Should investors be concerned about a foreclosure crisis?


With the real estate market continuing to hit new highs, there are legitimate concerns that current prices will not be sustainable. In the media and real estate investment world, there is talk of a crash on the real estate market in the coming months.

When considering which (of many) factors could trigger price drops, one of the most commonly cited is a potential foreclosure crisis. With the COVID-19 moratorium on foreclosure into its sixteenth month, many fear that once the moratorium is lifted, a rapid spike in the supply of homes will hit the market and push prices down.

But will that happen? Could a foreclosure crisis like the one in 2007 hinder post-pandemic recovery? Or has the collaboration between lenders and the government to expand the availability of forbearance worked?

Let’s see what the numbers say about whether a foreclosure crisis is likely and whether it could lead to big changes in the U.S. housing market.

background

COVID-19 rocked many sectors of the economy, and almost nothing has been as impactful as the huge spike in unemployment that rocked the US around the time of the initial lockdowns.

Linked to this was the justified fear that there would be massive foreclosures on the housing market because homeowners could not afford their mortgages.

As such, the government stepped in (both federal and local) and issued bans on foreclosures and evictions. Instead of excluding banks from customers, the government and housing industry worked together to develop a deferral program that would allow homeowners to temporarily reduce or cancel their payments.

The forbearance program does not absolve borrowers from their debts. Rather, forbearance allows homeowners to reduce or even eliminate their mortgage costs while they survive difficult economic conditions.

When this plan was announced, many people benefited from it. At its peak in June 2020, there were an estimated 4.3 million homeowners in the forbearance program. At the time, there were fears that this could get out of hand and lead to another collapse in the property market.

After all, foreclosures were a big part of the 2007 property crash, and people were understandably concerned.

Lots of people still are. There are tons of experts who say the real estate market will collapse once the foreclosure ban is lifted.

But the data suggest otherwise. From my point of view, there are three reasons why we will not experience a foreclosure crisis like in 2007 at the end of the moratorium.


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1. Forbearance works

The number of forbearance loans is falling steadily. Week after week we see data from the Mortgage Bankers Association showing declining deferrals.

Last year around this time there were 4.3 million deferred loans. Now there are only about 1.75 million left. Things just got better and better and this trend is very likely to continue. In fact, the decline seems to be accelerating recently.

In addition, it is estimated that between 85-90% of homeowners have good reputations from the loans that are deferred.

But of course the question of the remaining 1.75 million loans remains. And what happens there is still a little unclear.

Some believe that these loans are the riskiest. If they are still indulgent, it may be because they are least able to pay. That could be the case.

On the other hand, some believe that these remaining loans will only be tolerated for as long as possible, even if they could resume payments as originally planned. The acceleration in loans that have been leaving the moratorium lately makes this theory credible – as the moratorium is coming to an end, people are finally being forced to leave the moratorium.

Personally, I think it’s a bit of both. There is likely a lot of risky loans left in those 1.75 million loans, but some will likely come out well.

But even with these risky loans, I still don’t think we’re going to see a huge flurry of evictions because of the second data point here.

2. Jobs

The employment situation in the US is very different now than in 2007. There are also early signs that wages may start to rise due to inflation, which should hopefully help people get back on their feet.

Fred 1

In 2007, the entire economy collapsed, and unemployment began to rise in May 2007, rising to nearly 10% by 2019. It took almost nine years for unemployment to return to 2006 levels.

Fred 1 1

Now the situation is different. Before COVID-19, unemployment was extremely low at 3.5%. It rose to almost 15% like nothing we had seen before last spring, but quickly fell back to below 6%. The restoration of jobs is much, much faster this time. It took seven years to get back below 6% after the great recession. This time it took a year.

And while job numbers have not been overwhelming in recent months, hopefully unemployment will continue to fall. There are nearly 9 million job vacancies (the graph above is only valid until Q1 2021 and has grown since then), which is more than the total number of job seekers.

For the housing market, this means that, in most cases, people will find work, increasing the likelihood of paying off their mortgages. The worst of the unemployment crisis was forgotten and many people’s homes were saved.

3. Credit quality

After all, the quality of credit has improved a lot since the great recession. The main trigger of the real estate collapse in 2007 was that banks gave too risky loans to unskilled borrowers.

After this crisis, regulations were put in place to mitigate the risk of another subprime crisis. And it worked. The number of risky loans has decreased over the past decade. Check out this data from the Consumer Financial Protection Bureau.

Consumer credit

Unfortunately, the data doesn’t go back to the financial crisis, but you can see that the issuance volume for the riskiest mortgages is about half what it was after the great recession.

There is a lot more data at the link above if you want to check it out. In simple terms, however, the quality of the loan is higher which, on average, makes a borrower less likely to default now than it was in 2007.

Debt loans are declining, there is a strong job market to support homeowners, and the debts are less risky than those that were foreclosed during the great recessions.

For all of these reasons, I don’t think we will see a large influx of foreclosures in the months ahead. Yes, if the foreclosure ban is lifted in late July there will be a surge in foreclosure activity – there is absolutely no doubt about that.

But I suspect that only a fraction of the 1.75 million loans that are still tolerated will end in foreclosure. My estimate is that about half could end up in foreclosure.

That’s a lot, and it will likely slow the pace of the property market, but in my opinion it is very unlikely to see a collapse in the property market.

By comparison, at the height of the great recession, foreclosures stood at 2.8 million per year. There were only 216,000 foreclosures in 2020 – a number that is artificially low due to the ban. Even if we see a spike of up to 1 million foreclosures in 2021, that would be 2015-2016 levels – a time when the housing market was growing rapidly.

So the next time you see someone say there is going to be a massive foreclosure crisis, keep in mind that the numbers tell a different story. Yes, there will be an increase in foreclosures, but the numbers won’t come close to what we were in the great recession. It will likely just cool the real estate market and not cause a crash.



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