As the housing market continues to hit new peaks, there is reasonable fear that current prices are not sustainable. Across the media and real estate investing world, there’s talk of a crash in the housing market in the coming months.
When imagining which (of many) factors could be the catalyst for price declines, one of most cited is a potential foreclosure crisis. With the COVID-19-induced foreclosure moratorium going into its sixteenth month, many fear that once the moratorium is lifted, a rapid increase in the supply of houses will hit the market and push prices lower.
But will this happen? Could the post-pandemic recovery be stymied by a 2007-like foreclosure crisis? Or has the collaborative effort between lenders and the government to expand forbearance availability worked?
Let’s see what the numbers say about whether a foreclosure crisis is likely, and whether it could cause major changes to the U.S. Housing Market.
COVID-19 shook many sectors of the economy, and almost nothing was as impactful as the huge spike in unemployment that rocked the U.S. around the time of the first lockdowns.
With that came a very reasonable fear that there would be mass foreclosures in the housing market because homeowners would not be able to afford their mortgages.
As such, the government (both federal and local) stepped in and implemented bans on foreclosures and evictions. Rather than banks foreclosing on customers, the government and the housing industry worked together to develop a forbearance program that allows homeowners to temporarily reduce or eliminate their payments.
The forbearance program does not excuse borrowers from their debts. Rather, forbearance allows homeowners to reduce, or even eliminate, their mortgage costs while they weather challenging economic conditions.
When this plan was announced, a lot of people took advantage. At its peak in June 2020, there were an estimated 4.3 million homeowners in the forbearance program. At that point, there was a lot of fear that this could spiral out of control and could lead to another housing market crash.
After all, foreclosures played a huge role in the 2007 housing market crash, and people were understandably concerned.
Many people still are. There are tons of pundits out there saying the housing market is going to crash as soon as the foreclosure ban is lifted.
But the data suggests otherwise. In my opinion, there are three reasons why we won’t see a foreclosure crisis at the end of the moratorium like we saw in 2007.
More Pro articles from Dave
1. Forbearance is working
The number of loans in forbearance is declining steadily. Week after week, we see data from the Mortgage Bankers Association that shows declining forbearance numbers.
Last year around this time there were 4.3 million loans in forbearance. Now, there are only about 1.75 million. Things have been getting better consistently, and that trend is very likely to continue. In fact, the rate of decline appears to be speeding up of late.
Furthermore, of the loans that are exiting forbearance, it is estimated that between 85-90% of homeowners wind up in good standing.
But of course, there is still the question of those remaining 1.75 million loans. And what happens there is still a little unclear.
Some believe that these loans are the riskiest. If they are still in forbearance, then perhaps it’s because they are the least likely to be able to pay. That could be the case.
On the other hand, some believe that these remaining loans are just staying in forbearance as long as they can, even if they could resume payments as originally scheduled. The acceleration in loans leaving forbearance of late, makes this theory credible – because the moratorium is coming to an end, people finally are forced to leave forbearance.
Personally, I think it’s a bit of both. There are probably many risky loans remaining in those 1.75 million loans, but some are probably going to come out just fine.
But even with those risky loans, I still don’t think we’re going to see a huge flood of evictions due the second data point here.
The employment situation in the U.S. currently is very different from what it was in 2007. There is also early evidence that wages are starting to grow, possibly due to inflation, and which should hopefully help people get back on their feet.
In 2007, the whole economy crashed, and unemployment started rising in May 2007 and grew to nearly 10% by 2019. It took nearly nine years for unemployment to reach where it had been in 2006.
Now the situation is different. Prior to COVID-19, unemployment was super low at 3.5%. It spiked like nothing we’ve ever seen before last spring, up to nearly 15% but has quickly come back down to below 6%. The jobs recovery this time around is much, much faster. It took seven years to get back below 6% after the great recession. It took one year this time.
And even though the jobs numbers have been underwhelming over the last few months, unemployment will hopefully keep falling. There are nearly 9 million jobs open (the chart above is only through Q1 2021, and it’s gone up since), which is more than the total number of job seekers.
For the housing market, this means that for the most part people will be able to find work, and therefore will be more likely to make payments on their mortgages. The worst of the unemployment crisis overlapped with forbearance, so many people’s homes were saved.
3. Loan quality
Lastly, the quality of loans has increased greatly since the great recession. The primary trigger of the housing collapse in 2007 was banks making overly risky loans to unqualified borrowers.
After that crisis, regulations were put in place to mitigate the risk of another sub-prime meltdown. And it worked. The number of risky loans has gone down over the last decade. Take a look at this data from the Consumer Financial Protection Bureau.
Unfortunately, the data doesn’t go all the way back to the financial crisis, but you can see the volume of origination for the riskiest of mortgages is about half of what it was after the great recession.
There’s plenty more data at the link above if you want to check it out. But simply put, the quality of loans is higher, making it less likely, on average, that a borrower will default now than in 2007.
Mortgages in forbearance are declining, there is a strong job market to support homeowners, and the loans that are in forbearance are less risky than those that were foreclosed on back in the great recessions.
For all these reasons, I don’t think we’re likely to see a huge influx of foreclosures in the coming months. Yes, when the foreclosure ban is lifted at the end of July, there will be an uptick in foreclosure activity—there is absolutely no doubt about that.
But I am guessing only a fraction of the 1.75 million loans still in forbearance will wind up in foreclosure. My estimate is about half could end up in foreclosure.
That is a lot, and it will likely slow the pace of the housing market, but it’s very unlikely to cause a housing market crash in my opinion.
For reference, foreclosures were at 2.8 million per year at the height of the great recession. In 2020, there were only 216,000 foreclosures—a number that is artificially low due to the ban. Even if we see an increase up to 1 million foreclosures in 2021, that would be 2015-2016 levels—a time at which the housing market was growing rapidly.
So next time you see someone saying there is going to be a massive foreclosure crisis, remember that the numbers tell a different story. Yes, there will be an increase in foreclosures, but the numbers will not come close to approaching where we were in the great recession. It will likely just cool the housing market—not cause a crash.