The extra time given to distressed homeowners through mortgage deferral is leading to a decreasing increase in the number of distressed homeowners digging out of crime.
And while forbearance has been a much-needed lifeline for millions of distressed homeowners, indulgence in payment hiatus is a double-edged sword: erosion of home equity even if there is more time to recover from losing a job or income.
Eroding equity means that many distressed homeowners have less chance of avoiding foreclosure the longer the forbearance programs and moratoria on foreclosure are extended.
Decreasing decline in delinquency
First, let's look at the diminishing returns out of tolerance.
Deferred active mortgages and overdue mortgages both peaked in May 2020 when the country was hit by the pandemic economic shock, according to data from Black Knight’s Mortgage Monitor and weekly forbearance reports. Over the next three months, the percentage decrease in defaulted mortgages roughly paralleled the percentage decrease in active deferrals from the peak.
After some time to get back on their feet, millions of distressed homeowners made up their payments and left indulgence while curing or avoiding crime. Black Knight data shows that 45 percent of the 7.1 million mortgages ever tolerated are out with no arrears (not past due) at the end of March 2021. Another 15 percent used the extra time to refinance themselves into loans with lower interest rates that were more affordable. Together, these two categories add up to more than 4 million homeowners who used the indulgence to get back on their feet after the shock of the pandemic.
However, the declines began to diverge in September, at the end of the first six month lock-up period under the CARES Act.
Since September, the gap between the decline in deferral and the decline in late payments has widened further. In February 2021, the number of deferrals fell 43 percent from the peak in May, while the number of defaults fell by just 22 percent over the same period. This translates into a decrease in forbearance of 2 million homeowners compared to a decrease of less than 1 million (969,614) in late payments. Seriously overdue mortgages only fell 310,378 – or 12 percent – over the same period.
Eroding home equity
Time alone will not cure many of the stubbornly remaining seriously overdue loans. That's because more time means more missed mortgage payments, and that is eroding home equity – the last remaining lifeline to foreclosure prevention that many homeowners in need.
A Black Knight analysis of deferred mortgages in January 2021 found that 18 months of missed mortgage payments would add nearly $ 25,000 to the balance of the mortgage for the average deferred homeowner who already has less than 10 percent equity.
Mortgage balances bloated by deferred interest, taxes and insurance would result in a higher proportion with less than 10 percent equity – important because this is the minimum amount of equity normally required to sell a home in the traditional real estate market and thereby avoid foreclosure.
Black Knight estimates that 22 percent of all deferred mortgages would have less than 10 percent equity after 18 months of deferral – more than double the 10 percent at the start of the deferral. That low equity percentage increases to 36 percent for FHA mortgages after 18 months of indulgence.
Lower equity corresponds to a higher risk of foreclosure
Unsurprisingly, most properties that end up being foreclosed on have less than 10 percent equity. In the past eight years, 84 percent of foreclosure sales on the Auction.com platform had less than 10 percent equity. The equity for these foreclosures was calculated by comparing the total debt of the foreclosed mortgage to the final sale price in the foreclosure auction.
In the run-up to the pandemic, the proportion of foreclosures with low equity declined and reached an all-time low of 73 percent in the first quarter of 2020. But even with the acceleration of real estate price hikes during the pandemic and demand on the Auction.com marketplace, the proportion of foreclosure sales with low equity has risen again and reached up to 79 percent in the third quarter of 2020. In dollars, the average amount of negative equity for foreclosure sales rose to $ 19,635 in the first quarter of 2021, the highest since before the pandemic.
The increase in negative equity on foreclosures is not due to falling prices on distressed properties. The average foreclosure auction price in the first quarter of 2021 was $ 138,904, an impressive 11 percent increase from the previous quarter. But total foreclosed real estate debt has increased even faster than sales prices, up 13 percent in the first quarter of 2021 compared to the previous quarter. That was the largest quarterly increase in average total debt in more than eight years.
The increase in the average total debt of properties in foreclosures in the first quarter, along with the increasing proportion of low-equity properties falling into foreclosures, is a wake-up call for those who believe that time combined with rising home values is can prevent all foreclosures. The unfortunate reality is that the longer many delinquent mortgages have a charter from foreclosure, the less chance there is of avoiding foreclosure once that protection is lifted.
On the flip side, the sooner those overdue loans can be put on a more proactive service path, the more likely the distressed homeowners will be able to avoid foreclosure – either through loss mitigation that puts the loan back into compliance status, or through an early foreclosure that removes any home equity uses to allow a graceful exit from the property.