What role will ex-homeowners who lost their homes to foreclosure or short sale play in the housing recovery?
Singling out foreclosed homeowners
Once a homeowner loses their home to foreclosure or short sale, what is the likelihood they will return to homeownership?
To answer this question, the Federal Reserve Bank (the Fed)’s economists tracked a sample of mortgages from the first quarter of 1999 to the fourth quarter of 2011. They then singled out the point at which a mortgage balance was satisfied and the trust deed mortgage was reconveyed.
Editor’s note —The Fed’s researchers used national data, thus their sample of defaults included both nonjudicial and judicial foreclosures. However, the type of foreclosure had surprisingly little relationship to when borrowers returned to the mortgage market. In fact, judicially foreclosed borrowers returned to borrow again more quickly than their nonjudicially foreclosed counterparts. The difference was within one-to-two percentage points.
Borrowers were split into two diametrically opposed groups based on their mortgage payoff history:
- borrowers who were in good standing on their mortgage prior to payoff; and
- borrowers who were subject to a foreclosure or short sale.
Editor’s note — For simplicity, we will refer to borrowers who lost their homes to foreclosure or short sale as foreclosed homeowners. The Fed’s data takes into account both types of former homeowners, but does not analyze a distinction in behavior between them.
35% of borrowers in good standing had taken out new mortgages within the 12-year sample period. That means nearly 70% did not return to buy a home by obtaining purchase-assist financing.
In contrast, only 13% of foreclosed homeowners had taken out new mortgages within the 12-year period. Since our concern is whether these foreclosed homeowners return to buy a home, let’s delve further into the Fed’s research.
The effect of the Great Recession
The 12-year sample period encompasses the credit crunch of the Great Recession. To review the recession‘s effects, researchers compared foreclosed homeowners’ return to the market before and after the Great Recession hit.
Foreclosed homeowners were separated according to the year of their foreclosure:
- 2001 and 2003, in the thick of the housing boom; and
- 2008, during the Great Recession.
Accordingly, 2001 and 2003 foreclosed homeowners were four times more likely than 2008 foreclosed homeowners to buy a home (with a mortgage) within the first three years after a foreclosure or short sale.
Editor’s note — Why only three year time periods? Data for 2008 defaults does not extend further than 3.75 years beyond the default date.
What accounts for the difference? 2001 and 2003 foreclosed homeowners had subprime mortgages at their disposal. The loose underwriting standards of these loans gave even foreclosed homeowners easy access to new mortgage money. In contrast, 2008 foreclosed homeowners were stonewalled in the credit crunch.
Though more likely to return to homeownership than 2008 foreclosed homeowners, the majority of 2001 and 2003 foreclosed homeowners did not return within the sample period. Only 25% of the 2001 and 2003 foreclosed homeowners returned to the market to buy again within three years, even with thriving economies and readily available financing.
Credit scores play a role
Researchers then sliced up the pool of foreclosed homeowners by credit score at the time of mortgage origination:
- prime foreclosed homeowners with credit scores higher than 650; and
- subprime foreclosed homeowners with credit scores of 650 or lower.
Following the foreclosure or short sale, both prime and subprime foreclosed homeowners’ credit scores dropped below 600.
However, by the end of the 12-year sample period, around 35% of prime borrowers had taken out new mortgages. Only 10% of subprime borrowers had taken out new mortgages.
Why did prime foreclosed homeowners fare so much better than subprime foreclosed homeowners?
This is a crucial question since a large chunk of the loans made and foreclosed on during this recession and recovery was subprime loans. If credit scores are a factor, this will direct future buyer behavior.
And as it turns out, credit improvement plays a pivotal role in determining which foreclosed homeowners return to the market. Foreclosed homeowners who increased their credit scores by more than 100 points were more likely to return to the market within five years of their default.
Further, another Fed research paper found that credit score recovery was slower for recent foreclosed homeowners (2008-2010, in this second study) than earlier (2001-2006) foreclosed homeowners. The recent foreclosed homeowners were subject to economic fallout of the financial crisis. Sudden unemployment or underemployment created a long-term economic problem for many households, and persisted after the foreclosure or short sale.
The sustained lack of income created a vicious feedback loop: lack of income led to delinquency, delinquency led to more expensive credit, more expensive credit led to lack of disposable income, which led back to delinquencies…and so forth.
Pre-default behavior impacts recovery
In theory, credit score recovery can occur as soon as two years after a major derogatory credit event if the defaulter pays all his other bills on time. [See first tuesday Form 217-1]
But how many homeowners took stock of their situations and prepared for default?
Not many. Lack of meaningful government guidance, post-bust, left homeowners to navigate the crisis on their own. Most negative equity homeowners continued (and continue) to pay on their underwater homes.
Consider the impact: homeowners who pay on their underwater homes are basically losing their money. They merely divert money away from paying other bills, and expose themselves to risk. This risk is realized when an economic shock – lost job, ill health, divorce, etc. – hits. They’re left with their money depleted, and no home equity or additional savings to show for all their mortgage payments.
Recovery from this situation is much more difficult than had the homeowner put his financial house in order, then strategically defaulted.
Mortgage reform, FHA impact
The return of foreclosed homeowners will also be impacted by the availability of Federal Housing Administration (FHA)-insured mortgages.
FHA-insured mortgages have taken over the role of subprime lenders in providing low-down-payment financing for those with low credit scores. Many of these will include some of the most recent batch of foreclosed homeowners, ready to take another stab at homeownership.
The FHA anticipates it will add $11 billion of loans in 2013, down slightly from its projected 2012 total. As its share of the mortgage market decreases as it has for a couple of years, so will access to mortgage funds for foreclosed homeowners. This will slightly decrease the rate at which foreclosed homeowners return to the market.
However, the FHA’s influence will be tempered by its solvency problems. The FHA will likely need a bailout from the federal government in 2013. In order to balance out its role as a mortgage titan, it will be tightening its own purse-strings by increasing its mortgage insurance premiums.
Homebuyer demand will return
The Fed’s analysis looks at the nature of the defaults of the recent past to determine future demand. The housing recovery we have experienced thus far corroborates their findings. It will take a long time for foreclosed homeowners to return to the market, longer than it has taken in the past. Instead of 15 years, it may be 20, or even more, before some return. Most may not return at all, and opt to be tenants.
This does not mean that demand is dead, or the real estate industry is in decline. It’s merely a reality check. The pace of homeowners added during the boom was simply not sustainable, and it won’t be recreated in the recovery. Instead, expect more renters, and more opportunities for branching out into property management.
Related articles:
San Francisco Federal Reserve Bank: Credit Access Following a Mortgage Default
Federal Reserve Board of Governors: Foreclosure’s Wake: The Credit Experience of Individuals Following Foreclosure
WillyP…. your ignorance of the truth and your desire to blame anyone else but the borrower amazes me! Moe S. and the others above are absolutely correct! The Do Gooders (read liberals who have never had a REAL job or run a business) in our government FORCED these loan programs on all of us in the mortgage and banking industry.
Yes … there were a few players on Wall Street who did wrong.
Yes there were a few loan officers who were greedy who did wrong. Unfortunately the stats show that most of these loan officers and lenders were minorities screwing their own people. This is where most of the fraud has been discovered. And it is still going on.
BUT….. these borrowers were ALL given disclosures disclosing the loan detail in FULL. The law requires this. These disclosures designed and required by our federal and state governments. We in the industry could ONLY use regulator approved disclosures. Every item you state above is totally untrue as it relates to the 95% of us lenders who are honest and ethical. Please remember that EVERY lawsuit filed has been done against Wall Street and the Big Banks, not us mortgage brokers.
The paying of 4+ points rebate was not illegal nor a violation of RESPA. The bulk of that rebate was used to pay the borrower’s closing costs, to help them purchase a home.
Yes, the builders have been ripping off buyers for decades! Forcing them to use thier in-house lender or lose the builder’s dollar savings incentives. Which were all built into the over-priced home.
As far as stearing borrowers into inappropriate loans…. Do you blame Nordstroms, Maceys, and others for overpricing their goods? Do you blame the car dealer who makes $10K on the sale as opposed to the dealer who only makes $3K? When is the buyer RESPONSIBLE for his or her actions? Is it the responsibility for any merchant to provide only the lowest price? Again I ask you … When does the buyer assume responsibility for what they do? As far as speaking English… would not the responsible buyer/borrower seek translations services to protect himself? Who is REALLY at fault here?
The “blame the borrower” folks ignore the facts. Except for fixed rate loans, the loan documents, marketing, and representations were all designed to deceive the borrowers. E.g., most Option ARMs never told borrowers the true (fully-indexed) rate, nor did they quantify the amount of negative amortization that would occur immediately, even though that was known. Borrowers who asked about the loan future status were told, “Don’t worry, we’ refinance you”, even though that was known to be impossible after 2007-8 with rising balances and falling values. Builder-lender subsidiaries used false appraisals to move subdivision inventory on unsuspecting buyers. Lenders openly violated RESPA by paying 4+ point rebates in order to induce originators to sell out borrowers and steer them into inappropriate loans, such as the Option ARMs. And many borrowers were given loan docs in English, although they only spoke another language, in which all the negotiations had been conducted.
Certainly, there were also foolish borrowers. But in view of the system-wide fraud by the banks/Wall Street, which allowed sale of the loans to defrauded investors without recourse, the lion’s chare of blame has to fall on the players in the securitization game.
Jeff,
Most banks and their underwriters follow government protocol. If the government regulators said dont worry about making a bad loan, we’ll buy it off you, and it will be gauranteed by the US. We think everyone should have a home, with stated income and hardly any qualifing, so thats what they did..
Most home loans are bought by the government, so the lenders will have money to loan again. A good lender wont make a bad loan if they are going to have to sell it legitimately or hold on to it themselves.
As a mortgage broker I cannot do anything that the lenders and their underwriters do not allow me to do. The lenders and the underwriters cannot do anything unless the government allows them to do it. That is why we went from full documentation for loan, to no documentation, and then way back again. The government created the entire housing bubble by the infusion of easy money, and then they pulled the carpet out because they realized they had made a huge mistake. Nobody in jail though – Barney Frank should be locked up along with the other screw ups that interfered with a sound market. Whenever the government thinks they know best and mess around with something, they screw it up every time. Blame the democrats for the utopian state of, every body deserves a home without qualifying.
I agree that it is morally responsible and ethical to repay debts but you have to look at the banks actions. It is their actions (ARM loans, sub-prime loans, no doc loans, etc.) that led to the housing crash. If the banks did their job and only loaned to qualified borrowers many home owners wouldn’t have been underwater and this whole mess wouldn’t have happened.
I guess what I am saying is that it was the banks that were unethical and immoral first. The homeowners are just responding to the effect of the banks actions. Maybe the effect of all the foreclosures will teach the bank a lesson? Oh wait, the taxpayers are paying their losses… That’s moral and ethical!
100% agree with both of you and thank goodness there are still people who believe in honoring their contracts and being ethical. People I associate with are outraged that we were brought up to do the right thing, pay our bills, live below our means, and yet we are the ones being punished by subsidizing the many dishonorable rip off artists.
I am disgusted by many politicians buying political favor and not speaking out against principal forgiveness etc as being a bad idea for our country. Most of these underwater homeowners would cry foul if the government asked them to share their equity appreciation, but have no problem asking the government (aka “Us”) to pay for their greed when they bought homes they knew they couldn’t afford. They gambled on markets going up and they lost. Now we have to pay, so unfair!
It sounds benign to talk about “strategic default” as being in the best interest of underwater homeowners, but it is morally tantamount to theft.