Executive Vice President at RealtyTrac, the leading source of distressed property data for investors and real estate professionals.
Historically, there’s been a strong correlation between unemployment and foreclosures. Job loss typically results in mortgage delinquencies – which ultimately lead to foreclosures. Given the number of jobs lost during the Covid-19 pandemic, many people may be expecting to see foreclosure activity reach – or even surpass – the record levels seen during the Great Recession.
But this recession is different from prior ones, and there’s strong evidence that suggests that the level of foreclosure activity it causes may be different as well.
Won’t Record Unemployment Lead To Record Levels Of Default?
The Covid-19 recession was unprecedented in its speed and severity, as the government issued shelter-in-place orders in an attempt to slow down the spread of the disease. Unemployment rates skyrocketed, and nearly 50 million Americans have filed for unemployment insurance since the beginning of the pandemic.
But unemployment is different than what we’ve seen in previous recessions. Certain industries – retail, entertainment, travel, hospitality and restaurants – have suffered much higher job losses than others. Employees in these industries – which tend to offer relatively low wages – are often young adults who earn below the median income. Because of this, these employees are less likely to be homeowners than they are to be renters. So homeowners and the pool of potential homeowners are less likely to be unemployed in this downturn 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 losses. Over 20 million jobs were lost in the first few months of the pandemic, but almost 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 as well as faster than most economists predicted. Hopefully, many workers will find themselves back at work sooner than later.
Won’t Borrowers In Mortgage Forbearance Wind Up In Foreclosure?
The CARES Act 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% – almost 4.3 million borrowers. But the number of borrowers in the program 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 was now just below 7%.
Still, three or four million people asking for forbearance is a large number. Isn’t it reasonable to assume that many of them will simply default at the end of the forbearance period? The MBA numbers suggest not. As borrowers have exited the forbearance program, less than 8% have gone delinquent on their loans. Interestingly, MBA reports that as of September 6, 2020, 24% of the borrowers in forbearance have continued to make on-time, monthly mortgage payments while in the program – even though they’ve been granted a deferral.
Finally, 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’re due when the loan is paid in full, refinanced or when the property is sold. Borrowers won’t have to go to extreme measures to catch up on payments when they exit the forbearance period.
Housing Market Dynamics Weigh Against Another Foreclosure Tsunami
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 go up, but how much.
Market conditions suggest that many homeowners will be able to avoid foreclosure even if they’re financially challenged. Homeowners entered the pandemic with a record level of equity – over $6.5 trillion. According to ATTOM Data, nearly 70% of homeowners have more than 20% equity in their homes, and equity helps distressed homeowners avoid foreclosures. Current conditions in the housing market – an extremely limited supply of homes for sale combined with strong demand fueled by historically low mortgage rates – give distressed sellers the opportunity to sell their home – potentially at a profit – rather than risk losing it to foreclosure.
Another factor weighing against a huge influx of foreclosures is that the loan quality today is far superior to the loans on the books during the Great Recession. Prior to the pandemic, 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 Real Estate Investors
Investors hoping for a flood of foreclosures to hit the market are probably going to be disappointed, but it’s almost certain that there will be an increased amount of defaults and distressed property sales. For example, if 8% of the borrowers exiting forbearance ultimately do become delinquent, that could add between 300,000 and 400,000 more delinquent homeowners than we might have normally expected in 2021. In addition, a certain percentage of them will ultimately default on their loans.
It doesn’t seem likely that we’ll see as much default activity this time as we did in 2008, but we’ll absolutely see more delinquencies and foreclosures than what we’ve seen over the past few years. Foreclosures are often the hidden gems in the housing market, offering high returns for fix-and-flip, buy-and-hold and wholesale investors. This cycle won’t be anything like the Great Recession when there were a record number of foreclosures. 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.