Foreclosure Wave

A foreclosure wave is coming!  Well, that’s been a persistent claim for a few years and I disagree big time.  Yes, the market across the country got overheated, but that doesn’t mean that foreclosures are going to spike.  Let me lay out five reasons that I think the foreclosure wave is nothing but a ripple. If you'd prefer to read the reasons, the transcript can be found below the video.

First, let’s look at unemployment.  It’s a top indicator of foreclosures for an obvious reason.  If you’re unemployed, you can only pay your mortgage for a finite period of time before you start missing payments and, if prolonged, headed for foreclosure.  But if we look at unemployment today, that in no way indicates a lot of foreclosures on the horizon.  We’re at 3.8% which is historically low.  On this chart is the 75-year average at 5.7% and the average during the Financial Crisis from 2008 to 2012 was 8.3%.  At this point, unemployment is not a widespread problem that will lead to a massive increase in foreclosures.

Another claim is that the amount of mortgage debt in the US has never been higher.  I agree with that, but there’s an obvious explanation – the value of homes has increased a lot over the past few years to prices most markets have never seen.  As a result, people need to borrow more on their mortgages.  And, until recently, this borrowing was done at super low interest rates making payments affordable.  Let’s look at this through a different lens – comparing mortgage payments to disposable income.  According to the St. Louis Fed, that ratio is currently 3.9% - one of the lowest in over 40 years.  It peaked at 7.2% shortly before the Financial Crisis.  So while the total mortgage balance is higher, the ability to make those payments is excellent.

A third claim is that there are still many people in forbearance from the pandemic.  While this was the case back in 2020, it’s barely a blip today.  As a reminder, forbearance was a way to delay mortgage payments when people were not getting paid in 2020.  As it turned out, many of the people who were granted forbearance never even missed a single payment.  But of those who did need it, the vast majority of those people got out of forbearance without losing their house – which was the entire point.  At one point, about 8.5% of all US mortgages were in a forbearance plan – today the number is less than a half percent.  Even if every one of them went to foreclosure, it wouldn’t be a wave.

Next, let’s look at loans that are behind on their payments.  Clearly, if there are a lot of people behind of payments now, then foreclosures will be coming.  Here’s a chart showing the percentage of loans that are in serious delinquency, which is defined as three months or more behind in payments.  One line is Fannie Mae loans and the other is Freddie Mac – you can see they are following the same pattern.  In January 2021, just over 1% of all mortgages were seriously delinquent.  Right now, it’s about half that coming in at 0.55%.  For context, during the Financial Crisis, this number ranged from around 3.5% to almost 5%.  So even if I’m wrong and a wave is coming, I can tell you that based on this leading indicator, it isn’t coming soon.

Another aspect to examine is negative equity.  This is when the house is worth less than what is owed.  It’s important because if a borrower gets behind on payments, they have equity in their house so they can sell it to gain access to their equity and avoid foreclosure.  If you have no equity, there’s less incentive to sell and the foreclosure becomes more likely.  At the height of the financial crisis, over 16 million US homes were in a negative equity situation.  Right now, that number stands at less that 350,000.  Almost every homeowner in the country has equity in their home.

To recap, of those five leading indicators, none of them points to a wave of foreclosures coming anytime soon.  So while I’ve been hearing this chatter for at least two years, the number of foreclosures today is very low.  But what about the recent headlines screaming that foreclosures are up almost 200%?  Let’s take a look.  This chart shows the actual number of foreclosures in the first six months of each year.  During the Great Recession, it was over 1 million every year, peaking at 1.7 million in 2010.  And this year?  186,000.  Yes, it’s the highest in three years, but keep in mind that part way through 2020 and well into 2021, many states didn’t permit foreclosures, so those years were artificially low.  To say this year is almost 200% higher than 2021 is technically correct, but it’s disingenuous and designed simply to alarm the public.  As I said earlier, the foreclosure wave is just a ripple. I expect it to stay that way for quite a while.  Now, could a big, unexpected economic shock come along that changes this outlook?  Of course, but nothing known today is predicting a lot of foreclosures heading our way.