Prevention Measures and Increased Borrower Equity Lower Foreclosure Risk

The Urban Institute (UI) says the surge in
foreclosures predicted as the COVID-19 pandemic drove unemployment to the
highest level since the Great Depression may not materialize, even when the
current forbearances end. Two UI researchers, Michael Neal and Laurie Goodman,
say that even vulnerable homeowners may be spared, and they think they have identified
the reasons.

Mortgage
forbearance rates peaked at 8.55 percent of active mortgage in June 2020 and
began to fall when unemployment rates did. Since
October, however, both unemployment and forbearance rates have flattened. This
has heightened concern that many homeowners could face foreclosure later this year.

The authors say about a quarter of the 2.7 million
borrowers who remain in forbearance plans are continuing to make their
payments, but about 2.1 million are delinquent along with another 1.1 million
homeowners who are not in plans. Forbearance is now scheduled to end mid-year
and many borrowers who haven’t regained their pre-pandemic financial positions
may face the loss of their homes.

UI says this won’t necessarily
happen
, even among government loan borrowers whose risks are higher due to higher-initial-loan
to value (LTV) and debt-to-income (DTI) ratios, lower credit scores and lower
incomes than borrowers with conventional loans. They may benefit from the large
amounts of home equity that borrowers have accumulated through home price
appreciation and the loss mitigation waterfalls
put in place by Fannie Mae,
Freddie Mac, the FHA VA, and the Department of Agriculture’s Rural Housing (RH)
program.

Those
waterfalls, or forbearance off-ramps, allow borrowers options to pay back the past
due amounts
that accumulated during forbearance. The first step in the waterfall
is to repay the forborne amount in a lump sum or over a short period. But,
where a borrower is unable to increase their pre-forbearance payment, they can
revert to their pre-forbearance payment and move the forborne amount to the end
of the loan.

For an FHA mortgage, the forborne
amount becomes a “soft second” or a subordinate loan on which the borrower is
not required to make payments until the house is sold or refinanced. For a GSE
(Fannie Mae and Freddie Mac) loan, the mortgage term is extended. If the
borrower’s then current income is not enough to cover their original monthly
payment, they could qualify for a modification which would lower their monthly
payment. Loss mitigation options are also available to borrowers who did not
utilize forbearance. However, not all borrowers will qualify for a loan
modification and may have to exit homeownership.

Even where borrowers are not
financially stable when forbearance expires and do not qualify for a
modification, those with home equity could still exit the home with their
credit intact and possibly some cash in hand by selling their home and downsizing
or renting. Equity also increases the viability of the waterfall because
lenders are more likely to work out an alternative solution to foreclosure for a
delinquent homeowner who has it.

Of the 3.2 million currently delinquent
borrowers, 626,000 have government loans in Ginnie Mae securities and, because
the average LTV ratio at origination is 96.5 percent for FHA purchase
borrowers, 100 percent for VA loans, and 101 percent for USDA loans, these
borrowers will generally have less equity than those with GSE loans.

Goodman and Neal developed a
methodology to estimate the home equity for government loans that shows that
even among delinquent borrowers less than 1.0 percent have negative equity and
5.5 percent are near negative, a total of 3.6 percent. In the aftermath of the
Great Recession, the latter number was approximately 30 percent.

Further, they found the average
government loan borrower has 22 percent equity. Most of the 3,771 delinquent or
forborne borrowers in negative equity are VA borrowers (2,817), many of which
had origination LTVs of 100 percent. Another 1,000 in negative territory are evenly
split between FHA and RH. Nearly all the negative equity loans were originated
from 2018 to 2020, most in 2020.

The additional 5.5 percent of
borrowers with near-negative equity or less than 5 percent will have none left
after the transaction costs of selling. They have little incentive to sell by
themselves.  

Home price gains (60 percent from
early 2012 through late 2020) have pushed home prices up above their pre-recession
peak by an average of 19.7 percent
, but those increases have been uneven. Many areas
still have prices below the 2005-2006 levels. The share of mortgages with
negative equity range from 0.1 percent in several states to highs of 1.8
percent in Wisconsin and 1.4 percent in Illinois. The share of non-current borrowers
with negative equity or near-negative equity are mostly in the single digits,
with only Wisconsin, Illinois, and Alaska exceeding 10 percent.  These may
be the states that do see significant numbers of foreclosures.

The authors say that even as improvement in the forbearance
rates have slowed along with the decline in unemployment, they still expect far
fewer foreclosures than during and after the Great Recession. Many of today’s
homeowners in distress have both significant equity buffers and improved loss
mitigation tools. The extensions in forbearance terms announced earlier this
month will give struggling borrowers more time to benefit from improved
employment prospects as the economy recovers and to build an equity cushion;
this is particularly critical to homeowners without equity.  A further
extension in forbearance may well be necessary.

Source: mortgagenewsdaily.com