After mortgage forbearance rates peaked at 8.55 percent in June 2020, they began to decline as the unemployment rate fell. Since October, however, the unemployment rate has moderated significantly, which has led to a similar flattening of forbearance rates.
These flatlining forbearance rates have generated considerable concern, with some experts predicting that a large number of homeowners could face foreclosure in 2021.
About a quarter of the 2.7 million or so forborne borrowers are continuing to make payments, but about 2.1 million are delinquent. Another 1.1 million borrowers are delinquent and are not in forbearance programs (PDF). Some policymakers worry about what will happens at the end of forbearance to these borrowers and whether borrowers who have not regained their prior financial position will go into foreclosure.
But this widespread forbearance won’t necessarily happen, even among government loan borrowers who have a higher risk of default due to higher-initial-loan to value ratios, higher debt-to-income ratios, lower credit scores and lower incomes than borrowers using conventional loans. Loss mitigation policies and substantial housing equity can keep foreclosures at bay in most states. The two strong lines of defense are the loss mitigation waterfall and the amount of home equity that borrowers have accumulated thanks to robust home price appreciation.
The loss mitigation waterfall
Fannie Mae, Freddie Mac, and the government mortgage insurers (the Federal Housing Administration, or FHA; the US Department of Veterans Affairs; and the US Department of Agriculture’s Rural Housing program) established a loss mitigation waterfall that allows borrowers to pay back the forborne amount without increasing their pre-forbearance monthly payment.
The first step in the loss mitigation waterfall is to repay the forborne amount in a lump sum or over a short period. But if a borrower cannot increase their pre-forbearance payment, they can revert to their original payment and move the forborne amount to the end of the life of the mortgage.
For an FHA mortgage, the forborne amount becomes a “soft second” or a second, subordinate loan on which the borrower does not make payments until they sell or refinance the home. For a government-sponsored enterprise mortgage, the mortgage term will be extended. And if the borrower’s income is insufficient to meet their pre-forbearance payments, they will be considered for a mortgage modification, which would lower their monthly payment.
Borrowers not in forbearance programs are also eligible for loss mitigation options, including mortgage modifications. But not every borrower will qualify for a modification, and some will be forced to downsize or rent.
The home equity buffer
If many of the 2.1 million borrowers in forbearance are not financially stable when the forbearance period expires, those with home equity could exit their home, if they needed to, with their credit intact and potentially some cash in hand. If a borrower has equity in their home but cannot make their monthly mortgage payment or qualify for a modification, they can sell their home and buy a smaller home or rent a home. Housing equity also increases the viability of the loss mitigation waterfall because lenders are more likely to work out an alternative solution to foreclosure for the delinquent homeowner.
Borrowers in government securities have an average 22 percent equity buffer
Approximately 626,000 of the 3.2 million delinquent borrowers have government loans in Ginnie Mae securities. Because of their high loan-to-value ratios at origination, these borrowers are likely to have less home equity. The median loan-to-value ratio is 96.5 percent for an FHA purchase loan borrower; 100 percent for a US Department of Veterans Affairs borrower; and 101 percent for a US Department of Agriculture borrower, compared with 80 percent for Fannie Mae and Freddie Mac borrowers (PDF).
To determine how much of a home equity buffer these borrowers have, we developed a methodology (described below) to estimate the home equity for government loans. Our analysis shows that, even among delinquent borrowers, less than 1 percent have negative equity and 5.5 percent have near-negative equity. For comparison, in the aftermath of the Great Recession, approximately 30 percent of homes were in negative or near-negative equity, but the number is now 3.6 percent.
According to our analysis, the average borrower with a government loan has 22 percent equity. Only 3,771 of nearly 626,000 delinquent or forborne borrowers, or 0.6 percent, have negative equity. Most (2,817) are US Department of Veterans Affairs loans, many of which are originated with loan-to-value ratios above 100 percent. Fewer than 500 FHA and Rural Housing loans have negative equity. Nearly all the loans with negative equity were originated from 2018 to 2020, though mostly in 2020.
We also find that an additional 5.5 percent of borrowers have near-negative equity (i.e., the current principal balance as a share of the estimated home value is less than 5 percent). These borrowers will have no equity left after the transaction costs of selling, so they have little incentive to sell by themselves.
In some states, the smaller home equity buffer may result in more foreclosures
Though US home prices are up 60 percent from early 2012 through late 2020, and homes are worth, on average, 19.7 percent more than they were during the precrisis peak, home price gains have been uneven. Home prices in some parts of the country, including Chicago, Illinois; Baltimore, Maryland; and Riverside, California, are still below their precrisis peak. These areas are where we may see a greater number of actual home foreclosures.
The share of mortgages with negative equity values range from a low of 0.1 percent in several states to highs of 1.8 percent in Wisconsin and 1.4 percent in Illinois. The share of borrowers with negative equity or near-negative equity are mostly in the single digits, with only Wisconsin, Illinois, and Alaska exceeding 10 percent.
Forbearance rates have largely stagnated amid a slow decline in the unemployment rate, but we expect far fewer foreclosures than we saw after the Great Recession. Many of today’s homeowners in distress have both significant equity buffers and improved loss mitigation tools. The three-month extension of the forbearance period, announced on February 9 was welcome news, as it gives struggling borrowers more time to benefit from improved employment prospects as the economy recovers and to build an equity cushion; this is particularly critical to homeowners without equity. A further extension may well be necessary.
A quick look at our methodology
We determined the average amount of equity held by borrowers of Ginnie Mae loans by dividing the original loan amount by the loan-to-value ratio to estimate the original purchase price. Using the origination date of the security, assumed to occur two months before the borrower’s first payment date, we estimated the home’s current market value using Black Knight data at the state level (as we have loan-level information only at the state level). We then compared the estimated current market value with the loan’s unpaid principal balance to determine whether the borrower has equity. We used the market value at the state level, which may misrepresent the situation for certain hard-hit municipalities. But we also used the aggregate home price indexes, even though the lower tier of the market has done better, and Ginnie Mae loans are mostly in the lower half of the price distribution. This makes our analysis more conservative and offsets the lack of more detailed geographic information.