Mortgage debts are increasing. FHA borrowers are feeling it

After reaching an all-time low in 2023, mortgage defaults have risen rapidly in recent quarters, especially within the Federal Housing Administration (FHA) portfolio. The shift is driven by a combination of factors, including macroeconomic pressures, the impact of natural disasters and rising property insurance premiums and taxes.

Certain groups of borrowers are particularly vulnerable, including those with lower credit scores, higher debt-to-income ratios and those who have opted for more affordable loan products. Similarly, some borrowers who transitioned from COVID-19 forbearance plans to workout options are now experiencing new financial pressures as they renegotiate terms with their servicers.

Despite the upturn, economists warn against concern for the time being. Although defaults have increased, they remain relatively low by historical standards. Still, further deterioration could pose challenges for some investors and managers and should be closely monitored, according to industry experts.

Links with unemployment

The year-over-year increase in delinquencies is reflected in several market statistics.

ICE mortgage technology reported a national default rate of 3.48% in September, up from 3.29% a year earlier. Data for the third quarter of the Association of Mortgage Bankers (MBA) showed a 3.92% default rate for one- to four-unit residential loans, compared to 3.62% in Q3 2023 and 3.37% in Q2 2023 – the lowest levels since 1979. And TransUnion highlighted a 60-day default rate of 1.22% in the third quarter of 2024, up 27 basis points (bps) from the same time last year.

Rather than current levels, the primary cause for concern is the upward trend in mortgage delinquencies. This is due to the strong correlation between unemployment rates and home loan defaults, according to Marina Walsh, MBA’s vice president of Industry Analysis.

“When we look at the delinquency rate, we often also look at the unemployment rate, and our forecast is that the unemployment rate will certainly rise to 4.7% next year,” Walsh said.

“The year-over-year increase in delinquencies is certainly worth keeping an eye on,” Satyan Merchant, senior vice president and mortgage leader at TransUnion, said in a statement. “However, it is important to note that current default rates remain low compared to long-term measures. It remains to be seen whether the aforementioned rate cuts and cooling inflation will help counter this increase in the coming quarters.”

Meanwhile, rising homeownership costs are adding to the challenge. Dave Vida, head of sales at subservicer Loan carespeaking on one Information management network (IMN) servicing conference in New York in November said property taxes and insurance costs rose about 12% across the LoanCare portfolio last year.

Historically, insurance and taxes have represented 30% of a borrower’s total mortgage payments, but this share increased to 33% last year. Vida added: “If that payment is 40% of the total, there is a direct correlation to delinquency performance.” He added that LoanCare is actively working to identify early signs that borrowers are struggling to pay off their mortgages.

Regulators are also taking note of the problem, though solutions remain elusive as they continue to gather information. “The challenge for them is that taxes and insurance are governed by state regulations and not federal regulators, so there are limits to what they can do,” said Krista Cooley, a partner at Mayer Brown.

Natural disasters also contribute to the increase in delinquencies. The physical damage and financial strain caused by recent hurricanes have affected homeowners’ ability to meet their mortgage obligations. According to ICE, approximately 4.9 million mortgage holders, with a combined $1 trillion in unpaid principal balances, were in the path of Hurricanes Helene and Milton. Among them, 2,500 borrowers fell into delinquency as a result of the storms in September and October.

In addition, Hurricane Beryl has affected approximately 1.2 million mortgage holders, 13,000 of whom are already struggling to keep up with their payments, ICE reported.

Where is the risk?

Signs of financial stress are concentrated in specific portfolios. Walsh said there is a “big question mark” regarding FHA loans, which registered a 10.46% default rate in the third quarter of 2024, compared to 9.5% in the same period last year. This represents an increase of 96 basis points, surpassing the increase of 82 basis points The U.S. Department of Veterans Affairs (VA) loans and the 30 basis point increase for conventional mortgages.

Exclusive data shared by the MBA with HousingWire revealed the long-term difference between FHA and conventional loan defaults. Since 2014, the average difference has been 620 basis points, but has now increased to 783 basis points. The spread peaked at 1,010 basis points in the first quarter of 2021 and contracted to 405 basis points in the first quarter of 2017.

“What this tells us is that in the event of any event, whether it’s hurricane or storm related, or related to the economy, it’s going to be felt more by FHA borrowers than the others,” Walsh said.

The relative resilience of VA loans may be related to policy interventions, Walsh explains. More specifically, the development of a loss mitigation waterfall encouraged servicers to prevent these loans from defaulting. “It could be policy-related,” she added.

Another group concerned is borrowers opting out of COVID-19 forbearance plans. According to the MBA, servicers have granted forbearance to nearly 8.4 million borrowers since March 2020. As of October 2024, 235,000 were still in forbearance plans, with an increase of 65,000 in October – the largest monthly gain since May 2020. Of the new additions, the MBA attributes 45% to natural disasters and 55% to temporary hardships such as job loss. , death, divorce or disability.

Importantly, in October the share of loans with completed workouts was 68.47%, down 29 basis points from the previous month and 384 basis points lower than a year earlier.

Larry Goldstone, president of capital markets and lending at BSI Financial Servicesis particularly concerned about how FHA and VA loans are being managed as they transition from pandemic-related forbearance plans to workouts. At the IMN services conference in New York last month, Goldstone said there are now “COVID default loans.”

“The rate of new defaults on modified loans is not insignificant; it is probably at 50%, meaning half of these borrowers cannot afford the house they live in,” Goldstone said. “They just need more and more government support, and at some point it will run out.”

According to Goldstone, governments are “already offering 30% off your mortgage balance as free government support,” which he believes is a “pretty generous program.”

Christopher Sabbe, senior vice president of corporate sales at PHH Mortgage, said investors appear “complacent” about current default levels because financial stresses have not reached the critical levels seen during the Great Recession.

“Last week I had a client who said: ‘I have a payment arrears of 9%, and that’s fine with me,'” Sabbe said during the IMN conference. “I replied, ‘Today it is 9%. What will it be like in a year?’”

While some investors may not yet be feeling the pressure, others are beginning to proactively address the situation by transferring their entire portfolios or segments – such as loans that are 30, 45 or 60 days past due – to specialist servicing companies.

“Not all of us are the best at everything: pick a specialist and take the assets that can really be used and get that borrower to perform again,” Sabbe said. “If you can reduce delinquency by 20% – say you have a 5% book and you go to a 4% book, that on a 10,000 loan, call it $2 billion – then you go $600,000 to $ Save 1 million.”