While more foreclosures may be inevitable, one economist suggests that this recession may be different from what has come before.
As COVID-19 swept America, economic activity declined, and the unemployment rate spiked to 14.4 percent in April (and remains elevated today), some pundits predicted that up to 30% of homeowners would require forbearance, ultimately leading to a “foreclosure tsunami,” reported Odeta Kushi for First American.
Forbearance, in fact, peaked at 8.6 %, not 30%, and has been steadily falling since, she said.
She added that, “forbearance does not equal foreclosure, and focusing on mortgage delinquency rates alone ignores the dual trigger responsible for foreclosure – economic hardship and lack of equity. The rising inability to pay in this crisis is unlikely to lead to large amounts of foreclosure activity because homeowners have more equity than ever before.”
A proper prediction of things to come includes understanding foreclosure’s two-step process or “dual trigger hypothesis.
First, the homeowner suffers an adverse economic shock—loss of income, serious illness, or the death of a spouse—leading to delinquency. But delinquency doesn’t always result in foreclosure. With sufficient equity, a homeowner has the option of selling or refinancing to tap into equity. The reverse also is true: a homeowner who has low equity but endures no financial setback—thus no delinquency— never faces foreclosure.
“Alone, economic hardship and a lack of equity are each necessary, but not sufficient to trigger a foreclosure. It is only when both conditions exist that a foreclosure becomes a likely outcome,” Kushi noted.
Her reporting is supported by comparisons to previous recessions.
The 2001 recession led to a rise in unemployment without a comparable rise in foreclosure activity. The unemployment rate among homeowners increased from 2.5 % in the second quarter of 2001 to 3.7% in the same quarter the following year. Yet, the average number of new foreclosures barely increased. This was largely because of high household equity, which nationally was nearly 64% in the quarter leading up to the 2001 recession, 12% above the historical average.
During the Great Recession, high levels of housing debt combined with declining house prices resulted in a 5.6% decline in household equity between the first quarter of 2008 and second quarter of 2009. Paired with soaring unemployment, which more than doubled for homeowners over the same time period, the dual trigger produced a wave of foreclosures, as foreclosure starts quadrupled compared with their pre-recession pace.
This time, it’s different, for two main reasons: First, the housing market is in a much stronger position compared with a decade ago. Accompanied by more rigorous lending standards, the household debt-to-income ratio is at a four-decade low and household equity near a three-decade high. Indeed, thus far, MBA data indicates that the majority of homeowners who took advantage of forbearance programs are either staying current on their mortgage or paying off the loan through a home sale or a refinance.
Second, this service sector-driven recession is disproportionately impacting renters. Data from the Census Pulse Survey, averaging across the four weeks of June, show 53% of renter households experienced a loss of employment income, compared with 39% of owner households.
“Some foreclosures are still likely to happen,” according to the First American report. “And trends will vary by geography, but this time it’s different – only one of the dual triggers exists today.”