FHA has placed a moratorium on foreclosures from mortgage loan defaults and offered any borrower that requests it an extension to not make payments for a year (HUD). This effectively kicks the can down the road and pushed out any impending actions until March of 2021. What does this mean for the mortgage market? How will real estate be impacted? How big of an issue will this actually be? What markets will be most impacted.
FHA market share hit a peak
Prior to 2008, the FHA market share was around 4-7% of the total mortgage market, fast forward to 2020, the share of FHA loans is now around 21% of the market. As the subprime mortgage market imploded in 2008 and 2009, these borrowers now are financed by FHA which has led to the explosive growth (source HUD).
FHA loans are considerably riskier for defaults
FHA rates are between ½ to ¾% of a percent higher than conventional loans. On a 400k house this adds up to around 3k/year. Why are borrowers choosing to go FHA versus your traditional conventional mortgage? It is easier to qualify! FHA allows down payments as low as 3.5%, credit scores down to 580, and higher debt to income ratios.
According to 2019 data from Core logic, the default rate of an FHA loan is over 3 time more likely than a conventional mortgage. Why? FHA loans are riskier loans due to decreased equity and decreased credit and income requirements. FHA is a subsidized “subprime” lender sponsored by the federal government and tax payers.
FHA loans now have the highest delinquency rate in at least four decades. New Jersey had the highest FHA delinquency rate, at 20%. The state also had the biggest increase in the overall late-payment rate, jumping to 11% in the second quarter from 4.7%. Following were Nevada, New York, Florida and Hawaii — all states with a high proportion of leisure and hospitality jobs that were especially hard-hit by the pandemic, according to the mortgage bankers association.
Last 2 years of loans most at risk
The last 2 years of FHA mortgages are most at risk of default. Let’s assume someone bought a house a year ago, the real estate across most of the country has been about flat depending on when they bought their property. Let’s assume they put 3.5% down, and don’t pay for a year, they will quickly be underwater. Here are two quick examples:
| Assume own for a year | |||
| Purchase price | 400000 | ||
| Down Payment (3.5%) | 14000 | ||
| Equity Prior to default (assume 5% appreciation) | 34000 | ||
| Default Int rate (assume 15% above current rate) | 57900 | * one year at default | |
| attorney/Foreclosure costs | 3000 | ||
| Equity after default | -26900 | ||
| Assume own for two years | |||
| Purchase price | 400000 | ||
| Down Payment (3.5%) | 14000 | ||
| Equity Prior to default (assume 5%/yr appreciation) | 54000 | ||
| Default Int rate (assume 15% above current rate) | 57900 | * one year at default | |
| attorney/Foreclosure costs | 3000 | ||
| Equity after default | -6900 | ||
*** note the actual equity is even less if you added in realtor fees if the borrower decided to sell the property ***
What does this look like for the residential market?
Based on historical data, FHA loans default at considerably higher rates than conventional mortgages. This leads us to the next question, how big on an issue is this. If I assume the last two years are most at risk due to the amount of negative equity, the defaults will start adding up quickly. Below is a quick analysis, based on actual loan volumes originated by the FHA in 2019 and 2020 (assume Q3/4 2020 follows 19 patterns on originations)
| Dollar Volume | ||||
| 2019 Q1 | 39 | |||
| 2019 Q2 | 59 | |||
| 2019 Q3 | 72 | |||
| 2019 Q4 | 75 | |||
| 2020 Q1 | 66 | |||
| 2020 Q2 | 69 | |||
| 2020 Q3 | 39 | * assumed same volume as 19 | ||
| 2020 Q4 | 59 | * assumed same volume as 20 | ||
| Total | 478 | billion | ||
| Default rates | ||||
| 7% | 33.46 | billion | ||
| 10% | 47.8 | billion | ||
| 15% | 71.7 | billion | ||
| 20% | 95.6 | billion | ||
| # of loans | ||||
| 2019 Q1 | 187806 | |||
| 2019 Q2 | 277170 | |||
| 2019 Q3 | 322691 | |||
| 2019 Q4 | 328060 | |||
| 2020 Q1 | 291607 | |||
| 2020 Q2 | 302499 | |||
| 2020 Q3 | 322691 | * assumed same volume as 19 | ||
| 2020 Q4 | 328060 | * assumed same volume as 20 | ||
| Total | 2360584 | |||
| Default rates | ||||
| 7% | 165,241 | |||
| 10% | 236,058 | |||
| 15% | 354,088 | |||
| 20% | 472,117 | |||
Summary
Between 200 and 500k loans will likely go into foreclosure starting in March of 2021 which equates 45-100 billion dollars depending on how bad the defaults actually are. Based on current default projections and the lack of equity in the last two years in many of these properties, I would expect that rate to be on the high side around 500 thousand loans and 100 billion dollars in properties that would go into foreclosure and ultimately have to be sold.
The million dollar question is how well will the markets absorb 500 thousand new distressed properties. In places like Denver, Colorado with very low inventory and continued demand, the market will likely not hiccup much. But, in places like Detroit, the absorption will be much more difficult and lead to substantial market declines. Regardless of the location, 100 billion dollars of foreclosures is a large number that will have to be dealt with by the federal government.
Unfortunately, I have yet to see any government officials (regardless of political party) release a back of the napkin calculation of the problem coming in March nor are there any prospective solutions other than to try to kick the can down the road and hope for the best.
Early/Mid 2021 is going to be a reckoning for the economy and real estate as eventually the piper must be paid. Even though there will likely not be March madness on the TV, there will be plenty of March madness unpredictably in real life.
Additional reading
https://www.hud.gov/program_offices/housing/hsgrroom/fhaprodrpt
https://www.hud.gov/program_offices/housing/rmra/oe/rpts/fhamktsh/fhamktqtrly
FHA loans now have the highest delinquency rate in at least four decades
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine, The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
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