Market MythBusters: The Foreclosure Tsunami
A few months ago I was speaking with a client that wanted to help her son buy his first home outside the Bay Area. (We’ll call her Ashley.) She has cash, patience, and was sure a good deal could be had with all the pandemic-induced foreclosures hitting the market. I suggested this was not the case but she held on to her conviction.
Fast forward to a couple of weeks ago. I get a call from Ashley telling me how shocked she is at the competition for homes. Other than total fixers there are no deals or foreclosures to be had. I commiserated, suppressing the “I told ya so” impulse.
Ashley is not alone. A lot of people have been sitting on the sidelines, expecting a wave of distressed sales to hit the market. It’s understandable considering the massive economic drag imposed by the pandemic, and the constant news of large-scale mortgage forbearance programs. But let’s pull back the curtain and I’ll show you why a wave of foreclosures didn’t, and won’t become a reality.
Forbearance is not Foreclosure
When Covid hit in earnest large sectors of the economy were essentially shut down. Unemployment spiked and a lot of people found themselves unable to maintain their mortgage payments. The mortgage industry has learned a thing or two since the 2008 housing crisis; among other things, that nobody benefits from taking a lot of people’s homes. And while there was no way to know how long this current situation would last, everybody knows that it is temporary, and most people will be back to work and making money. Enter the forbearance programs. In forbearance, a homeowner’s mortgage payments are deferred for a defined period of time. There are a lot of ways to structure forbearance, but generally when the deferment ends the borrower must resume normal payments, plus make up the principal and interest accrued. This is, in the truest sense, a short-term solution as opposed to a loan modification, which is a permanent restructuring of the loan.
Can Borrowers Make Up The Deferred Payments?
The pandemic has persisted for a while now, and most forbearance programs have ended or been extended. So again comes the expectation that all those back payments coming due would drive the foreclosure tsunami. So why hasn’t it? While the government did put a moratorium on foreclosures through at least March 31, there are deeper dynamics at play. At its peak in May 2020, there were almost 4 million homeowners in forbearance, roughly 8% of outstanding loans. If we look at all the forborne loans, only 2% have left the program and are delinquent on their payments. 98% are either current, still in the program, or have paid off the mortgage entirely.
You Don’t Foreclose on Equity
The #1 reason why we won’t see foreclosures pouring onto the market is equity. Of all the active forbearances that are past due, 90% have a minimum of 10% equity. If the economic distress continues we might see more people selling their properties to get out from under the debt, but these will not be distressed sales. Given the massive undersupply of houses in our market (and most markets across the US), we could easily absorb a significant increase of listings without putting any downward pressure on pricing.