the Great Recession. Before the pandemic, both delinquency rates and default rates were running well below their historical averages. ATTOM reported that national foreclosure activity was running at the lowest level in the past 15 years at the end of 2019 and hit an all-time low in July due to the various foreclosure moratoria in place across the country.
Implications for Investors
Real estate investors hoping for a flood of foreclosures to hit the market are probably going to be disappointed. They will likely have to wait until the end of first quarter 2021 before the federal and various state governments allow foreclosure proceedings to begin again in earnest.
That said, it’s almost certain there will be an increased amount of defaults and distressed property sales. If 8% of the borrowers in forbearance ultimately become delinquent, for example, that could add between 300,000-400,000 more delinquent homeowners than we might have normally expected in 2021.
Investors will need to find those homeowners early in the process. Many of them likely will sell their homes to avoid a foreclosure. It’s also likely most of the properties in foreclosure will sell at auctions rather than going back to the lenders, so waiting to pounce on REO inventory probably isn’t a great strategy.
Foreclosures are often the “hidden gems” in the housing market, offering high returns for fix-and-flip, buy-and-hold and wholesale investors. But like precious gemstones, they’re sometimes hard to find and difficult to mine. This cycle won’t be anything like the Great Recession, when there were a record number of foreclosures. To succeed in this limited inventory environment, investors will need to have the resources to find and analyze these properties—ideally in the earliest stages of foreclosure—and the capital to move quickly on properties that meet their ROI criteria.
