The percent of California’s mortgage debt balance that was 90+ days delinquent and not yet in foreclosure under a notice of default (NOD) decreased to 3% in the third quarter (Q3) of 2012. This was down from 4% one year earlier. The normal 90+ day delinquency rate for mortgages not yet in foreclosure is less than 0.5%.
The 90-day delinquency rate on home mortgages is a leading indicator of the trend in short sales, NOD recordings, trustee’s (foreclosure) sales and REO resales. Home loans in California make up 12.9% of all loans in the nation, and roughly 20% of the nation’s delinquent mortgage loans are found in California. Thus, our state’s delinquency rate has a substantial bearing on both the California and national economies.
Data courtesy of Mortgage Bankers Association.
Gray bars indicate periods of recession.
The above charts depict the percentage of California mortgage loans 90 or more days delinquent and not yet in foreclosure. Traditionally, lenders commence foreclosure when a mortgage is 90 days delinquent.
Loans delinquent and unlikely to be paid in full
With employment only modestly improving and cramdowns still off the table, the number of homeowners delinquent on their mortgages remains elevated.
In the third quarter (Q3) of 2012, 3% of all California mortgage loans were 90 or more days delinquent and not yet in foreclosure.These mortgages are headed for a notice of default (NOD) and foreclosure if a pre-foreclosure workout is not quickly arranged. This is down from the7% peak delinquency level in Q1 2010, but still far above the quarterly average of 0.4% during 2000-2006.
Editor’s note —The chart above only includes loans which are 90 days or more delinquent, and are NOT in foreclosure. The 90+ day delinquency rate including loans in foreclosure is about twice as high. Thus, the chart above portrays a slightly more optimistic picture for lending than it would otherwise.
In about half of all instances, mortgage delinquency leads directly to foreclosure unless the homeowners arrange short sales with the lender’s approval. Of course, once the foreclosure is complete, the property returns to the real estate market as a flipped property via speculator interference or as a real estate owned property (REO).
Short sale approval has actually become the more common route for lenders to take when a homeowner becomes seriously delinquent. As of Q3 2012, short sales make up 25% of all California resale activity. This action has significantly reduced the REOinventory.
The above chart depicts the most serious delinquencies — those most likely to lead to foreclosure — as a percentage of California mortgage loans. As the chart indicates, delinquencies jumped exponentially from an artificially low level during the Millennium Boom to new 70-year heights following the start of the Great Recession in December 2007.
Today, the peak in serious delinquencies has passed, and a slow decline in the rate of delinquency is underway. A full return to normal delinquency rates is held up by the lack of jobs and a return of prices to their long-term, historical mean price level.
Delinquencies and foreclosures
Delinquencies gauge homeowners’ financial ability or willingness to continue paying their mortgage loans. Trends in the delinquency rate anticipate future levels of:
- NODs: the lender’s first step in the foreclosure process, NODs are usually recorded on all mortgages 90+ days delinquent;
- short sales: in the present market, selling a home for less than the value of the mortgage remains one way for many Californians to relocate;
- trustee’s sales: the homeowner’s point of no return, when the lender or a third-party bidder acquires ownership of the home through foreclosure, leaving no further ability for the prior owner to reinstate the mortgage or redeem the property; and
- REO and related resales: the resale of property acquired by the lender at the trustee’s sale.
NOD recordings peaked in Q1 2009, with 135,431 NODs in that quarter alone. This was also the peak moment for REOs as a percentage of all home sales (excluding trustee’s sales). REO properties then comprised 54% of all homes sold statewide. For comparison, the average from 2000-2006 was 1.7%. Historically, REO resales have made up around 7% of the properties for sale.
Since 2009, NODs, trustee’s sales, and REO resales have all declined significantly, albeit fitfully, in a staircase movement. Much of the recent drop in foreclosures and REOs is attributable to an equal increase in short sales. Still, REO resales show few signs of declining back to pre-2007 levels until sometime after 2016.
In contrast, the 90+ day delinquency rate peak ended comparatively late, in the first quarter of 2010, and has since seen a gradual but constant fall — with several years still to go to return to normal.
This difference between delinquency (indicating the homeowner’s ability or willingness to pay a loan) and foreclosure (indicating the lender’s willingness to penalize the homeowner for their financial condition rather than provide a workout) shows that lenders’ decision to foreclose depends on other factors than simple delinquency. These include whether a homeowner can qualify for a loan modification or a short sale discounted payoff based on a documented hardship. Hardships may include:
- relocating for a job;
- inability to make payments due to a job loss;
- death of a co-borrower;
- living in a neighborhood blighted by vacant, foreclosed homes; and
- negative equity.
Nor do we expect delinquencies to continue to fall indefinitely. Several years still remain, through at least 2016, before delinquency levels return to their normal market lows. As with foreclosures and REOs, the trend in delinquencies going forward is likely to be downward. But it will also to be slow, halting, and subject to occasional reversals (interest rates rising for example) as the housing market sputters back to ignition and take off.
In 1990-2000, the average 90+ day delinquency rate for California was 0.6%. By the end of the 1990s, home sales volume and prices were both rising, and the market had fully recovered from the 1990-91 recession. The Federal Reserve (the Fed) had already put the brakes on the economy by raising interest rates beginning in mid-1998, driving the economy into a mild and Fed-controllable recession in 2001.
When delinquency rates fall back to turn of the century levels, our economy — and the real estate market — will have attained full recovery. We currently anticipate this state of recovery to arrive after 2016, likely around 2018-2019. This forecast is based on:
- the pace of job recovery;
- rising interest rates; and
- pervasive negative equity conditions.
At the moment, however, negative equity homeowners and those delinquent on their mortgages may feel imprisoned in their homes. Sales conditions from 2006-present have not permitted homeowners who bought or refinanced between 2000 and 2009 to sell their property for the amount of the mortgage balance, much less at the price paid. This means any property purchased or refinanced in the 2000s will lead to a financial loss in real terms, if not actual dollar terms. As such, many owners have decided to stay in their homes as long as possible, losing out on job opportunities, postponing retirement, subjecting themselves to a reduced standard of living, as well as other relocation-based concerns while waiting in the hopes of improvement.
Factors at work today
Several factors are at work to reduce delinquencies, particularly rising levels of employment and consumer confidence.
California still requires over 800,000 jobs to return to December 2007 peak levels (and another one million jobs needed to account for the increase in state population), as of the end of 2012. As time passes and jobs develop, new employment will lead to increased demand for housing. Increases in income determine a family’s ability to “pay and stay”: to make payments on their negative equity mortgages, averting default.
In the meantime, those who remain tragically unemployed will turn with increasing frequency to strategic default. Just under two million California homeowners today owe more on their mortgage than their home is currently worth. Thus, most of them are insolvent, candidates for bankruptcy (which would in most cases cause them to have to sell their home and the lender to take a loss).
Many of these homeowners will eventually become frustrated at the lack of upward home price movement in the years to come. They will then likely cease to pour their income into an insolvent homeownership situation. Instead, many will exercise their put option right to walk away from their home, mortgage and all, leaving the recalcitrant lender to deal with the property.
For a real estate recovery to take place, demand must be fueled by end users (notspeculator activity). The single most important factor in generating end user demand for homeownership is the wealth of the population, as determined by jobs.
When California employment numbers accelerate to a pace of 350,000-400,000 new jobs created annually for two consecutive years, real estate sales volume will begin to consistently rise. Within one year, rising demand for homeownership will drive up prices. Rising prices, in turn, will help current homeowners develop equity in their property sufficient to sell without seeking short payoff approval. Then — finally — the delinquency rate will return to normal.
For recent years, home sales volume has maintained a bumpy plateau: rising and falling from period to period, but showing little to no long-term change annually. Conditions in sales and pricing will slowly increase in 2013-2014. The exception will be spates of speculator activity on the bet that the market will get a jump start and produce a juicy profit on payoff by a resale at 20% annual price increases within one or two years of purchase.
As soon as asset prices (including home prices) begin to rise in 2015, the bond market, then the Fed, will raise interest rates to combat unsustainable growth. This time, the Fed will have the additional task of withdrawing a huge portion of the dollars they infused into the banking system in an effort to drive the recovery.
Increased interest rates for the next decade or two will likely restrict price gains to the rate of inflation (historically maintained at 2-3%). Thus, delinquencies and REOs will likely remain high even into 2017 and beyond.
This recovery is going to test the patience of all involved in the real estate market. In the end, speculators now stepping into the shoes of sellers will learn about the risk of loss that exists in the economy’s exit from the liquidity trap created by zero-bounded interest rates. This was last experienced in the U.S. during the 1950s as part of the recovery from the Great Depression and zero-bounded interest rates.