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This piece originally appeared in the January 2024 edition of MortgagePoint magazine, online now.
Whether you believe it will happen next year or in five years, it is inevitable that we will face a default spike of some sort in the near future. While default rates have remained artificially low for years, this is the result of a combination of public and regulatory pressure to avoid foreclosure at all costs at a time when most lenders have had the capital reserves and financial incentive to lean heavily on loss mitigation instead of foreclosure. This is most certainly not a bad result.
However, as interest rates continue to remain relatively high, lenders are increasingly finding that their ability to absorb the time and cost of undertaking a mitigation-first approach is declining.
With market conditions expected to remain subdued or deteriorate through 2024 and possibly into 2025—especially regarding rates and inflation—we’re already starting to see some increases in both default and foreclosure rates.
While talk of foreclosure and default tends to trigger memories of the foreclosure spike of the early 2010s, the next surge will look decidedly different. The regulatory and legislative environment has changed. The perspective of mortgage lenders and servicers towards delinquency has changed. And the number of tools available to manage a sudden increase in default activity has increased exponentially.
What’s Different About Default in 2023?
For many outside the mortgage lending industry, especially among the general public, talk of the Great Recession and housing meltdown evokes heart-wrenching images of sheriffs evicting unfortunate homeowners who’ve recently lost jobs or vacant, unkempt nuisance properties sitting unmaintained and off the market for months or years. We are reminded of the horror stories about large banks foreclosing at the drop of a hat, or we recall old news articles about evictions being carried out on the wrong properties.
It’s those exact stories and images that drove a wave of public indignation that resulted in a stream of regulatory reform to the foreclosure process. After 2015, lenders and servicers were given incentive to avoid foreclosure and a much larger list of requirements that needed to be exhausted before a full foreclosure process could be initiated.
The pandemic of 2020–2021 was a great test for this new combination of incentives and deterrents to foreclosure. Although mortgage delinquency rates reached their highest levels since the peak of the Great Recession in 2010, the default rate remained well below that seen in 2010 and 2011. Although lenders have never looked to default and foreclosure as optimal outcomes by any means, their aversion to those processes has only grown. However, as market and economic pressure on their capital reserves increases, it’s entirely possible they’ll be forced to take on foreclosure proceedings in the future that they would otherwise have avoided two years ago.
The signs are already there, and much like an iceberg, there’s a lot more beneath the surface. While financial incentives and assistance have, thus far, helped keep the foreclosure rates low, banks and lenders, pressed for liquidity themselves, are becoming more stringent in that category. Some estimate that up to 300,000 homeowners receiving payment assistance could lose that in 2024.
What Will be Different When Default and Foreclosure Rates Rise?
Although public and political pressure has played a role in lenders’ increased aversion to the foreclosure process, the number-one reason remains that it’s expensive, time-consuming, and likely results in the lender gaining possession of an asset it never wanted in the first place, leading to the costs of asset management, property preservation, and resale. Expect lenders to continue to do all they can to avoid foreclosure—whether that’s using loan modifications or things like mortgage forbearance or deferments (as we saw so widely in 2020 and 2021)—to minimize costs and recover some or all the planned revenue.
Lenders are also seeing decreased interest in investor participation at foreclosure auction sales. SFR and other investors are becoming gun-shy because of the volatile market and soaring rates, which is leading to a decrease in what those who are participating are willing to pay. The result will likely be an increase in bank-owned property—a result no lender relishes.
Technology has dramatically evolved since 2010, and its role in the default and foreclosure segment is no exception. Communication has long been a challenge for servicers and lenders alike when attempting to negotiate with homeowners behind on their mortgage payments.
Now, however, with the growing use of apps, interactive technology, and even AI, servicers, and lenders are finding it easier to reach out to reluctant homeowners and present alternatives about which they might otherwise remain unaware. During the pandemic, in fact, we saw homeowners (and credit card debtors, auto loan holders, and more) increasingly able to request deferments by simply visiting a servicer’s website and clicking a button. In some cases, even, a decision was able to be made quickly—and perhaps without even having to require a conversation or additional information. While some of that came about because of the extraordinary crisis that pandemic shutdowns presented, the “pipes” for better communication between creditor and debtor are now in place.
Training and Technology—The Path Forward
The mortgage industry has also become much more aware of the negative optics foreclosure often presents. Many times, a default situation comes on the heels of life-changing trauma: death, divorce, terminal illness, job loss, or disability. It’s almost impossible for any lender or servicer—especially a high-revenue lender—to threaten to possess the home of homeowners facing such circumstances without the risk of projecting negative imagery, even if they’ve followed the letter and the spirit of the law completely. The process may be justified, and possibly even underutilized at times (e.g., in blighted neighborhoods dotted with abandoned properties), but it’s always poorly received in the court of public opinion and, subsequently, the compliance sector.
As a result, an increasing number of servicers and lenders are leaning on professionals specially trained to help homeowners who are fatally delinquent on their payments to relocate, understand their rights, and receive helpful services about which they were previously unaware, such as legal assistance and counseling. The recurring image of distraught evictees being forcibly removed from their homes is something no servicer or lender wants to see attached to their name. Now, far more than we saw around 2010, the mortgage and real estate industry is combining the human touch with technology to create a more compassionate foreclosure and eviction process. In so doing, they’re also realizing decreased costs from the entire process.
Although the foreclosure rate has hovered near zero for years now, certain economic conditions may force lenders once averse to the process to make use of the tool again. Fortunately, increased awareness by the mortgage industry about how foreclosure is perceived, new technology, better training, and more emphasis on assisting homeowners potentially facing the process have all prepared the default segment not only to better manage any sudden increase in volume but also to find loss-reducing alternatives more often.
Foreclosure is an unfortunate but necessary element of any lending lifecycle. There will always be borrowers who find themselves unable to live up to the terms of their loan agreement. Without recourse in those cases, the system would eventually crumble.
The key to mitigating the human toll of foreclosure is using improved technology and incorporating another layer of humane behavior into corporate policy. For example, perhaps lenders could put more resources and training into ensuring that foreclosed-upon homeowners are relocated and given the tools and education for a fresh start and a way back to homeownership.
Or perhaps the Freddie Mac First Look initiative could be a roadmap for more REO properties being funneled toward first-time homebuyers or renters instead of investors. Whatever the formula, there’s much that can be done to lessen the impact of foreclosure without simply eliminating the process. It’s likely that the next default wave will see an increase in the use of these tools as well.
