Dreading a rise in foreclosures? Here’s one economist’s take

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The market has certainly shifted since mortgage rates started skyrocketing last year and, with prices pulling back across much of the country, some have started to become concerned about the likelihood of foreclosures rising — clearly a timely topic given current circumstances.

I pulled the latest data on foreclosure starts and looked at the quality of mortgages that have been given to buyers in order to give you a clear idea of how foreclosures will impact the overall housing market. 

For the purposes of this exercise, I’m going to concentrate on foreclosure starts rather than foreclosure filings because data shows us that a majority of homeowners where a foreclosure filing has been submitted to a court by their lender are able to avoid it by refinancing or selling the home — which makes total sense as over 93 percent of owners in the U.S. have positive equity.

As you can see here, foreclosure starts rose significantly last year. In fact, they were 181 percent higher than in 2021.

But if we zoom out, it’s important to note that foreclosure starts were 31 percent lower than 2019 and 88 percent lower than the 2009 peak.

Am I surprised at the increase in foreclosure starts? Not really. The forbearance program was put in place at the start of the pandemic, and it allowed homeowners to temporarily stop making mortgage payments and not be foreclosed on, but that program ended 18 months ago. 

And, although a vast majority of the 4.7 million households who entered the program have left it and sold or refinanced their homes, there were always going to be some who were not able to, and this has led to the overall foreclosure activity rising.

Let’s take a closer look.

This is a heat map of foreclosure starts by state. And you can see that California, Florida and Texas saw the highest numbers in 2022.

But remember that these are the states that have the greatest number of homes with mortgages so, statistically, we would expect the total number of homes in foreclosure in those states would be higher than the rest of the country. 

That said, foreclosure starts were significantly higher in Florida, California, Texas and also New York, than they were in 2019, the last pre-COVID year and before the forbearance program started.

And when we look more myopically, metro areas including New York/New Jersey, Washington D.C., the Delaware Valley, Atlanta, Miami, Baltimore, and Dallas all saw total foreclosure starts rise well above what they were in 2019.

This may suggest that there are some markets that could see foreclosure activity rise to a level that could materially impact housing in those locations. 

But looking at the country as a whole, there are other factors leading me to believe that we will not see the number of homes entering foreclosure rising above the long-term average, and certainly not sufficient to have a material impact on US housing prices.  

Let me show you what’s happening on the mortgage side of things. First: Credit quality.

The median FICO score for new mortgages was 766 in the 4th quarter of 2022. Yes, this is down from the peak seen in early 2021 when it was a whopping 788 but as shown here, it’s far higher than we saw before the housing crisis. 

Buyers over the past several years had very good credit and, given the tight labor market, we are certainly in a very different place than back before the housing bubble burst.

Secondly, buyers are using larger down payments than in the mid-2000’s, and with the historically low mortgage rates that we saw during the first two years of the pandemic benefitting new buyers as well as allowing existing homeowners to refinance, the share of disposable income that is used to cover mortgage payments remains very low. This basically means that owners aren’t as burdened by their house payments as they were in 2007-2009.  

And finally…

With the significant runup in housing values that we have seen over the past few years, 48 percent of all homeowners with a mortgage have more than 50 percent equity — and although this share has pulled back a little as mortgage rates rose and values pulled back, it’s still a massive amount of money and, as I mentioned earlier, many homeowners who are faced with foreclosure, will end up selling their homes as they still have positive equity rather than go through the foreclosure process.

So, my answer to those of you wondering if we will see foreclosures rise to a level that could impact the overall housing market is no.

I don’t see any reason to believe that distressed sales will hurt the market in general but, I will say that there are some local markets where distressed sales could rise to levels that could act as a headwind to price growth in these areas.