COVID-19 is a historically unique event for the mortgage industry. Typically, during a crisis or catastrophic event that impacts the housing industry, you’d see a significant downtick in mortgage originations and an uptick in delinquencies, ultimately leading to foreclosures. However, the COVID-19 pandemic has been a unique crisis to not only live in and learn to work through, but also to follow as it relates to the mortgage business. Many factors have contributed to the type of downturn we’re seeing – one that’s far from normal.
Pandemic expectations
In trying to wrap our arms around the COVID-19 pandemic, we expected to experience a decline in mortgage originations. Mortgage industry participants ran scenarios reflecting a decline in originations, a decline in overall revenue and generally-speaking, an overall decline in housing activity, along with an increase in loans in forbearance and ultimately in delinquencies. That’s generally how a crisis impacting the housing industry works. As jobs are lost and incomes diminish, people stop buying homes and the rate of requests for forbearance or some type of homeowner assistance goes up. The mortgage industry flips the switch from helping people get into homes to preparing to work closely with homeowners to help them remain in their homes.
Ultimately, the effect of the pandemic on housing could end up playing out exactly how we expected. We’re keeping a close watch on how the pandemic is impacting customers, employees and the overall business of doing business. Interestingly, though, what we are seeing so far is not in line with those expectations.
Pandemic realities (So far, anyway)
Lenders are experiencing higher delinquencies due to the number of borrowers in forbearance as a result of the tens of millions of Americans that have filed for unemployment over the past few months and the availability of federal forbearance programs. Black Knight reported that in August, 7.5% of all active mortgages are in forbearance. That part we expected. What we did not expect was, with historically low interest rates, new mortgage originations remain high as many existing homeowners were driven to refinance their mortgages and renters were considering making the jump to homeownership.
It’s a tale of two markets. On one hand you have employed borrowers who are able to take advantage of purchasing a home or refinancing an existing mortgage. And on the other hand, in a very different market, unemployed borrowers have access to programs that can assist them in keeping their homes, such as forbearance and payment deferral. While one market is seeing signs of health, the other is seeing signs of distress. Typically, the front- and back-end of the mortgage industry are not busy at the same time, which makes this particular event incredibly unique. While housing inventory remains tight across the country, COVID-19 has not deterred the purchase mortgage market.
What’s driving this dichotomy?
There’s a clear dichotomy between the strength of the origination market and mortgage delinquencies, but what’s driving it? Low interest rates, the difference in unemployment between geographies and industries and even stay-at-home orders all have contributed to this contrast we’re living and working through.
Low interest rates: Lower interest rates helped make housing more affordable, especially for borrowers who had been sitting on the sidelines, waiting for an event to help push them into the mortgage market. The decline in interest rates gave potential homebuyers more reason to buy. Over the first half of 2020, mortgage rates were down 80 basis points from the year before, saving borrowers over $1200 a year on a $250,000 loan. The lowest mortgage interest rates on record enabled a large number of borrowers to refinance.
Weekly refinance applications ranged from two to six times last year’s number. Interestingly enough, apartment rental growth turned slightly negative in the first quarter (down 0.2% annually), as it became a less attractive option when compared to homeownership. According to Freddie Mac’s Quarterly Refinance Statistics report, on average, borrowers who refinanced their first lien mortgage in the first quarter of 2020 lowered their rate by about 0.75 percentage points. A year earlier, refinance borrowers only lowered their rate by 0.15 percentage points on average. The report also states that during the first quarter of 2020, borrowers saved on average close to $2,000 in annual interest payments by refinancing, though the amount saved differed significantly by refinance purpose; borrowers who refinanced in order to lower their rate or extend the term of their loan saved on average about $2,300 in annual interest payments while cash-out borrowers saved on average less than $1,000 in annual interest payments.
Unemployment by region and industry: Most borrowers that experienced unemployment had the option of entering into a forbearance plan, thereby stabilizing the for-sale market, at least for now. At the end of the forbearance period, some borrowers will be able to transition into a modified loan and avoid foreclosure. However, anecdotally, we’re hearing that once borrowers realized that forbearance didn’t mean forgiveness, they were less interested in entering into forbearance.
While the labor market remains fragile with an unemployment rate at close to 10%, how that percentage impacts homeowners and forbearance activity is very uneven. Higher hit areas for COVID-19 forbearance and delinquencies include the states and metros that have higher numbers of COVID-19 cases or where efforts to contain the virus through lockdowns were more severe. For example, states such as such as New York and New Jersey had high numbers of cases and states like California acted early to impose restrictions to contain the virus’ spread. Self-employed borrowers and certain industries such as travel, tourism, hospitality, and personal services (think hair and nail salons) have also been harder hit.
According to the June data from the Bureau of Labor Statistics, states frequently visited for their hospitality, entertainment and gaming appeal, like Nevada and Florida, are experiencing some of the highest levels of unemployment in the U.S.: upwards of 15%. Whereas most midwestern states, while still impacted by the effects of COVID-19 though less populated than California, Florida and Texas, are reporting significantly lower unemployment rates, between 4.3% and 7.4%.
If you look at unemployment through the lens of income level, 40% of households earning below $40,000 in annual income reported a job loss in March. To take it a step further in terms of education level, households that have earned bachelor degrees and above saw an unemployment rate of 6%, versus those households that have obtained high school degrees or less who experienced upward of 25% unemployment.
COVID-19-related job losses also have disproportionately affected Black and Hispanic communities. The Wall Street Journal’s Real Time Economics Special Report reported that Black and Hispanic populations were experiencing unemployment levels between 13% and 15% in July.
You see the same unevenness reflected in the broader commercial market, as companies like Amazon, Microsoft and Netflix are experiencing record market value and stock increases as their services are being used even more frequently. On the other side of the industry coin, popular retailers like J. Crew and JCPenney, who you wouldn’t have thought would be struggling during a normal downturn, have had to declare bankruptcy. There are various indicators during this cycle that show the impact of this particular downturn is significantly more targeted, concentrated or selective than we’ve seen in the previous downturns.
Stay-at-home orders: Nationwide stay-at-home orders also affected the housing market, especially between March 15 and April 12 where the number of purchase applications were down 33%. However, since April 12, the purchase market increased by 59% and was up 16% compared to mid-July of 2019.
Stay-at-home orders implemented across the U.S., school closings and a rapid transition to work from home have made our homes an even more functional part of our day-to-day routines. If the work-from-home environment remains for a significant period of time, many families are even rethinking their current space and what they may need that they don’t currently have, such as office and educational space. For those who are able, this may serve as a reason to purchase a new home or refinance in order to gain the ability to remodel or make at-home adjustments.
How the market is dealing with the dichotomy
The number of COVID-19 cases has been rising since the middle of June, which has resulted in pauses and reversals in re-openings and more voluntary social distancing efforts across consumers and businesses. As of June, Black Knight reported an increase of 1.2 million homeowners in serious delinquencies as the initial wave of borrowers impacted by COVID-19 missed their third mortgage payment. This could eventually result in higher foreclosures and more foreclosure sales in the housing market.
According to data from the Mortgage Bankers Association, home purchase applications rose 54% from early April to mid-summer. To address both these phenomena, we’re seeing credit availability tighten as lenders raise minimum credit scores, lower maximum debt to income ratios, and exit certain products not backed by the U.S. government in an effort to manage both the influx of business and their long-tail risk.
Additionally, verifying borrowers’ income and employment prior to loan closing has become increasingly challenging with some borrowers’ incomes or income histories being affected as well as many offices being closed where all or most of the employees are working from home. Determining an appropriate qualifying income is becoming more subjective as underwriters have to make judgments on whether pay reductions, furloughs and other events are temporary or long-term events to be considered.
What’s next?
With so many questions swirling throughout the mortgage and housing industry, industry leaders are wondering how lenders will treat borrowers who come out of forbearance and apply for a new mortgage, and most Americans are wondering what the rest of 2020 looks like for them from an unemployment and economic stimulus perspective. As an industry, there are a few ways we can make the most of what we have to ensure success as we take steps to recover and prepare ourselves for 2021.
First, we need to make sure that we tailor our actions to the respective markets. On the front-end of the market, even though it’s a large market and many are currently working in a virtual environment, that doesn’t mean that we change our credit or underwriting standards. Underwriting rigor, holding the right amount of capital, and making sure we have strong counterparties should all still be processes and activities in place on the front-end to ensure that we are still putting qualified borrowers in homes they can afford. Even if we’re doing virtual appraisals in this environment there are still ways to make sure we’re taking the right precautions to ensure we’re originating good loans. That same rigor can help all of us navigate through the cycle and hopefully give us optimism that as an industry we can come out of this cycle relatively quickly.
Second, we need to make sure that we use the playbook from the last downturn to help guide the path forward. For people who are financially distressed, have lost their income and are going through the forbearance program, it’s imperative that mortgage professionals and companies are providing the right help to those homeowners to help them stay in their homes. As recorded by Genworth Mortgage Insurance’s Chief Economist Tian Liu, the last recovery showed the industry’s ability to adapt and innovate during a downturn. For example, some investors realized that people who lost homes to foreclosure or those who could not buy because of tight credit standards still needed a place to live. This gave rise to investor-owned, single-family rental businesses. Nonbank lenders also seized their opportunity when bank lenders reduced their participation in the mortgage market, and these nonbank entities represent a major segment of the mortgage industry today. Because housing is such a fundamental part of people’s lives, disruptions within the housing industry will give rise to alternatives to meet those same needs.
Third, we must embrace the innovation that tends to accompany market disruptions like this one. The biggest lesson we learned from the past recession is that we should remain agile and recognize that a severe disruption to the economy and the housing market calls for change. For example, there were new policies and services, and enhancements to existing policies, born out of the 2008 financial crisis, including automated income and employment verification, Private Mortgage Insurer Eligibility Requirements that strengthened the mortgage insurance industry’s risk and capital standards, and credit risk transfers from the GSEs to private investors. Disruption naturally creates a path to innovation.
Given what we’re experiencing in the market, we need to have the right discipline on the front-end and we simply cannot allow all the action we took coming out of the last crisis to help homeowners on the back-end be in vain. We can’t ignore the part of the population that’s struggling just because there’s a lot of volume on the front end.
We also can’t be tempted to fall back to the practices known for producing short-term success, but instead we must work to put the industry in a position to manage another round of challenges down the road. Now, more than ever, it’ll be critically important that we’re taking our lessons from the past, coupled with our current programs and an innovative mindset, to help order our next steps.
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