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Trouble Brewing in the Subprime Mortgage Market

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Last month, we reported that mortgage delinquencies charted their biggest quarterly rise ever. Digging more deeply into the numbers, we find even more trouble brewing in the subprime mortgage market.

Of the 8 million active mortgages the FHA insures, 17% were delinquent in July. That ranks as the highest level in history. That translates to about 1.4 million delinquent FHA loans.

It’s not just FHA loans going delinquent in the subprime market. Fannie Mae, Freddie Mac, the VA, and Ginnie Mae are also reporting a surge of delinquencies.

The overall delinquency rate for mortgages on one-to-four-unit residential properties spiked by nearly 4% in Q2, reaching 8.22% as of June 30, according to the Mortgage Bankers Association’s National Delinquency Survey. The jump in the delinquency rate was the biggest quarterly rise in the history of the survey.

The FHA is part of HUD. According to its website, it’s been helping people become homeowners since 1934 with “low down payments, low closing costs and easy credit qualifying.” The FHA does not make loans. It insures mortgages issued by FHA-approved lenders. FHA-backed loans require lower down payments and lower credit scores than conventional loans. In effect, the federal government assumes the risk of risky loans to low and moderate-income borrowers. The FHA serves as an important backstop in the subprime market.

A FICO credit score below 620 is considered subprime. The FHA makes loans to people with scores well below that number. A borrower with a FICO score of at least 580 can qualify for a loan with just 3.5% down. With a 10% down payment, a borrower can qualify with a credit score as low as 500.

An FHA delinquency rate of 17% is a significant warning sign in the subprime market. And in many metro areas, the delinquency rate exceeds 20%. Nassau County-Suffolk County, NY, and New York-Jersey City-White Plains, NY-NJ both have rates over 27%.

The delinquency rates include borrowers who were behind and then entered a forbearance agreement. During the term of forbearance – six months, under the CARES Act, extendable by another six months – the borrower doesn’t have to make payments, but must pay the missed interest and principal payments in the future. For many borrowers, forbearance simply kicks the can down the road and pushed the inevitable foreclosure into the future.

“The COVID-19 pandemic’s effects on some homeowners’ ability to make their mortgage payments could not be more apparent,” Mortgage Banker Association Vice President of Industry Analysis Marina Walsh said, adding that “delinquencies are likely to stay at elevated levels for the foreseeable future.”

The high subprime delinquency rate has not raised much concern because unlike during the 2008 crisis, home prices are rising. Thanks to the Federal Reserve, mortgage rates are at an all-time low and that has pumped up a new housing bubble even as many homeowners struggle to pay their mortgage. As Peter Schiff put it in a podcast, a weak economy is actually driving a strong housing market.

But as an article published at WolfStreet explains, there could be big trouble looming down the road.

When millions of homeowners cannot make the mortgage payments and have to put these millions of homes on the market – forced sellers – they trigger a sudden surge of supply of homes for sale, and the entire supply-and-demand equation, and thereby the pricing environment, are going to change.”

American Enterprise Institute’s Housing Center explained it this way.

It would be expected that these delinquency percentages will increase over time. At some point, a significant percentage of the then delinquent loans would be expected to be placed on the market by owners under distressed conditions or become foreclosures, and then enter the market. It is at that point we would expect buyer’s markets to develop in zip codes with heavy exposure to FHA and other high-risk lending combined with high levels of delinquency.”

In effect, the housing market has split in two, with a boom on one side and a bust forming on the other.

Even if we don’t eventually experience a major financial shock due to people’s inability to pay their mortgages, the high delinquency rates drive another stake through hopes of a quick economic recovery. Even if jobs quickly come back (and that seems unlikely given the number of temporary layoffs becoming permanent), it will take a long time for people to catch up on their past-due mortgage payments.

Meanwhile, businesses are shutting down and bankruptcies are at a 10-year highAmericans owe billions in back rent. There is a rising number of over-leveraged zombie companies. And a tsunami of defaults and bankruptcies are on the horizon.

In effect, we’re witnessing a permanent contraction in the US economy. That means that even if we deal with the coronavirus, the economy isn’t going to simply spring back to what it was before. And the ugly truth is it wasn’t that great before the pandemic. In fact, it was a big, fat ugly bubble. Now we’re watching the air slowly come out.

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