The foreclosure problem has been around longer than just the past decade, a new report shows. In fact, foreclosures have been on the rise nationwide over the last five decades.
The foreclosure trend has been an upward slope since 1960, according to a report by CoreLogic. As all practicing members of the real estate industry know, the general loss of incomes and falling home values during the Great Recession triggered the most recent spate of foreclosures. This jump in foreclosures has only just returned to pre-recession levels by the end of 2014.
But why have foreclosures risen over the past 50 years?
It’s directly related to increasing loan to value (LTV) ratios. When LTVs rise, the leverage homeowners have against default decreases.
A homeowner’s LTV is determined by two factors:
- the original down payment amount; and
- home values as they currently stand.
Homeowners can’t control the perpetual rise and fall of surrounding home values, which ultimately affect their LTV ratio. However, homebuyers certainly can control their down payment, analogous to their skin in the homeownership game. A significant down payment — 20% — gives homeowners a buffer for when home values decrease, as occurred during the Great Recession.
Without that significant down payment buffer, only a minimal decrease in home value may occur before the homeowner is plunged underwater – owing more on their mortgage than their home is presently worth. As CoreLogic shows, underwater homeowners in a negative equity position are more likely to default. These owners find themselves imprisoned by a black-hole asset, unable to sell their home through traditional means to cover the mortgage amount.
Editor’s note — Some underwater homeowners attempt a short sale, in which the mortgage holder agrees to sell the home for the current fair market value (FMV) of the property in full satisfaction of the debt. However, lenders were reluctant to allow short sales in the years immediately following the Great Recession. Short sales didn’t become a common foreclosure alternative (and a ubiquitous feature of the California resale market landscape) until around 2012, after the worst of the economic carnage.
This brings us back to the rising rate of foreclosure since the 1960s. Since then, LTV ratios have consistently sloped higher. For instance, the average LTV ratio on all homes owing money on a mortgage was:
- 25%-30% in 1960;
- 30%-35% in 1970;
- 30%-35% in 1980;
- 30%-35% in 1990;
- 40%-45% in 2000; and
- 60%-65% in 2010.
Not coincidentally, the personal savings rate has fallen to below 5% at the end of 2014 since peaking at over 12% in the 1970s. Potential homebuyers have been saving less and less, as smaller down payments have become the norm, facilitated by lax lending standards leading up to the boom. In fact, first tuesday Journal readers report fewer than one in four of their homebuyers have saved enough funds for the historically encouraged 20% down payment.
But are decreasing down payments entirely the fault of homebuyers? Not necessarily. Modern homebuyers simply don’t have to save as much anymore, as higher LTVs are encouraged and even subsidized by the government. Fannie Mae and Freddie Mac announced 3% down payments beginning in 2015, even lower than the 3.5% down payment required by the Federal Housing Administration (FHA). The government mechanisms encouraging homeownership are beginning to churn yet again.
The lesson: expect foreclosures to remain higher than necessary in the coming years, until higher down payments become standard once more. Specifically in the near term, foreclosure rates will be more volatile and rise whenever prices decline, as is expected in 2015.
