Housing Crisis: Why 40-Year Mortgages Might Help Delinquent Borrowers

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About the author: Patrick Harker is the president and CEO of the Federal Reserve Bank of Philadelphia.

The Covid-19 pandemic is not over. But many of the pandemic assistance programs associated with it are done, or soon will be. 

Mortgage forbearance, which began after passage of the Cares Act, is a case in point. Throughout the pandemic, federal and private programs have allowed borrowers to stay in their homes and stop mortgage payments for up 18 months with no negative impact on their credit scores. 

The number of loans in forbearance now stands at around 680,000 mortgages. That’s a whole lot of people, but it in fact represents a steep decline. All told, more than 8.5 million borrowers entered forbearance at some point during the Covid-19 pandemic, north of 15% of the total mortgage market.

Simple arithmetic suggests that nearly 8 million households who were in forbearance no longer are. Temporary protections against foreclosure have expired as well. Which is to say, this is a real-time “stress test” not only for borrowers but for lenders as well.

So what has become of this sizable chunk of homeowners and their families? Researchers at the Federal Reserve Bank of Philadelphia have been tracking these data and have made important findings.

Begin with the positive.

The first bit of good news is obvious to anyone perusing listings on

Zillow

: The American housing market is exceptionally strong. While this has had undeniably negative impacts on those seeking to enter the housing market, it does ensure that most past-due borrowers can avoid losing their homes and that banks won’t suffer losses large enough to meaningfully affect their capital positions. Homeowners are sitting on more than $10 trillion of tappable equity – a record. Other borrowers coming off forbearance who are unable to resume their payments likely have the option to extract equity from their properties.

The contrast with the Great Recession is remarkable. Recall that back then nearly half of all distressed borrowers were “underwater,” meaning they owed more on their mortgages than their houses were worth.

Also, as of today, nearly three-quarters of those who have exited forbearance have voluntarily paid off or are current on their mortgages, many making use of payment deferrals or loan modifications. For borrowers able to resume timely payment, a deferral creates a no-interest, second loan out of their missed payments not due until the loan is paid off. This is significant because payments missed during forbearance do not disappear: Borrowers will still have to pay them back eventually. Tacking them onto the end of a primary loan is a smart way to ease this burden. 

Loan modifications, meanwhile, work like a no-cost, cash-out refinance. Borrowers are offered lower rates and extended loan terms while being allowed to forgo immediate payback of their past-due arrears, resulting in reductions in their monthly mortgage payments of 20% or more. Deferrals and loan modifications are the two major types of Covid-19 loss mitigation options on offer. 

But many American borrowers continue to face heavy burdens.

Nearly one million mortgages are seriously delinquent, split evenly between those classified by servicers as in loss mitigation and those not. Most borrowers who remain seriously delinquent and not in loss mitigation never entered forbearance at all and were in nonpayment before the pandemic struck.

And of the borrowers classified as in loss mitigation, three-quarters are still in process and have not, as of yet, resumed timely payment on their mortgages. The burdens are not distributed equitably. Black and Hispanic borrowers have much higher shares of nonpayment — either being in forbearance or delinquency.

Losing one’s home is a profoundly destabilizing event with potentially lifelong consequences. It’s a heavy burden to lenders as well: Foreclosures are expensive and time-consuming to service. Lenders should be thinking hard about how to keep people in their homes and to minimize their own losses.

One solution being pursued is for the Federal Housing Administration to offer 40-year terms for their modifications, just as the two government sponsored enterprises,

Fannie Mae

and

Freddie Mac
,
do now. This would lower the monthly mortgage payment even more than when extending beyond the currently offered 30-year term, providing more relief to borrowers. The Department of Housing and Urban Development placed a proposed rule into the Federal Register on April 1 to increase the term for loan modifications to 40 years for FHA-insured mortgages. We are now in a 60-day comment period.

Longer term, lenders should think of ways to improve communication with their customers. Our data suggest millions of distressed borrowers who qualified for forbearances never took advantage of them. A study from my colleagues at the Federal Reserve Bank of Philadelphia found that millions of borrowers— disproportionately Black or low-to-moderate income—did not apply to refinance their mortgages during the pandemic, when they could have enjoyed significant savings. This was a missed opportunity.

With a fairly weak public social safety net for Americans, houses are not only our shelters — they are a significant source of our household wealth and retirement savings as well. Let’s do what we can to make sure people don’t lose this most vital asset. 

Watch Philadelphia Fed President Patrick Harker on Barron’s Roundtable, airing on Fox Business at 10 a.m. and 11:30 a.m. ET, on Saturday, April 9, and Sunday, April 10.

Guest commentaries like this one are written by authors outside the Barron’s and MarketWatch newsroom. They reflect the perspective and opinions of the authors. Submit commentary proposals and other feedback to [email protected].