Based on the recent data reported by Black Knight, 4.73 million homeowners are in active forbearance as of the end of May 2020. The big question is how many of these will end up in default and foreclosure. According to Black Knight, about half a million homeowners have less than 10 percent equity in their homes and face a greater risk of foreclosure in the worst case scenario.
At SP Group, our analysis suggests that the worst-case scenario for the COVID-19 impact on the housing market will play out differently than the past housing recessions. While the pandemic has induced income volatility and a liquidity crisis among the homeowners, it hasn’t disrupted the structural foundation of the housing market. In the 2008 housing recession we saw plummeting house prices causing deep negative equity for borrowers who faced defaults and foreclosures. This is not the case currently. Forecasts by Moody’s Analytics and Core Logic show that home prices are expected to decline annually by about 1-2 percent nationwide. The limited decline in prices is also being driven by the very low inventory of homes coupled with the record-low mortgage rates. Furthermore, the credit quality of mortgage loans remains strong with a significantly lower number of subprime mortgages, unlike the previous housing crisis. The median FICO score for current purchase loans is about 40 points higher than the pre-housing crisis level.
COVID-19 induced unemployment has contributed to income volatility, but it is unclear if this shock will be permanent. Unemployment statistics are coming down and the likelihood of being unemployed is currently about 8 percent lower for a homeowner (with a mortgage) compared to a renter, based on the recent Household Pulse Survey conducted by the U.S. Census. The unemployment rate gap between homeowner and renter widened during May 2020 and is narrowing as the unemployment statistics are improving.
Taken together, these factors suggest that the worst-case scenario for COVID-19 impact on the housing market will be driven by financial instability of borrowers rather than structural disruption of housing values. As such, public and private sector stakeholders should explore options that specifically address the default risk associated with income volatility. The foreclosure moratoriums introduced by HUD and the GSEs were an appropriate response to provide relief to cash-strapped borrowers. As these moratoriums sunset by August 31, 2020, it will be important for the industry to continue to provide options to borrowers that reduce the repayment pressure while allowing for sufficient time to build liquidity.
We at SP Group have identified three steps that we believe will dissipate the worst case scenario of loan defaults. These are discussed in our blog – “Don’t Panic, Let’s Innovate”.