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Forborne mortgages have similar traits to those likely to default

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Mortgages in forbearance status have very similar characteristics to loans associated with higher default rates, a Freddie Mac study found. Both commonly feature low equity in the property and borrowers with low credit scores and high debt-to-income ratios.

Consumers faced with a loss of income during the periods studied — several months of 2017 and 2020 — turned to a forbearance program to avoid default or a forced sale of their property. The forbearance saved the borrower from a distressed home sale that could depress home values, which in turn leads to a loss of equity and the possibility of further mortgage defaults as neighboring properties move underwater on their loans, the GSE said.

The GSE undertook the study in order to prepare for what may come next in the upheaval created by pandemic, its head economist Sam Khater wrote in a press release on the report.

"Mortgage forbearance provides liquidity to households and plays a vital role in mitigating the damage to homeowners during times of crisis whether it be a hurricane, wild fire, or health epidemic," Khater wrote. "Research on this topic is important because it will help us prepare for the next several months as we continue to navigate the COVID-19 pandemic, and beyond."

The study found that the rate of mortgage borrowers requesting forbearance between March and June of this year was similar to that of the highly destructive 2017 hurricane season.

An examination of 30-year fixed-rate mortgages in Freddie Mac's portfolio found that the forbearance rate was 5.6% during the COVID-19 period and 5.8% during the 2017 storms.

Unlike the CARES Act-mandated forbearances of the pandemic, the 2017 loans were eligible for disaster-related assistance between August and December of that year, primarily as the result of Hurricanes Harvey, Irma and Maria.

As a control, the study included a baseline period established between January 2019 and February of this year, where the forbearance rate was a modest 0.09%.

While loans with LTVs of 60% or lower made up 52.4% of Freddie Mac's 30-year FRMs during the pandemic period, they were 43.4% of all loans in forbearance. But the bucket between 61% and 70% were 17.5% of the total portfolio but 19.4% of loans in forbearance.

The remaining nearly 30% of Freddie Mac's portfolio, including a scant 0.1% where the LTV was over 100%, made up over 37% of loans in forbearance.

For the 2017 period, a similar pattern exists, where the 61% to 70% LTV bucket has a higher share of loans in forbearance than their weight in the total portfolio, but the difference is not as vast. These loans made up 17.3% of Freddie Mac's portfolio at the time, but 17.8% of loans in forbearance.

The 2017 period also had a much higher share of loans where the LTV was over 100% than during the pandemic, at 1.9%, with a 5.6% share of the Freddie Mac 30-year FRMs in forbearance.

But only 3.73% of the loans with an LTV under 40% were in forbearance during the pandemic. For loans with an LTV between 81% and 90%, 7.4% were in forbearance and in the bucket of loans with LTV of 91% and 100%, the rate was 7.7%.

Compare that to the heavy storm season of 2017, when 3.09% of the under-40% LTV mortgages were in forbearance, but 9.63% of the 81% to 90% loans and 11.27% of the 91% to 100% loans were in forbearance.

When looking at the DTI, the forbearance rate during the pandemic for the under 25% bucket is 2.72%. But that grows to 4.24% for DTIs between 26% and 35%, 6.18% for the 36% to 40% bucket, 8.35% between 41% and 45%, before a slight drop to 8.26% for DTIs over 46%.

In comparing the loan sets by credit score bands, a lower percentage of loans under a 700 FICO score took a deferral in 2020 than in 2017, but a larger percentage over that point took one in 2020 than in 2017.

But it is all relative, as 11.13% of loans below 620 and 11.21% between 620 and 639 were in forbearance for COVID-19, compared with 4.06% for those between 760 and 779, 2.86% for those between 780 and 799, and 2% for those with a credit score over 800.

The report raises questions for future studies, asking why some borrowers who have entered forbearance continue to make their mortgage payments and why borrowers who qualify for forbearance sometimes choose to default.

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