The US Federal housing administration has recently placed a moratorium on foreclosures ranging from mortgage loan defaults. It has offered any borrower an extension of not making payments for up to wear for those who request it.
This is essentially going to increase the scope of commercial mortgage defaults in the coming year. What does this mean for the commercial mortgage market? How is it going to impact real estate? How big of an issue could this be? Why should you worry about it, and what markets will be the most impacted ones.
This blog will provide you a brief on large commercial mortgage defaults and how it might impact the commercial real estate market at large.
When it all began
Before the housing crash of 2008, the US Federal Housing Administration market share was around 4% to 7 % of the total mortgage market. As opposed to this today, the h a loan is around 21 % of the total commercial mortgage market. It was evident that the subprime mortgage market imploded in the year 2008 and 2009, and these borrowers are now financed by the FHA, which has led to this explosive growth.
In the light of the new eviction laws under the democratic governments, certain changes are expected in the commercial real estate market and commercial mortgage markets. The FHA financed are allowed to extend their period to pay back their loans and defer their loan payments.
FHA Loans are Riskier for Defaults
The fact that the FHA loan rates are around 0.5% to 0.75% higher than its conventional loan mortgage counterpart is already known. For instance, on a 400k house, this would add up to around 3K per year.
The question here is, why are borrowers still choosing to go ahead with FHA loans instead of traditional conventional mortgage loans?
The simple answer to this is official loans are much easier to qualify. They have a few lending requirements, with lower credit score requirements. Additionally, FHA loans allow for down payments that are as low as 3.5 % of the property value coupled with credit scores as low as 580.
A typical FHA loan would have a default rate over three times more likely than a conventional or a bank mortgage. The reason? This is because FHA loans are generally riskier than the traditional mortgage loans due to increased equity and lower credit and income requirements of the borrower in question.
To put it in simple words, an FHA loan is a subsidized subprime lender sponsored by the Federal government and the taxpayers. Further, it is worth noting that the FHA loans currently have the highest delinquency rate from the past four decades.
New Jersey has had the highest official relevancy rate, striking as high as 20%. It also had the most significant increase in the accumulated late payment rate jumping to as high as 11% in the second quarter from 5%. The states that follow New Jersey are Nevada, New York, Florida, and Hawaii – which are all, again, some of the states with a high proportion of leisure and hospitality jobs.
The covid-19 pandemic especially hard hit these jobs, and thus we can see the clear cause and effect relationship over here. According to the Mortgage Bankers Association, all states with a greater proportion of leisure and hospitality jobs were some of the worst-hit sectors.
What Loans are at the Utmost Risk?
It might be interesting to know what kind of loans are at the utmost risk in this context. According to the experts, the last two years of the Federal housing association voltages are at most at the risk of default.
Let us suppose that someone bought a house a year ago when the real estate across most of the country’s states had been about flat, typically depending on when an individual was their property. Further, if we assume that they put around a 3.5% down payment and do not pay for a year, it is evident that they will quickly be underwater. Thus, it is evident that the actual equity in the property would go down.
What does this translate for the residential market?
Based on the previous data, the official owns default is considerably much higher than the conventional mortgages. This leads to the next question of how big an issue this could be. If we assume that the last two years are at utmost risk due to the amount of negative equity present in the commercial mortgage market, the defaults will start adding up quickly.
Between the range of 200k to 500k loans that would likely go into foreclosure beginning from the month of March in 2021, it will essentially be around 45 to 100 billion dollars, depending on how worse the actual defaults turn out to be.
Based on the current mortgage default projections and the lack of equity that is seen in the last two years in most of these properties. We can expect this rate to be on the higher side, approximately around 500 thousand loans, and a hundred billion dollars in properties that might go into foreclosure and might have to be sold ultimately.
This leads to the next most important question: how well the current mortgage market will observe 500 thousand new distressed properties? To answer that, we can say that in places like Colorado and Denver, which have very low inventory and continued demand – this market cruncher will likely not hiccup too much.
However, on the other hand, in places like Detroit – this absorption will be much more difficult and might lead to substantial market declines, which might take years to recover. In a nutshell, regardless of the location, 100 billion dollars of foreclosure is a huge number, and it needs to be dealt with by the Federal government eventually.
However, shocking is that there are no government officials, regardless of their political inclinations, who have released a back of the napkin calculation for the problem that is going to come in March.
As far as real estate experts are concerned, they do not see any prospective solutions other than to try to kick the can down the road, cross fingers, and hope for the best. Thus, the year 2021 will be a reckoning for the US economy, and the commercial mortgage real estate industry in particular.
Eventually, the Piper needs to be paid, regardless of these delays or deferments in payments. How will the whole scenario payout is something we should wait and watch!