The dangers of granting too much time for COVID mortgage delinquencies

The extra time afforded to distressed homeowners through mortgage forbearance is having a diminishing lift on the number of distressed homeowners who are digging out of delinquency.

And while forbearance has been a much-needed lifeline for millions of distressed homeowners, the payment pause allowed with forbearance is a double-edged sword: eroding home equity even as it gives more time to recover from the loss of a job or income.

Eroding equity means many distressed homeowners have less chance of avoiding foreclosure the longer forbearance programs and foreclosure moratoria are extended.

Diminishing Delinquency Decline
First, a look at the diminishing returns from forbearance.

The number of active mortgages in forbearance and the number of delinquent mortgages both peaked in May 2020, with the country in the throes of the pandemic-induced economic shock, according to data from Black Knight’s Mortgage Monitor and weekly forbearance reports. In the following three months, percentage-from-peak decreases in delinquent mortgages ran roughly parallel to percentage-from-peak decreases in active forbearance numbers.

Given some time to get back on their feet, millions of distressed homeowners were catching up on payments and exiting forbearance while curing or avoiding delinquency. Black Knight data shows that 45 percent of the 7.1 million mortgages ever in forbearance have exited and are performing (not delinquent) as of the end of March 2021. Another 15 percent took advantage of the extra time to refinance into lower interest rate loans that were more affordable. Combined, those two categories add up to more than 4 million homeowners who took advantage of forbearance to get back on their feet following the shock of the pandemic.

But the decreases began to deviate in September, at the end of the first six-month forbearance period stipulated by the CARES Act.

Since September, the spread between decreases in forbearance and decreases in delinquency has continued to widen. As of February 2021, forbearance numbers were down 43 percent from the May peak while delinquency numbers were down only 22 percent over the same period. This translates into a decrease of 2 million homeowners in forbearance compared to a decrease of less than 1 million (969,614) in delinquency. Seriously delinquent mortgages decreased by only 310,378 — or 12 percent — over that same time period.

Eroding home equity
Time alone will not be able to heal many of those stubbornly remaining seriously delinquent loans. That’s because more time means more missed mortgage payments, and that translates into eroding home equity — the last remaining foreclosure prevention lifeline available to many distressed homeowners.

A Black Knight analysis of mortgages in forbearance as of January 2021 found that 18 months of missed mortgages payments would result in nearly $25,000 being added to the balance of the mortgage for the average homeowner in forbearance who already has less than 10 percent equity.

Mortgages balances inflated by forborne interest, taxes and insurance would result in a higher share with less than 10 percent equity — important because that’s the minimum amount of equity typically needed to sell a home on the traditional real estate market and thereby avoid foreclosure.

Black Knight estimates that 22 percent of all mortgages in forbearance would have less than 10 percent equity after 18 months of forbearance — more than double the 10 percent at the beginning of forbearance. That low equity percentage balloons to 36 percent for FHA mortgages after 18 months of forbearance.

Lower equity equals higher foreclosure risk
Not surprisingly, most properties that end up foreclosed have less than 10 percent equity. Over the last eight years, 84 percent of foreclosure sales on the Auction.com platform had less than 10 percent equity. The equity for these foreclosure sales was calculated by comparing the total debt owed on the mortgage in foreclosure to the final sale price at the foreclosure auction.

Leading up to the pandemic, the share of low-equity foreclosures was on the decline, hitting an all-time low of 73 percent in Q1 2020. But even with home price appreciation accelerating during the pandemic, and demand on the Auction.com marketplace hitting record highs, the share of low-equity foreclosure sales has started to climb again, reaching as high as 79 percent in Q3 2020. In dollar terms, the average amount of negative equity for foreclosure sales increased to $19,635 in Q1 2021, the highest since before the pandemic.

The increasing amount of negative equity at foreclosure sale is not because distressed property prices are declining. The average price for a foreclosure sale in Q1 2021 was $138,904, up an impressive 11 percent from the previous quarter. But the total debt owed on properties being foreclosed has been rising even faster than sales prices, up 13 percent in Q1 2021 compared to the previous quarter. That marked the biggest quarterly rise in average total debt in more than eight years.

The first quarter spike in average total debt on properties going to foreclosure sale, along with the rising share of low equity properties going to foreclosure sale, acts as a wake-up call for those who may believe that time combined with rising home values can prevent all foreclosures. The unfortunate reality is the longer many delinquent mortgages have carte blanche protection from foreclosure, the less chance they have of avoiding foreclosure once that protection is lifted.

On the other hand, the sooner those delinquent loans can be put on a more proactive servicing path, the more likely the distressed homeowners will be able to avoid foreclosure — either through loss mitigation that returns the loan to performing status, or through a pre-foreclosure sale that leverages any home equity to allow for a graceful exit from the property.